Daring bond bulls are betting on slow growth, decline in inflation

October 23, 2005|By JAY HANCOCK

I don't know if Gary Shilling and Lacy Hunt skydive or wrestle alligators, but they don't need to. They own long-term bonds, which to most people these days seems just as daring.

Shilling, Hunt and a few other fanatics are the last of the bond bulls - those who believe that inflation is still dead, that a 25-year trend of lower interest rates is not over and that a 30-year Treasury bond paying 4.6 percent is a terrific deal.

Bond bulls are often viewed as slightly nutty, but rarely is the perceived loony-tunes factor greater than now.

A bond's No. 1 enemy is inflation, because rising inflation erodes the worth of a bond paying a fixed interest rate. (Why lend at 4 percent if 5 percent inflation erases your return?) At the moment inflation seems to be making the biggest comeback since the Astros signed Roger Clemens.

The government reported last week that the consumer price index rose 1.2 percent in September. That was the highest monthly rate in 25 years. If sustained it would deliver a compound annual inflation rate of 15 percent.

Yes, much of the pop came from shortages and price squeezes caused by Hurricane Katrina, especially in energy.

But inflation shows alarming signs of perking up over the longer term, too. It rose at a 6 percent annual rate in July and August - before Katrina - and looks like it'll breach 4 percent for the year for the first time since 1991. Even if crude oil prices fall back to $50 a barrel from the $70 neighborhood of late August, that's still higher by half than they were in early 2004.

Shilling is a New Jersey economist and consultant. Hunt, quoted often in this space, is chief economist for Hoisington Investment Management in Texas. Shilling and Hunt's boss, Van Hoisington, were bullish on bonds as recently as July, when their freakish opinions attracted the interest of Barron's, the investment weekly.

But surely the latest inflation data has scared them into their senses. Everybody else is chickening out. Since June investors bid up the yield on the 30-year Treasury bond to 4.6 percent from 4.2 percent as inflation flared and the Federal Reserve raised short-term interest rates, which often bumps long rates higher, too.

Does Gary Shilling still like bonds? "I have for 25 years. How can I give up now? Is the Pope Catholic?"

Hunt is equally steadfast. The recent increase in long-term rates has hurt bond prices and prompted a 6 percent decline since August in his Wasatch-Hoisington U.S. Treasury Fund, which is stuffed with long-term government paper.

But Hunt, an economic history expert who notes that long-term Treasury yields have averaged 4.2 percent since 1871, says, "I think we're going to go below the long-term average by a considerable magnitude over the next several years."

What do they see that nobody else does? More of what this century has already brought us, essentially.

More economic weakness. More mediocre job growth. More poor income growth. More pressure from global competition. More technology investment allowing higher volumes of products to be sold with fewer workers.

And more pressure from Alan Greenspan and the Federal Reserve, who seem determined to send the economy into recession by raising short-term rates and slowing money-supply growth.

That's not a recipe for higher inflation and higher interest rates, which are typically bred by overheated economies, out of control money supplies and a shortage of goods.

The world's problem today is too many goods and too little money. Central and East Asia are investing billions in factories and materials assuming the U.S. consumer will keep buying their products. Even now the consumer is hard pressed to keep up. A Greenspan-induced recession would tip the balance, possibly causing another Asian capacity glut such as the one in 1998 and another bout of lower inflation, not higher.

"A year from now, I think we'll be in a recession," says Shilling. "And I would think the yield on the long [30-year] bond - we're now at 4.6 - would be south of 4."


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