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The recent macroeconomic logic of the mainline trade between China and the US: seemingly a breakthrough, but actually a continuation.

The high volatility in the US stock market is likely to continue, with the cash cow style becoming more resilient.

"Broad fiscal policy + loose monetary policy" helps the economy to warm up, prompting the trading style to further converge towards a pro-cyclical direction.

Over the past three years, the global "cash cows" based on the free cash flow ratio (FCFY) have continued to bloom (see "Global 'Cash Cows' Under the New Macro Paradigm"), especially since mid-July this year when the global stock market entered a high volatility period, the US "cash cow" index has risen against the trend, and the pro-cyclical sectors have also made a noticeable effort to take over the technology stocks.

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Last Wednesday, the Fed unexpectedly cut interest rates by 50bps, and on Friday, Fed Governor Waller released the possibility of a further 50bps cut in early November (depending on employment data), showing the Fed's determination to stabilize the economy in the election year.

Considering the factors supporting the resilience of the US demand side are still in place, and the continuity of the expansionary fiscal policy, the preemptive and front-loaded interest rate cuts have increased the risk of medium and long-term inflation and the rise in US Treasury rates, further strengthening our judgment of "high inflation, high interest rates, high volatility" under the new macro paradigm.

Higher macroeconomic volatility, combined with more expensive capital costs, often favors the cash cow style with stable profitability.

At the same time, we have observed that the terminal demand in the US continues to expand at a relatively high speed, and the front-loaded interest rate cuts help the economic cycle to warm up.

We judge that the restocking cycle continues, and the equipment investment cycle restarts after two years, with the pro-cyclical sectors driven by profits and globally priced resources being more resilient.

The marginal impact on A-shares may be relatively small, and the market is still dominated by domestic fundamentals.

The cash cow style that is both offensive and defensive remains unchanged and will further converge towards central state-owned enterprises.

Against the backdrop of the Fed's preemptive and front-loaded interest rate cuts, it has instead intensified the upward pressure on long-term US Treasury rates, making it difficult for the long-term interest rate spread between China and the US to narrow significantly.

Against the backdrop of the new macro paradigm of deglobalization and financialization, the Fed's preemptive interest rate cuts may not bring a large-scale return of foreign capital and a significant improvement in domestic market liquidity.

In the second half of the financial cycle, with weak internal momentum, the main contradiction in the market still lies in the earnings on the numerator side, so targets with resilient demand and the ability to generate stable cash flow will still enjoy a premium for certain cash flows.

On the margin, the domestic economic recovery is slow, and the market sentiment is cautious.

Central state-owned enterprises naturally have more stable demand, and with the help of state-owned enterprise reforms and growth, the cash cow style shows a trend of further convergence towards central state-owned enterprises.

In addition, it is recommended to continue to pay attention to the spillover and pull of the US pro-cyclical sector on A-shares, focusing on two main lines: 1) durable goods that reflect the resilience of household sector demand, such as hardware, plumbing, furniture, home furnishings, home appliances, etc.

; 2) computer electronic equipment, industrial equipment, chemical products, coal and petroleum products, etc., that reflect equipment investment and the manufacturing cycle.

The US: "Cash Cows" continue to bloom, pro-cyclical sectors start to exert strength, and US technology stocks pull back, with "cash cows" and pro-cyclical sectors outperforming.

Since July 11, 2024, US technology stocks have shown a clear pullback, with the Nasdaq index pulling back by 3.75% as of September 20, underperforming the S&P 500 index by 4.9%.

At the same time, in terms of style, the US cash cow index (COWZ) achieved a positive return of 6.6%.

In terms of industry, typical pro-cyclical sectors in the US stock market such as industrial/material/real estate/finance have achieved returns of 8.9%/6.1%/14.9%/8.5% respectively.

In "2024 H2: Asset Implications Under the Rebalance of Sino-US Economy", we pointed out that "cash cows" and pro-cyclical styles are more aggressive under the current policy background of the US fiscal policy exerting strength again and shallow interest rate cuts.

We have selected the 25 best targets with the best free cash flow ratio (FCF/EV) in the consumer discretionary, industrial, and material industries of the Russell 1000 [1] to form the "pro-cyclical cash cow" index [2].

Since 2024, the pro-cyclical cash cow has achieved a return of 17.1%, close to the Nasdaq's 19.5% return, and has performed brightly since mid-July when volatility was high.

Since June this year, we have always judged that the policy combination of broad fiscal policy + shallow interest rate cuts in the US will benefit the US pro-cyclical sector to take over technology stocks [3].

We believe that the underlying factors supporting the resilience of US demand are still in force (see "2024 Between Breaking and Establishing: Consensus and Variables in Overseas Markets"), and the Fed's interest rate cuts in September will reduce financing costs and thus promote a broader recovery of demand in the US, improving the profitability of pro-cyclical industries and benefiting the numerator side more.

First, terminal demand continues to expand at a relatively high speed.

The leverage ratio and debt burden of US residents are the lowest in the past forty years [4], and the US fiscal policy has significantly exerted strength in July and August [5], making the deficit rate of the 24 fiscal year as high as 7%.

