David vs Goliath: The Small-Cap Setup for the Next 12 Months

Thoughts on the Market

The emerging shifts that began in November are becoming increasingly difficult to ignore. What used to be an extremely narrow market — obsessed with AI and liquidity — is now giving way to broader participation across sectors.

As evidence of this breadth emergence, investors’ focus is shifting, allowing this market to reach new all-time highs without relying on AI.

With more rate cuts likely and a solid earnings setup expected for 2026, we think this shift still has room to run and could be the trend that carries us into next year.

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Following last week’s dovish rate cut, Fed Funds Futures are pricing in two more cuts in 2026, with a 39% probability of even deeper easing. But with Powell stepping back in May, and Hassett likely to take over as Fed Chair, there’s still a lot that could shift.

For now, the Fed’s broader message remains encouraging: while rates may be approaching neutral, rate hikes aren’t anyone’s base case.

While the debate is basically down to “pause here” or “cut again,” the Fed’s job isn’t getting any easier — largely because of ongoing measurement challenges in key economic reports.

Since the government shutdown ended, some data have been all over the place, which is why this Thursday’s November CPI report deserves a healthy dose of skepticism. We’ll approached it with caution, as it’s unlikely to provide a “clean” reading.

Last week’s Jobless and Continuing Claims show the kind of noise we’re talking about. Initial Jobless Claims jumped the most since 2020 — right after hitting a 3-year low the week before. At the same time, Continuing Claims fell by over 100k, the biggest drop in four years.

Confusing, right?

So, which one is it?

As long as the data remains this noisy, we prefer to take a step back and focus on the bigger-picture indicators that have consistently signaled labor market recovery for some time.

Right now, our favorite is still the weekly ASA Staffing Index, which tracks shifts in temporary and contract work and often hints at where Nonfarm Payrolls and the broader economy may be headed.

What makes it stand out right now is its reliability: unlike other measures, this index wasn’t disrupted during the shutdown and has now posted 14 consecutive weeks of positive year-over-year growth.

Historically, these are classic early-cycle signs: businesses see more activity, so they add hours and temps before committing to costly full-time hires.

Beyond the Fed’s tilt toward easing financial conditions, the potential recovery we’ve been seeing in the jobs market for a while now should continue to act as a tailwind for the broader stock market.

Take a look at this next chart showing the S&P 500 on both a cap- and equal-weighted basis, along with the percentage of stocks hitting new highs.

We’re finally seeing the biggest wave of new highs since March. But if you look back over 2024, it really feels like the move is just getting started.

As we’ve been saying, leadership off the lows has looked exactly how you’d want it to. And the nice thing is that we’re seeing it on both a cap- and equal-weighted basis.

The next chart makes this really obvious: it shows how each sector has stacked up against the S&P 500 — once using cap-weights and once using equal-weights.