Two Years into Another Small Cap Golden Era

02/09/12 -

Stimulative Financial Conditions & Improving Monetary Velocity Will Drive Earnings, Stocks (& Inflation) Higher as they did then.

• Small-caps are in the early years of a multi-year bull market, complete with exceptional nominal and relative returns as the equity market and US economy recovers from the Great Recession. 
• An analogous period to the current bull market is 1975 to 1982 when small-caps posted exceptionally strong returns driven by highly stimulative financial conditions, rising monetary velocity from low levels, rising inflation, robust M&A and investors increasing risk appetites following the ’73-’74 bear market. 
• Americans felt extremely discouraged during the ’75-’82 period due to Watergate, the Carter Presidency and Japan’s ascendency.  Substitute China for Japan, Obama for Carter, today’s Washington gridlock and antagonism for Watergate and Europe for stagflation and the eras similarities are clear. We stress – the ’75 – ’82 blues did not prevent superior small-cap returns.  In fact, policy makers response to the era’s difficulties created the strong small-cap returns much as we believe current policy makers actions are creating the current small-cap bull market.
• ’75 – ’82 1-year nominal small-cap returns:  61%, 51%, 17%, 17%, 46%, 33%, 3%, and 29%.
• ’75 – ’82 1-year relative small-cap returns ( vs. S&P 500):  17%, 22%, 26%, 9%, 23%, 1%, 8%, and 7%.
• Monetary velocity is low and still slowing, retarding rising returns ascent.  As confidence returns and inflation’s positive effects on earnings and asset values becomes clearer, monetary velocity will rise and return will accelerate.