Like others, we can’t help but notice the massive outperformance of small caps in 2010, with the Russell 2000 doubling the performance of the S&P500. The Russell was up over 25 percent in 2010. Isn’t this only supposed to happen in the emerging markets?
If the Russell is a proxy for smaller businesses, which do the bulk of the hiring in the economy, and the index incorporates, at least, a modicum of information about the sector’s current and future fundamentals, could economists be underestimating the recovery in the labor market?
We looked at the Russell 2000 12-month moving average and U.S. nonfarm employment since 1988 in the below chart and was surprised to see how closely they both track each other, with the Russell leading by about one to twelve months. At the end of the day, projecting the future is, at best, an educated guess. How you arrive at your projection is what counts, in our book.
We once worked with a bond salesman, who was the classic “Monday morning quarterback,” always second guessing our trades. To make a point and to shut him up, we asked his 3-year old daughter at a weekend party at his house if we should buy or sell a certain bond. She said buy. We bought that Monday morning. The bond was up 2 points at the close. We sold. He got the point.
Sometimes, however, having no model is better or less dangerous than having the wrong model. Chairman Greenspan and Bernanke, and unfortunately, the country and world, learned that painful lesson the hard way.
We don’t pretend to have sophisticated 900 equation econometric models, but based on some anecdotal data of our friends working in the construction sector, who are seeing more work after lowering their prices and wages, coupled with our Russell/employment analysis, we’re taking the “over” and betting on a stronger jobs recovery this year.
The risk to our bet is the “depression economics” being practiced by the state and local governments, who are experiencing massive revenue deflation and where layoffs loom wide and large. Public sector unions are just too strong and their resistance to wage and benefit flexibility in order to save jobs is too great. Even Keynes, in his, General Theory of Employment, Interest, and Money, stated that the unemployment of the Great Depression was caused by “sticky” nominal wages that failed to adjust to declining prices.
We’re watching two state governors and betting on their meteoric rise as we believe they will be transformative in tackling their states fiscal woes. California’s new/old governor, Jerry Brown, and New Jersey Governor Chris Christie. A crisis and meltdown in the municipal bond market will be more of a political choice rather than an inevitability, in our opinion.
Governor Brown may just be the Nixon/China, Reagan/Soviet Union political metaphor, where he is the only one in the state with the credibility to negotiate the large and necessary public sector union concessions. Governor “Moonbeam”, as he was known in the 1970′s during his first run as governor, is just too old for us to bet as “Presidential timber,” however.
Governor Christie’s tough stance is bolstering his reputation throughout the nation as strong leader and it’s our conjecture he will be hailed as the “New Reagan” of the Republican Party by year-end. The “snow scandal” is noise and will melt away as soon as the state gets back to work. He is just starting to show up on the national radar.
Christie is way underestimated as a national candidate and is given only a 2.8 probability at Intrade of winning the 2012 Republican nomination. We’re big buyers. And that’s not a political statement.
Russell Doubling S&P 500 Return Signals Economy Will Drive 2011 Rally – Bloomberg
Brown serves up hot dogs, austerity for California – Reuters
New Jersey Gov. Chris Christie leads in 2012 GOP presidential poll – Des Moines Register