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Publication: Investor's Notebook
LACY HUNT EXPECT LOWER INTEREST RATES

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        Investor's Insight - November 28, 2006           
          "A Digest of Investment Opinion From the 
             World's Leading Financial Advisers"

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LACY HUNT: EXPECT LOWER INTEREST RATES
by Scott Burns

AUSTIN, Texas -- Economist Lacy Hunt takes a measured 
view of things. That's what economists do, of course, 
except for the ones on television. But my regular pil-
grimage to the offices of Hoisington Investment Manage-
ment is a mission in grounding -- Hunt will have assembl-
ed one of the best economic chart books in the business.

We're talking about a good deal more than pretty pictures 
here. 

Over the last 15 and 20 years the fixed-income institu-
tional portfolios managed by Van Hoisington, Hunt and 
other team members have beaten the Lehman Aggregate Bond 
index by about 2 percentage points a year. 

That's a long time to be making good calls.  

It's also a margin of superiority that few can claim. 
Skeptics should consider the institutional shares of the 
fabled PIMCO Total Return fund, run by the equally fabled 
Bill Gross. Its annualized return over the last 15 years 
is only 88 basis points ahead of the Lehman Aggregate Bond 
index.

Listening here is good. 

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"The yield curve is inverted," Hunt says. Noting that 
short-term rates are higher than the yield on a 10-year 
Treasury, he points out that recessions nearly always 
follow. Add the decline in the leading economic ind-
icators index and that makes it virtually certain we'll 
have a slowdown next year. Maybe a recession.

No, he isn't ready to declare that recession is in-
evitable. Oil prices have declined enough that we just 
might luck through. But the odds aren't good.

Another big factor is the decline in the growth of 
money. "We've had two years of contraction. The Fed 
has brought monetary growth down rather significantly," 
he says.

His biggest concern: housing. "It's only 6 percent of 
GDP," he points out. "But it has a disproportionate 
impact on employment and an enormously disproportionate 
impact on consumer spending."

It has been so in every economic cycle, Hunt explains, 
but it is more so this time because of the amount of 
money people have been borrowing out of their houses 
to support their spending. With both housing starts 
and housing prices turning down, we'll get a double 
whammy. The borrowing will end and, with it, so will 
the spending. Cash-out refinancing never amounted to 
more than $50 billion in a year before 2000, his charts 
show, but is running at more than $75 billion a quarter 
so far this year. 

It will turn down.

Lots of people who were pouring concrete and nailing 
up Sheetrock last year will be looking for work. Since 
January 2002, Hunt points out, 1.3 million of the 5 
million jobs created were related to housing. That's 
26 percent of the total.

Needless to say, Hunt isn't alone in worrying about 
the home price bubble. To cite an extreme, economist 
Gary Schilling has gone on record expecting a 25 per-
cent decline in housing prices. This would literally 
bankrupt millions of homeowners.

You'll be glad to know that Lacy Hunt isn't expecting 
anything that extreme.

What's worrisome is that other sources of economic 
strength don't look very promising to Hunt, either.

How about foreign consumer demand?

Not likely, he says. 

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How about business investment and capital spending?

Hunt, always the proper economist, doesn't say 
"fuhgeddaboutit" -- but he might as well have. "With 
GDP slowing, it's very hard to believe capital spending 
will continue."

The bigger picture -- the one beyond this economic cycle 
-- is more positive. Hunt believes we have entered a new 
period of global markets and productivity. Like the long 
period from 1871 to 1930 -- with major increases in 
agricultural, manufacturing and transportation product-
ivity -- we may be in a long period of low to nonexistent 
inflation. Back then prices actually fell slightly every 
year. They averaged a 0.2 percent decline annually. Treas-
ury yields averaged only 2.9 percent.

So interest rates may fall further still.

Could something happen to throw a monkey wrench into this 
picture of benign deflation?

"Yes," Hunt says. "We have to worry about the law of un-
intended consequences. If the new Congress raises the tax 
rates on investment income, it would put us in a bad pos-
ition. We can't compete internationally on labor costs. 
So we've got to have strong capital investment. Raising 
the taxes on capital would take away our edge."

You can discuss this issue or any other topic in the new 
Investor's Insight forum. Check it out here...

 
Investor's Insight Forum

(Investor's Insight reflects the opinions of experts. It does 
not recommend any specific investments, and no endorsement is 
implied or should be inferred. For more information, contact 
the individual firms cited).

COPYRIGHT 2006 UNIVERSAL PRESS SYNDICATE

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