Lacy Hunt: Expect lower interest rates
November 25, 2006

Lacy Hunt: Expect lower interest rates

AUSTIN, Texas -- Economist Lacy Hunt takes a measured view of things. That's what economists do, of course, except for the ones on television. But my regular pilgrimage to the offices of Hoisington Investment Management is a mission in grounding -- Hunt will have assembled one of the best economic chart books in the business.

We're talking about a good deal more than pretty pictures here.


Over the last 15 and 20 years the fixed-income institutional portfolios managed by Van Hoisington, Hunt and other team members have beaten the Lehman Aggregate Bond index by about 2 percentage points a year.

That's a long time to be making good calls.

It's also a margin of superiority that few can claim. Skeptics should consider the institutional shares of the fabled PIMCO Total Return fund, run by the equally fabled Bill Gross. Its annualized return over the last 15 years is only 88 basis points ahead of the Lehman Aggregate Bond index.

Listening here is good.

"The yield curve is inverted," Hunt says. Noting that short-term rates are higher than the yield on a 10-year Treasury, he points out that recessions nearly always follow. Add the decline in the leading economic indicators index and that makes it virtually certain we'll have a slowdown next year. Maybe a recession.

No, he isn't ready to declare that recession is inevitable. Oil prices have declined enough that we just might luck through. But the odds aren't good.

Another big factor is the decline in the growth of money. "We've had two years of contraction. The Fed has brought monetary growth down rather significantly," he says.

His biggest concern: housing. "It's only 6 percent of GDP," he points out. "But it has a disproportionate impact on employment and an enormously disproportionate impact on consumer spending."

It has been so in every economic cycle, Hunt explains, but it is more so this time because of the amount of money people have been borrowing out of their houses to support their spending. With both housing starts and housing prices turning down, we'll get a double whammy. The borrowing will end and, with it, so will the spending. Cash-out refinancing never amounted to more than $50 billion in a year before 2000, his charts show, but is running at more than $75 billion a quarter so far this year.

It will turn down.

Lots of people who were pouring concrete and nailing up Sheetrock last year will be looking for work. Since January 2002, Hunt points out, 1.3 million of the 5 million jobs created were related to housing. That's 26 percent of the total.

Needless to say, Hunt isn't alone in worrying about the home price bubble. To cite an extreme, economist Gary Schilling has gone on record expecting a 25 percent decline in housing prices. This would literally bankrupt millions of homeowners.

You'll be glad to know that Lacy Hunt isn't expecting anything that extreme.

What's worrisome is that other sources of economic strength don't look very promising to Hunt, either.

How about foreign consumer demand?

Not likely, he says.

How about business investment and capital spending?

Hunt, always the proper economist, doesn't say "fuhgeddaboutit" -- but he might as well have. "With GDP slowing, it's very hard to believe capital spending will continue."

The bigger picture -- the one beyond this economic cycle -- is more positive. Hunt believes we have entered a new period of global markets and productivity. Like the long period from 1871 to 1930 -- with major increases in agricultural, manufacturing and transportation productivity -- we may be in a long period of low to nonexistent inflation. Back then prices actually fell slightly every year. They averaged a 0.2 percent decline annually. Treasury yields averaged only 2.9 percent.

So interest rates may fall further still.

Could something happen to throw a monkey wrench into this picture of benign deflation?

"Yes," Hunt says. "We have to worry about the law of unintended consequences. If the new Congress raises the tax rates on investment income, it would put us in a bad position. We can't compete internationally on labor costs. So we've got to have strong capital investment. Raising the taxes on capital would take away our edge."

ON THE WEB Archive of Hoisington Management Quarterly Reviews   

Related Articles

This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.

AssetBuilder Inc. is an investment advisor registered with the Securities and Exchange Commission. Consider the investment objectives, risks, and expenses carefully before investing.