Wall Street may have staged a spectacular rally overnight, but the outlook for the US economy next year is bleak, according to a leading US bond investor, Van Hoisington.
In an interview with Barron’s, Hoisington, who heads up the $US5.7 billion specialist bond fund, Hoisington Investment Management, argues that the US is set to fall back into recession next year, and that long-term US interest rates will tumble even lower.
"In the US, we have $15 trillion in gross domestic product, and we have $52 trillion in debt, which is 350 per cent of GDP. Since 1998, we went from 250 per cent to 350 per cent and the debt was for mainly non-productive investments. The prices of those investments – houses, commercial real estate, even stocks – have been falling since '08. Actually, stock prices are down since 2000. So we are in a circumstance of over-indebtedness.”
He notes that when debt-to-GDP ratios climb too high, economic growth is hobbled. "That is exactly what is happening. Through the third quarter, year-over-year growth rates are about 1.5 per cent. In the last 40 years, every time you have had a 1.5 per cent growth rate – they call it ‘the stall speed’ – you have slipped into recession because the economy is too weak to sustain any shocks. Unfortunately, we have had some shocks.”
At present, he says, the US government is spending about $US3.6 trillion each year: its revenues are $2.3 trillion and it borrows an extra $1.3 trillion. But this pattern cannot continue indefinitely. Studies show that once a country’s government debt reaches 100 per cent of GDP, its growth rate slows by at least 1 per cent. "Since we are only growing at 1.5 per cent, that takes you down to 0.5 per cent. Plus or minus 0.5 per cent is recessionary conditions.”
At the same time, he says US consumers are in trouble. "Real disposable income is down over the last 12 months, and because people have tried to maintain their spending, the savings rate has fallen to about 3.5 per cent. You have very little savings going into next year, falling disposable income, and no stimulus scheduled.” On the other hand, he says, about 35 states raised taxes last year, and are expected to do so again. "So the effective tax rate on consumers, if you take state, local, and federal taxes, is up $260 billion over the last two years. It's very difficult for us to see how consumer spending can sustain itself or get a lift.”
Business spending is also likely to slump when the special tax concession allowing 100 per cent accelerated depreciation on capital equipment expires at the beginning of January. "In the past, when accelerated depreciation charges were taken off, new manufacturing orders fell rather dramatically,” he notes.
What’s more, global economic growth is faltering. "We have the unfortunate circumstance that basically 60 per cent of the world is in recession: Europe, Japan. China is looking recessionary, because for them, a 7 per cent growth rate is not that good. Brazil recently reported a flat-to-slightly down quarter. And Korea has slowed to the slowest growth rate in three or four years.
"No matter where you look, there is a global recession starting. That means our exports and consumption aren't there. There won't be any increase in government spending. So we don't see how in the world you don't have a recession.”
Hoisington predicts that the real growth in the US economy will be between 0.5 per cent to 1 per cent next year, with the core growth rate falling close to zero by mid-year. At the same time, downward pressure on prices will push US long-term interest rates even lower. Next year, he says, yields on 30-year bonds could trade down close to the 2 per cent level (compared with around 3 per cent at present), while 10-year bond yields could trade between 1.25 per cent and 1.5 per cent (compared with around 2 per cent at present).
Hoisington believes that there’s about a 50-50 chance that the US central bank will launch a third massive bond-buying program, known as quantitative easing or QE. But, he argues, QE2 was actually responsible for the US slowdown because it pushed up commodity prices and long-term interest rates (including mortgage rates) and lowered real income. "If they happen to do another quantitative easing, all they will do will help the top 10 per cent by raising stock prices, but kill everybody else, like they did last time.”