At the same time, benefiting from the Fed's interest rate cut expectations, the interest rate of US consumer loans has decreased, and the recent increase in the growth rate of US wages has also pointed to a robust increase in terminal demand in the US.

The second quarter's durable goods consumption increased significantly from the total to each sub-item, and the retail data in July and August also expanded beyond expectations.

Driven by terminal demand, the growth rate of upstream and midstream orders and sales has shown an upward trend in recent months, such as manufacturing orders, sales of manufacturers and wholesalers, etc.

Second, the relaxation of financing conditions and the low inventory of the overall industry and most industries are optimistic about the continuation of the restocking and capital expenditure cycles.

With the Fed starting to cut interest rates, the banking industry continues to relax credit conditions, and the industrial equipment investment cycle is about to restart, which is expected to take over the construction of factory buildings and continue to drive the capital expenditure cycle upwards.

In summary, with the recovery of demand, the pro-cyclical industries dominated by profits are more resilient.

During periods of high market volatility, the advantages of the cash cow style are highlighted.

First, in the report "Global 'Cash Cows' Under the New Macro Paradigm", we pointed out that the essence of the cash cow style is strong blood-making ability and high profit quality, which is reflected in the stable cash flow premium during periods of high volatility.

Second, whether it is the tense US election or the historical relationship between the US 2s10s term spread and VIX, the US stock market is currently experiencing a period of high volatility.

Finally, compared with the S&P 500 index, the US cash cow index is over-weighted in pro-cyclical industries such as consumer discretionary, industrial, and materials.

From the perspective of market volatility and industry logic, we still believe that the cash cow style is still dominant, and we reiterate the offensiveness of "cash cow + pro-cyclical" under the current US "broad fiscal policy + shallow interest rate cuts".

With the Fed's interest rate cut cycle officially starting in September, the interest rate cut transaction that buys expectations may recede, liquidity (denominator) gives way to earnings (numerator), and the key to the US stock market is the expansion of earnings rather than the increase in valuation.

Under the background of the resilience of US demand, the Fed is likely to cut interest rates shallowly, and the possibility of the economy "soft landing" or even "not landing" is increasing.

We expect that inflation and long-term interest rates may return to the upward channel from the fourth quarter, which is beneficial to pro-cyclical and value styles.

First, shallow interest rate cuts may benefit the real economy more after the start of the interest rate cut cycle, thereby improving the earnings of US stocks.

It is manifested as the terminal demand represented by small businesses is once again boosted after the interest rate cut, and the economic cycle is expected to restart.

After the election, uncertainty fades, and with the support of resilient demand, pro-cyclical assets will gradually bloom; second, we expect that the ten-year US Treasury rate will fluctuate around 3.7%-4.1% before the interest rate cut, and after the interest rate cut, with the improvement of the economy and the inflation base effect, inflation may rise ("The probability of recession is low, but market volatility may continue"), and the ten-year US Treasury rate will also return to the trend of rising.

Moreover, we have observed that the US equipment investment cycle has recently shown signs of bottoming out and rebounding, supporting our judgment that the manufacturing, inventory, capital expenditure, and other real economy cycles will continue to rise ("The Asset Implications of the Restart of the US Equipment Investment Cycle").

Therefore, looking forward to the next two quarters, we believe that "cash cow + pro-cyclical" is still the dominant style.

Domestic: When "Cash Cows" meet central state-owned enterprises, they give birth to new market momentum.

Since May 2024, the dividend style index has shown a more obvious pullback, with the CSI Dividend pulling back by 16% as of September 20, underperforming the CSI 300 index by 5.5%.

At the same time, the central state-owned enterprise index, especially the central enterprise index, has shown strong resilience.

For the whole year, the central enterprise 100 still maintains a positive return of 3.3%, while the state-owned enterprise 200 and the CSI Dividend have a slight pullback of about 4%.

In "2024 Between Breaking and Establishing: Consensus and Variables in Overseas Markets", we pointed out that "cash cow + central state-owned enterprise" is both offensive and defensive in the current domestic financial cycle's second half.

We have selected the 50 best targets with the best free cash flow in central enterprises [6] to form the "central enterprise cash cow" index.

Since 2024, the central enterprise cash cow has achieved a return of 13.7%, which is significantly higher than the dividend index and the market, and the pullback situation since May is also better than the dividend and the market.

We believe that on the one hand, in the current context of the new and old momentum of the economy switching and insufficient domestic demand, targets with stable free cash flow have a higher certainty premium; on the other hand, central state-owned enterprises naturally have more stable demand, and with the help of state-owned enterprise reforms and growth, they enjoy additional reform and growth premiums.

Under the current cautious market sentiment, the cash cow style shows a trend of converging towards central state-owned enterprises, and the "cash cow + central state-owned enterprise" combination has more investment value.

In the second half of the financial cycle, the cash cow style is still dominant.

In the report "Global 'Cash Cows' Under the New Macro Paradigm", we pointed out that under the new macro paradigm, the world has started a new round of moving from virtual to real.

