Hoisington Investment Management Company Quarterly Review and Outlook
Fourth Quarter 2004
By Van R. Hoisington and Lacy H. Hunt, Ph.D.
snips:
Our judgment is that long term yields will move irregularly lower during the year, and that the yield curve will continue to flatten with the 30 year bond moving closer to its historical average yield of only 10-20 basis points above the 10 year note. Therefore, the profit potential will again lie in the long end of the market. This view is importantly related to the inflation and economic growth trends in 2005.
DEBT PROBLEMS
Household debt levels imply that the financial condition of the typical American household is stretched. Household debt was a record 115.3% of disposable personal income in the third quarter, an all time high for the series. The financial condition is only slightly better when household debt is viewed in terms of assets or net worth. This is surprising since the value of homes has increased sharply in recent years, and stock values have somewhat recovered. In the third quarter, household debt was 18.1% and 21.3% of total assets and net worth, respectively, mere fractions below their all time peaks reached two years earlier (Chart 2)
OIL SHOCK
In the first two months of the fourth quarter, total consumer fuel expenditures jumped to 8.3% of wage and salary income, the highest energy burden since 1990 (Chart 3). Fuel expenditures now require an additional 2.1% of total wage and salary income from the lows in 2001. The current oil shock now stands as the third largest of the five events that have occurred since the early 1970s. Each of the preceding oil shocks were associated with recessions.
MODEST PROSPECTS FOR CAPITAL SPENDING AND HOUSING
new orders for non-defense capital goods actually peaked in July 2004, and moved irregularly lower, with the November level about 0.5% below the July peak. The tax expiration should result in a significant deceleration for the early part of this year.
The housing sector is 5% of real final sales to domestic purchasers. The problems in this sector include more restrictive monetary conditions, over investment, and loss of momentum in key leading indicators.
Housing assets could be considered over-owned as nearly 70% of the population now own their home (Chart 5). If consumers were to realign their housing assets relative to the more normal relationships vis-à-vis income, housing could soften, perhaps for an extended period.
Some of the best leading indicators of the housing sector suggest that the beginning of that realignment process may be near. Single family building permits, which are a component of the Leading Economic Index (LEI), averaged a 1.55 million annual rate in October and November, almost 1% below the quarterly peaks reached in the second and third quarters. Single family housing starts, which were in the LEI for many years, were at a 1.54 million annual rate in the last two months, 6% below the peak level reached in the fourth quarter of 2003.
EXPORT PROSPECTS: NOT WHAT THEY SEEM
Most forecasters expect U.S. exports to improve this year because of the two year decline in the dollar, but this view may be too optimistic.
The stagnant economies of our trading partners do not point to much, if any, improvement in U.S. exports. Indeed, two factors have pushed the global economy into a slump: (1) monetary conditions were tightened in many key economies in 2004 (the U.S., China, Canada, Australia, and Great Britain), and (2) rising oil prices have hurt many foreign economies heavily dependent on imported oil.
THE FED'S SUCCESSFUL WAR AGAINST INFLATION
when the Fed says that it wants low inflation, and that it is willing to further tighten monetary conditions, the record suggests that it should be taken at its word. Future tightenings by the Fed will dampen the already sluggish growth in the monetary aggregates, supporting our view that economic activity will soften in the year ahead. Thus, the macro economy will be characterized by too many goods chasing too little money, the condition that produces disinflation.
The rate of increase in M3 like that of M2 dropped to a nine year low in 2004, effectively isolating the higher oil and other commodity prices. The CPI should reverse sharply to the downside this year, and the multi-year low in the core inflation rate lies ahead.
REAL YIELDS STILL ELEVATED
in real terms, current long term rates remain attractive, particularly when coupled with the steep 10/30 yield curve. Accordingly, long-dated Treasury bonds should continue to be a safe and very rewarding investment.
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