Making money like crazy is fun for the pessimist, too

April 16, 2003|By JAY HANCOCK

THE WAR is over, corporate earnings seem to be recovering, and retail sales and consumer confidence both rose last month.

Feeling better about the economy? Meet Lacy H. Hunt, who will squash that blithe optimism quicker than you can say Herbert Hoover.

A top executive at bond boutique Hoisington Investment Management in Austin, Texas, Hunt is the scariest kind of economist: a pessimist with a track record. By betting on a slowdown worse than most analysts and money managers predicted, Hoisington has already booked big profits for its investors. And its bet hasn't changed.

"We expect a bounce" in the economy after the war, but nothing permanent, Hunt says. "The typical postwar recovery will continue to be absent due to some deep-seated problems in the U.S. economy that have taken years to develop."

Whereas analysts such as Barton Biggs of Morgan Stanley believe that stocks could rise by a third or more and the U.S. economy could spurt back to 1990s speeds for a couple quarters, Hunt expects things to drag for several more years.

So gloomy about the country's prospects are the Hoisington seers that they have placed 70 percent of the firm's $3.3 billion in investment assets - including much of their own money - into 30-year Treasury bonds, which would get creamed in any turnaround.

The rest of the money is in zero-coupon Treasuries. Zeroes, which provide no income until they mature, would not just get creamed in a strong recovery. They would get annihilated.

Owning Treasury zeroes today, some economists believe, isn't very different from owning Amazon.com stock in December 1999. But while these analysts spy a bottom to the economic slope that began in early 2001, Hunt sees a minor outcrop, a ledge, perhaps, and then plenty more downhill, which would be great for zeroes and great for Hoisington's investors.

I interviewed Hunt in October 1997, shortly after the start of the Asian economic crisis, and even then he was warning about over-investment and deflation as risks to the world economy. He was the first economist I knew to talk about deflation, which had previously gathered dust as a history-book curio, as a living, malevolent force.

"You don't want the Federal Reserve to be so late to the game that when they take action to fight deflation, it's of no value," he said at the time. Since then, of course, deflation has taken root in Japan and threatens the United States.

Even in 1997, Hoisington was betting on lower growth, lower inflation and lower interest rates. The firm didn't need outright deflation - widespread and persistent falling prices - to make a lot of money. It did need an outcome that most analysts believed was extremely unlikely and hadn't happened in decades: an expansion that died before kicking up inflation.

That's what happened. The economy eventually imploded in an inflationless funk.

Meanwhile, Hoisington's investors have enjoyed after-fee gains of 22.9 percent for the 12 months ended March 31 and earned an average return of 10.5 percent for the last three years. In the same period, the Lehman aggregate bond index rose by an average of 9.8 percent annually, and Standard & Poor's index of 500 large-cap stocks fell an average of 16.2 percent annually.

Safe, long-term bonds become more valuable when the economy slows and rates fall because they pay interest at higher-than prevailing amounts. Bonds get no safer than Treasuries, and they don't often get longer than 30 years. Thus, Hoisington's success. The firm invests only in Treasuries, in any economic climate, so it has been helped by its category. But within that box it has played the long end of the yield curve like Yo-Yo Ma, and that's where its money remains.

Hunt paints similarities between the present slump, which followed over-investment in the Internet, and the depression of the 1870s, which came after over-investment in railroads, and the Great Depression of the 1930s, which trailed over-investment in the radio and car businesses.

These comparisons have become commonplace, but Hunt has been making them for years. He expects no sustained rebound because factories have too much extra capacity, consumers are indebted and hurt by stock losses and businesses are indebted and can't raise prices. He believes that yields on long-dated Treasury bonds could fall to 3.5 percent from their present level of near 5 percent, which would produce huge gains. Is he bonkers?

"Everybody said we were crazy" five years ago, Hunt says. "We're still considered generally to be crazy, just not as crazy."

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