China's financialization is more reflected in the slowdown of endogenous money in the second half of the financial cycle, with weak endogenous demand.

Industries such as energy resources and public utilities, which rely on stable cash flow, are less impacted and show obvious counter-cyclical characteristics.

Industries that obtain stable cash flow through rigid demand will enjoy a higher certainty premium.In fact, the core factor behind the dividend style is a stable cash flow.

Typically, companies that have the ability and willingness to increase their dividend payout ratios often have stable free cash flow as a support.

Compared to traditional dividend indices, A-share cash cows have a higher industry exposure in sectors such as consumer goods (both discretionary and staple), and telecommunications services.

We reiterate our focus on the cash flow premium, and targets with stable cash flow characteristics not only include the defensive attributes of traditional dividend styles but also have offensive capabilities distinct from dividend indices.

The new macro paradigm will benefit assets that can generate stable cash flows in the long term, opening up room for valuation reassessment.

Against the backdrop of financial deleveraging and industrial upgrading, state-owned enterprises (SOEs) enjoy a "triple premium" of stable cash flow, reform dividends, and growth potential.

SOEs are more distributed in industries with stable cash flow, and the continuous release of reform dividends leads to a higher certainty of cash flow premium.

SOEs are more concentrated in industries such as energy, telecommunications, and public utilities, which have more resilient demand, overall stable cash flow, and ROE performance stronger than the market as a whole, supporting the stability of SOE profits.

In 2023, the State-owned Assets Supervision and Administration Commission (SASAC) proposed a "one profit and five rates" indicator system, shifting the focus of assessment towards capital efficiency and cash flow security.

In January 2024, SASAC stated at a press conference held by the State Council Information Office that "further research will be conducted to include market value management in the performance assessment of central enterprise leaders" [7], linking changes in market value to management effectiveness, and exploring a variety of market value management methods such as shareholding increase, buyback, and dividend distribution to enhance the returns for shareholders of listed SOEs.

In March 2024, the China Securities Regulatory Commission (CSRC) issued the "Opinions on Strengthening the Supervision of Listed Companies (Trial)", strengthening the supervision of cash dividends [8].

The industry characteristics and reform dividends make SOEs more likely to have stable profitability and free cash flow.

In the current context where growth is relatively scarce, SOEs have a cash flow premium.

SOEs are accelerating entry into emerging strategic industries, or may enjoy a growth valuation premium, further highlighting their medium and long-term investment value.

Since 2023, the State Council's SASAC has proposed a target of 35% of the revenue share from strategic emerging industries for central enterprises by 2025 [9].

Against the backdrop of moving from virtual to real economy, economic transformation, and industrial upgrading, SOEs will undertake more tasks of industrial upgrading in the future.

With more policy initiatives being implemented, SOEs' accelerated entry into strategic emerging industries means that in addition to the cash flow premium, they may also enjoy a growth valuation premium.

In the short to medium term, the premium on cash flow will support the rise of the valuation center of SOEs; in the long term, SOEs will benefit from the growth space brought by a new round of reforms and active policy responses.

With the "triple premium", the financial indicators of the central enterprise cash cow index are leading other enterprises and outperforming the market.

Based on the free cash flow ratio, we have selected the top 50 central enterprises to construct the central enterprise cash cow index.

This index enjoys the "triple premium" of stable cash flow, SOE reform, and industrial growth potential.

First, according to the selection principles, the free cash flow ratio of central enterprise cash cows is much higher than that of other state-owned enterprises and companies [10]; secondly, a better cash flow situation makes enterprises more willing and able to increase dividends; finally, stable cash flow means that enterprises have better profitability, especially since 2020, the ROE level of central enterprise cash cows has significantly improved and is higher than that of other enterprises.

With the "triple premium", since 2023, central enterprise cash cows have significantly outperformed the A-share cash cow index and the market, showing strong resilience in the current market environment.

In September, the Federal Reserve is likely to start a shallow interest rate cut cycle, and the improvement in liquidity may be limited, with the key to the A-share market still in domestic fundamentals.

On the one hand, the Fed's interest rate cuts may marginally improve the current trend of foreign capital outflows from the equity market, but the key to foreign capital inflows and the domestic market still lies in domestic fundamentals and policy orientation.

In the current context of slow economic recovery, the "cash cow + SOE" combination is both offensive and defensive, enjoying a higher certainty premium.

On the other hand, a "soft landing" or even a "no landing" of the US economy is beneficial to targets with higher foreign demand exposure or faster growth rates, among which cash cow industries such as consumer durables, telecommunications services, and energy resources have a higher proportion of overseas revenue.

It is recommended to continue to pay attention to the spillover and pull of the US cycle on A-shares, focusing on two main lines: 1) durable goods that reflect the resilience of household sector demand, such as hardware, furniture, home appliances, etc.

; 2) computer electronic equipment, industrial equipment, chemical products, coal and petroleum products, etc.

that reflect equipment investment and the manufacturing industry cycle.