Touring the Alamo, presenting on how retirees can succeed in a crisis economy, and picking the brain of one of the world’s top economists, Dr. Lacy Hunt, about the future of low interest rates were among the highlights of my recent trip to San Antonio for the Casey Research Summit. In addition to authoring two books and countless articles for leading financial publications, Dr. Hunt is executive vice president of Hoisington Investment Management Company, a firm that manages $5.4 billion.
Lacy is also a favorite speaker of mine because in addition to being a terrific economist capable of running rings around the likes of Alan Greenspan, he can relate the big economic picture to average investors. He rates very high on the common-sense scale — a good philosophical fit for the Miller’s Money team.
Now, let’s find out what Dr. Hunt sees on the horizon for interest rates.
Dennis Miller: Lacy, thank you for carving out time to talk. Many baby boomers and retirees have borne the brunt of the bank bailouts. Interest rates are far below their retirement projections, and they’re hoping the good old days of 6% CDs and the like will come back quickly. Lacy, this started eight years ago. What would you say to folks looking for high yield rates on top-quality, fixed-income investments to return to “normal?”
Lacy Hunt: My pleasure, Dennis.
Interest rates are unlikely to normalize for several years or even longer. The low interest rates are a reflection of the overleveraged condition of the US economy, which is severely constraining growth. Long-term high-quality yields such as 30-year Treasury bonds are likely to decline in yields over this period as inflation eases.
Dennis: When planning for retirement, many baby boomers anticipated 6% returns and inflation under 2%. Those were conservative estimates. If interest rates are going to remain low, which I too believe is the case, this will continue to force boomers to risk more money in the market or change their retirement lifestyle.
People looking for some sort of yield and income have flooded the market with money. What do you see in the market’s future over the next five years or so?
Lacy: This is a time for caution concerning the stock market. I would recommend highly conservative investors who cannot rebuild nest eggs with earnings from employment remain on the sidelines until the risk of another recession is resolved. The stock market gains are being fed by excess liquidity rather than an improvement in corporate earnings. Such imbalances have historically led to swift downdrafts in the price of risk assets.
One way to protect risk assets bought for yield in this environment is to balance them with a partial holding in long-term US Treasury bonds. T-bonds are negatively correlated. If risk assets continue to do well, then Treasury holdings will limit the upside gain; but in the event that risk assets falter, T-bonds will limit downside losses.
This is not the time to shoot for the roses. I realize a lot of retirees have to invest in the market for income during this cycle, but you need to be very careful.
Dennis: In your San Antonio presentation, you said something to the effect of “When ‘buy now and pay later’ is your philosophy, eventually ‘pay later’ overwhelms the system.”
Lacy, anyone who has high credit card debt, student loans, and/or an abundance of monthly payments eventually has to come to grips with that situation and change his ways. You pointed out that not just the United States government, but also the rest of the world has astronomical debts growing at an alarming rate. How do you see this unfolding, and what are the investment implications for baby boomers and retirees?
Lacy: Extreme over-indebtedness for economies results in a number of critical symptoms: poor economic growth in comparison to the historical norm; the business cycle operates but in a much more muted fashion; inflation falls to abnormally low levels, and in many instances, the result is deflation; due to poor growth, demographics deteriorate; and long-term Treasury bond yields, which are heavily influenced by inflation, fall to historically low levels and remain depressed until the over-indebtedness is corrected. Also, the low inflation environment persists for a long time.
All of the major economies are experiencing the effect of “pay later” overwhelming “buy now,” and these symptoms are all too evident in the global economy.
As I mentioned earlier, if you have to be in the market for income, you need to be very careful and have a good exit plan.
Dennis: One final question. I often hear from Miller’s Money subscribers who really feel caught in the middle. They want the safety of top-quality, fixed-income investments, but they need better yield in order to supplement their other retirement income.
What tips might you have for folks who find themselves in that position?
Lacy: We believe there are opportunities for excellent returns in long-term US Treasury coupon and zero-coupon bonds. We have our accounts with a 20-year duration, which is a very aggressive stance and a very uncommon strategy. The returns will be caused by appreciation in the value of these bonds in the difficult business environment ahead. However, this path will be very volatile, and investors will require patience.
Due to this volatility, investors should include holdings in long-term Treasury bonds as part of a diversified portfolio. If the bull run in stocks continues, the Treasury bonds will too, reducing the upside gains. However, in a bear market, holdings of Treasury bonds will limit the downside risk of the total portfolio.
I would caution everyone to work with a bond professional, though. When to buy and what types and amounts is not something the average stockbroker really understands.
Dennis: Lacy, as always, thank you so much for your time and insight.
Lacy: My pleasure, Dennis.
San Antonio’s biggest highlight was the chance to meet and shake hands with Miller’s Money Weekly and Miller’s Money Forever subscribers. For more expert interviews, timely financial commentary and need-to-know economic news, sign up for our free, weekly e-letter here. And follow us on Twitter @millersmoney.