On January 7, 2025, China’s stock market experienced a slight recovery following an initial dropThe three major indices broke a consecutive four-day losing streak, with the small-cap stocks leading the chargeThe CSI 1000 Index, which tracks smaller companies, managed to stop its decline and ended the day with a 1.50% increaseHowever, the cumulative drop of 13.59% in the CSI 1000 Index since December 13, 2024, reflects a significant erosion of investor confidence, raising questions about the trajectory of small-cap stocks.

What has driven the continued downturn in small-cap stocks?

A primary factor contributing to the decline is that many small-cap stocks had previously seen substantial gainsAs a result, certain investors opted to realize their profits, choosing to secure their earnings by selling off sharesThe current market sentiments towards small-cap stocks are mixed, with concerns surrounding their performance compounded by new regulations surrounding delisting

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This uncertainty has led many investors to adopt a wait-and-see approach, further stifling confidence in these equitiesA critical observation is that there seems to be a marked shift in market styles, leading to a growing disconnect between the prices of small-cap stocks and their underlying valuations and fundamentals.

Historically speaking, the performance of small-cap stocks during year-end rallies has often been lacklusterResearch by Huafu Securities indicates that, during this time, lower-valued stock segments generally perform better than those valued at higher multiples, with high-quality stocks outperforming those that are loss-makingNotably, large-cap stocks often experience greater gains than their smaller counterparts during this periodHowever, it is essential to recognize that at the beginning of the year, the performance dynamics commonly reverse, with high price-to-earnings (P/E) ratios, loss-making stocks, and small-cap stocks frequently outperforming low P/E, high-quality, and large-cap stocks

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Therefore, the recent declines in small-cap stocks can be attributed not only to historical trends but also to their unstable fundamentals and external market pressures.

What are the characteristics of this transition in the A-share market at year-end and the beginning of the new year?

It is noteworthy that, since 2010, most major broad-based indices have exhibited robust performance at year-end and the start of the new yearFebruary has typically proven to be the best month for market performance throughout the yearFor instance, analyzing the Wind All A Index, which represents the overall performance of the A-share market, reveals that the median monthly return in November has been 2.1% since 2010, making it the second-highest in rankings across the year's monthsDuring December and the subsequent January, the A-share market generally demonstrates minor declines, while February increasingly becomes notable, with the median monthly increase reaching 2.8%, marking it as the standout month of the year.

From a market style perspective, the transition from one year to the next represents a crucial bifurcation in style

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After crossing into a new year, the probability of market gains increases significantlyTypically, from the Spring Festival to the Two Sessions of the National People's Congress, the market tends to favor small-cap stocks, where data indicates a remarkable 100% probability of rising for the Shenwan Small Cap Index during this period.

Have small-cap stocks precipitated into a “golden pit”?

Consequently, for the small-cap stocks that have been on a downward trajectory since mid-December 2024, despite their current “bumpy” road, there is potential for these declines to represent a “golden pit.” Following sufficient adjustments, it is anticipated that the upcoming spring market may provide favorable opportunities for investors looking to reposition themselves.

Recently, the A-share market has been volatile, witnessing significant losses on the last trading day of 2024 and the opening of 2025, with cumulative declines nearing 6%. This fluctuation across pivotal support levels, such as 3400 and 3300, indicates that while the market is not at historical lows, the recent selling pressures have emerged from prior gains and profit-taking activities

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This adjustment phase is typical and serves the dual purpose of allowing room for a true year-end rally.

Moreover, as we witness the shifting style of the market at year-end and the continued reassessment of small-cap stocks, the ongoing declines are not merely indicative of a typical correction but are setting the stage for a potentially robust market rally after the Lunar New YearWith the fundamentals gradually improving, proactive policy measures at play, and overall market liquidity remaining relatively high, the foundational elements for a positive mid-to-long-term market outlook remain intactOnce the risks associated with small-cap stocks have been adequately addressed, there stands a solid basis and vigorous impetus for another upward move.

The CSI 1000 ETF (159845), which tracks the CSI 1000 Index, serves as a representative for small-cap indices, with significant industry exposure in pharmaceuticals, electronics, power equipment, and computing