OCTOBER 18, 2011, 10:14 AM ET

Bond Uber-Bulls See New Recession Starting in 4Q

One of the best-performing money managers in America for the past 30 years or so is a small outfit in Texas that few people have probably heard of. Hoisington Investment Management in Austin, Texas, has just $4 billion in assets under management for big institutional clients and has an extremely simple investment style: It either buys long-dated Treasury bonds, or it doesnt. About 20 years ago, Hoisington flipped the sw itch to buy and has been buying and holding long bonds ever since w hich just happened to be the best investment strategy possible for the past couple of decades. Despite Treasury yields near their low s of the past several decades, Hoisington is still bullish on bonds. In their latest quarterly investment outlook, they explain w hy.
Julia Robinson for The Wall Street Journal

Van Hoisington, right, and Lacy Hunt, of Hoisington Inv estment Management.

Namely, they see GDP shrinking in the fourth quarter of this year and into 2012 a view thats w ay out of the economic consensus. But then, theyve been out of the consensus, successfully, for the past couple of decades. Their rationale:

Though partially caused by monetary and fiscal actions and excessive indebtedness, this contraction has been further aggravated by three current cyclical developments: a) declining productivity, b) elevated inventory investment, and c) contracting real wage income.
Businesses expected the economy to bounce back in 2010, Hoisington w rites. Instead, it struggled. That means businesses may have too many w orkers, hurting productivity, w hich w ill lead to layoffs. Meanw hile, businesses have built inventories too quickly, contributing to much of the economic grow th since 2009. The payback w ill slow dow n the economy. Finally, easy Fed policy has pumped too much money into the global economy, driving up commodity prices, w hich has hurt the disposable income of US consumers. Hoisington thinks these three factors, along w ith tighter fiscal policy and the unintended consequences of too-loose Fed policy, w ill lead to another recession or an extension of w hat might be an ongoing depression:

The appearance of a renewed slump only a short twenty-one months after the end of the last recession is highly remarkable. Harvard economic historian Niall Ferguson recently noted that the world is experiencing a slight depression. This sentiment has also been cogently expressed by Gluskin Sheffs astute economist, David Rosenberg, who notes that, Depressions are

basically long recessions lasting three to seven years. If our analysis of a new contraction in GDP is correct, the U.S. economy should be viewed as operating in the midst of a long-term slump, regardless of terminology.

This economic malaise is a direct result of the accumulation of excessive levels of debt and subsequent reduction in the price level of underlying assets. This is a process that U.S. economist Irving Fisher discussed in his 1933 paper The Debt-Deflation Theory of Great Depressions. According to Fisher and confirmed subsequently by Reinhart and Rogoff and the McKenzie Global Institute, a long period of time is required to unwind previous borrowing excesses.
And of course, if theyre right, then this all means good new s for Treasury bonds:

In view of the United States extreme over-indebtedness, we believe that 2% is a an attainable level for the long treasury bond yield. In the previous historic cases yields tended to remain close to their record lows for an extended period of time, coinciding with a long period of deleveraging. Presently the U.S. is in its fifth year of deleveraging, and patient investors in the long end of the treasury market have been financially rewarded. We continue to hold long positions in thirty-year treasury debt, but remain increasingly wary of the potential for further adverse meddling by Federal Reserve authorities.
There are parts of this analysis Im not sold on for example, do businesses really have that much payroll they can cut any more? And w hat about the influence of autos and housing, already at rock-bottom? It still seems hard to get to a second recession right now . But the idea of the economy being locked in a long deleveraging process is no doubt right, and could keep Treasurys looking good for quite a w hile.

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