Economist Lacy Hunt thinks long-term Treasury bonds are a buy.
That’s definitely not the conventional wisdom. He’s nearly alone in his view, but it has been correct year after year. The conventional wisdom has been wrong.
Maybe its time more people listened to what he says.
Hunt, the chief economist at Hoisington Management in Austin, makes a strong case that his view will be right for quite a few years in the future. To demonstrate, he shows a graph from his trusted book of charts.
“Look,” he says, “go back to 1990 when (long) bonds were yielding 9 percent and inflation was 6 percent. You had a 3 percent real return. Now follow the line. Yields have fallen with inflation. Now bonds are around 3 percent and there is no inflation. So it’s the same 3 percent real return.”
Today, while everyone else has been anticipating that the Federal Reserve will start raising interest rates, he sees the downward trend going on. “Let’s say we go to 1 percent deflation over the next few years,” he said.
“Well, the long Treasury will go to 1.5 percent, but your real return will be 2.5 percent. That’s pretty attractive as a real return.”
Sadly, this is not an impossible fantasy. It is what life is like in Japan.
The latest reason interest rates will continue sinking is China. “The Chinese decision to go down the currency devaluation path confirms that monetary policy is not working,” Hunt said.
“Think about China. Back in the Lehman crisis Chinese debt was 70 to 80 percent of their GDP. Growth was slowing. So they resorted to the debt engine. Now, public and private debt is much higher, 300 to 320 percent of GDP. They had an explosion of debt.
“But a large body of research shows that when a nation’s total debt exceeds 250 percent of GDP, it has a negative effect on growth. So the Chinese have exhausted the (economic growth) potential of increases in debt. They now resort to ‘beggar thy neighbor’ policies to steal economic activity from their trading partners.
“This process is called ‘the race to the bottom’--- it’s much like what happened in the 1926-1940 period. Competitive devaluations.
“Unfortunately, it doesn’t work. It’s a perfect illustration of the Prisoner’s Dilemma. You don’t want to go there.”
When I asked him to explain, he said it was like the situation of two crooks being held by the police for questioning. If both keep silent, the police have to find proof that they committed the crime. But if one tries to get freedom (or less punishment) by ratting out the other, the other may respond in kind. When that happens, both lose and both may get harsher sentences than if they had remained silent.
Today, he noted, we are all prisoners. We are held captive by an over-indebted global economy. China may gain a temporary economic advantage by devaluing its currency, but it won’t last because other nations will do the same.
“When the US devalued in the 1930’s, Mussolini’s economics minister also devalued. He called the American move economic warfare,” Hunt said.
“The last time China had a major devaluation was in the 1990’s and that caused devaluation all over Asia, hit the Russian ruble and took down (the hedge fund) Long Term Capital Management. And that was when the global economy was more resilient.”
Dr. Hunt is quick to point out that what is happening isn’t about a single action by China. It’s about the unintended consequences of having too much debt, everywhere.
“You need someone to lead,” he said. “It’s a critical concept.” In fact, no country in the world is in a position to lead and put us on a path to growth.
When I asked Dr. Hunt if he was frustrated that his interpretation of economic data was at the far edge of public discussion of our economy, he nodded. Then he noted that he was a fiduciary, not a missionary. His job at Hoisington was to manage money, not change minds.
If you visit the Morningstar website and check the performance of their retail fund, Wasatch-Hoisington US Treasury (ticker: WHOSX, no-load, expense ratio 0.70 percent, minimum purchase $2,500) you’ll see that the fund has been in the top 1 percent of its category over the last 10- and 15-year periods.
That’s quite fiduciary.