This story appears in the June 15, 2014 issue of Forbes. Subscribe
From the inaptly named trading floor of Van Hoisington's investment company in Austin, there's a commanding view of the Texas Hill Country. It's a nice diversion, since not much trading takes place at $5 billion-in-assets Hoisington Investment Management.
Hoisington, 73, has kept his clients almost entirely in long-term bonds, specifically 25- to 30-year Treasurys, since the Bush Administration. The first one. For a quarter-century he's been the Henry Ford of bond investing, offering customers anything they want as long as it's long-term Treasurys, and in the process has earned enough to buy himself a couple of Austin mansions and a ranch outside the Texas capitol.
In the early summer of 2007, when FORBES last spoke with Hoisington, he was predicting a severe recession and urging investors to load up on long-term zero-coupon Treasurys. As the stock market fell more than 30%, his clients made a quick 15%. Later in 2008, when "the Fed started ramping up its balance sheet by a trillion dollars at a whack and everybody assumed inflation would go up," he got nervous about his position, he now admits. Nevertheless, he stayed the course, and by the end of 2011 his clients were up 66%.
True, last year Hoisington clients lost 16.7% after fees. But they're up almost 12% so far this year, bringing their three-year annual compound return to 10.5%, compared with 14.7% for the Standard & Poor's 500. And over 20 years they've done even better comparatively, with a compound return of 8.2%, only slightly less than the 9.5% for the S&P. Now Hoisington plans to keep clients in long bonds a while longer.
Inertia? Stubbornness? "We're not wedded to these long-term Treasurys," insists Lacy Hunt, 71, Hoisington's chief economist and executive vice president. "We're in them as long as the fundamentals merit,'' adds the Texas-born economist, who made his name at Philadelphia's Fidelity Bank in the 1970s by accurately predicting the rise of stagflation.
Indeed, Hoisington and Hunt back their maverick view with detailed monetary and economic analysis.
Most fixed-income managers these days worry that the Fed's $3 trillion quantitative-easing program is priming the pumps for rising inflation and interest rates--making the 30-year bond "return-free risk," in the words of perennial inflation hawk James Grant.
But that, Hoisington and Hunt say, overlooks the collapse in the "money multiplier."
For many years that multiplier hovered above eight, meaning if the Fed injected $1 billion into the banking system by purchasing bonds, it could expect an $8 billion-plus expansion in the money supply. Since the financial crisis the multiplier has collapsed below three and has yet to start recovering. Why not? Probably a combination of low interest rates, high capital requirements and tighter regulation. Nearly half the excess reserves are credited to foreign banks that may want a ready supply of dollars in the next crisis.
Whatever the cause, the collapsing money multiplier means the Fed's efforts have had "zero effect on the growth of the money supply, and people just can't believe it," Hoisington says.
Okay, not exactly zero. The money supply is growing at a 6% annual rate. But velocity--the speed with which those dollars are moving through the economy--has also been dropping, by 3% a year. The result, Hunt says, is 3% GDP growth and no prospect for more. Yet another factor in the Hoisington/Hunt analysis is the overhang of public and private debt, which, despite talk of deleveraging, remains at 350% of GDP in the U.S. and even more in places like the U.K., at 520%, and Japan, at 650%. "When the economy gets overindebted, economic growth tends to slow, and fiscal and monetary policies become impotent," says Hoisington, who managed investments for a bank's trust department before starting his own firm in 1980.
Even if the economy doesn't ignite, what about that stagflation risk Hunt knows so well from his Philadelphia days? Didn't Milton Friedman famously consider inflation an ever-present risk and a monetary phenomenon? Inflation, Hunt answers, also requires tight supplies of commodities and manufactured goods. "We have the ability to produce ten cars for a world that demands six," he says. "So if the demand for cars rises to seven, it's not going to increase prices."
Of course, Hoisington and Hunt would be fools not to keep a close eye on the money supply, which the Fed discloses every Thursday. "If it started taking off like a shot, we'd start to get worried," Hoisington says. "But if things change, a bond guy's got all the time in the world to get out of Dodge."
Really? Pimco's Bill Gross and others have been avoiding long bonds partly because they fall fast if rates rise. The duration, or measure of how much a bond will vary with a change in rates, rises with its maturity. Today's lower-interest bonds also have higher duration risk than higher-rate bonds in the past. If rates go up one percentage point, the price of a 30-year zero-coupon bond is expected to lose 30%.
Duration works both ways, though, and if long-term rates fall another 50 to 100 basis points, that translates into a 15% to 30% increase in the value of their bonds. Not bad for paper bearing a 100% guarantee from Uncle Sam .
Hoisington says his firm's research suggests the low point in interest rates won't come until 14 years after the crisis, or sometime in the next decade. And having lived through the 1970s, just as Gross did, the septuagenarian pair of Hoisington and Hunt can tick off the differences between then and now. Among them: In the 1970s money velocity was stable, not slowing.
So what would worry these bond bulls?
"If the world got cut in two," answers Hunt, a history buff who collects rare books and has visited every significant battlefield from the Civil War and American Revolution. If one half of the world stopped trading with the other, he says, as it did when the Soviet Union and China retreated behind their respective curtains, the economies of scale from global commodity and production markets would shrink and inflation might return, as it did in the postwar period until Paul Volcker snapped the cycle in 1980. With Vladimir Putin threatening Ukraine, that seems to be more of a risk now than it has been in decades. "But China's got to go along," Hoisington is quick to add.
