I look forward at the beginning of every quarter to receiving the Quarterly Outlook from Hoisington Investment Management. They have been prominent proponents of the view that deflation is the problem, stemming from a variety of factors, and write about their views in a very clear and concise manner. This quarter's letter is no exception, where they once again delve into the history books to bring up fresh and relevant lessons for today. This is a must read piece.
Hoisington Investment Management Company (www.hoisingtonmgt.com) is a registered investment advisor specializing in fixed income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $4-billion under management, composed of corporate and public funds, foundations, endowments, Taft-Hartley funds, and insurance companies. And now let's jump right in to the essay.
There is some debate about whether the recession is over. The National Bureau of Economic Research (NBER), a non-governmental organization made up of economists, has a committee that meets and decides after the fact when recessions begin and when they end. Martin Feldstein, the former president of the NBER, focusing on the job market, said last November that "the current downturn is likely to last much longer than previous downturns ... We will be lucky to see the recession end in 2009."
I have called this recovery a Statistical Recovery, in that some of the normal metrics are only getting better in comparison to very bad numbers a year ago. It is likely that we will still have not recovered to the level of economic activity we enjoyed at the peak of the last cycle over two years ago on a nominal basis. This is highly unusual and lengthy for a recession.
William Hester of the Hussman Funds (www.hussmanfunds.com) has written a very thorough analysis of what the NBER committee will be looking at to tell us whether the recession is over or not. Not surprisingly, the data is to as conclusive as one might like. Some of the tings which they look at seem to clearly suggest the recession is over, and was over last summer. Others are not so clear, which is why Feldstein is not ready to say the recession is over.
I think you will find this Hester's analysis interesting as this week's edition of Outside the Box. I especially liked the charts, as it gave me some insights into past recoveries. All the best, and have a great week!
This week I am in the office for just one day, but I can rely on my friend Dave Rosenberg to give us solid insight on the latest GDP numbers for this week's Outside the Box. Dave slices and dices to show us what really happened. David was the former Chief Economist at the former Merrill Lynch (ah, Mother Merrill, we barely knew ye.) and is now Chief Economist at Gluskin Sheff + Associates Inc., which is one of Canada's pre-eminent wealth management firms. Founded in 1984, they manage $4.4 billion. David notes that the data gives us a mixed picture.
I am in Maine later this week. It is likely I will be on CNBC, as they will be shooting live from our fishing camp. Also, they plan to do a one hour special with a number of interviews. I will let you know when it airs. A quick note from me: The third quarter is likely to be positive, especially given the success of the "Cash for Clunkers" program which it looks like our Congress is going to pass another round of spending which taxpayers (our kids) will get to pay off, or more likely pay $50 million per years for decades in interest. Sigh. Essentially, we are moving up car sales today which would have been made later, except that if you can get someone else to make your down payment, why not make that purchase today? A very reasonable response on the part of the consumer.
A teaser from Dave's work below: "Consumer spending came in at -1.2% annualized, twice the decline expected by the consensus. This occurred in the face of gargantuan fiscal stimulus and leaves wondering how this critical 70% chunk of the economy is going to perform as the cash-flow boost from Uncle Sam's generosity recedes in the second half of the year. Imagine, government transfers to the household sector exploded at a 33% annual rate, while tax payments imploded at a 33% annual rate and the best we can do is a -1.2% annualized decline in consumer spending in real terms and flat in nominal terms? What do we do for an encore? In the absence of the fiscal largesse, it is quite conceivable that consumer spending would have shrunk at a 10% annual rate last quarter!"
There is a reason I call this column Outside the Box. I try to get material that forces us to think outside our normal comfort zones and challenges our common assumptions. I have made the comment more than once that is it unusual for two major bubbles to burst and for the conversation to be all about rising inflation and not a serious problem with deflation.
As Niels Jensen pointed out last week, the most important question that an investor can ask is whether we are in for deflation or inflation. And this week we read a well reasoned piece on deflation. This is one of the more important essays I have sent out. You need to set aside some time to absorb this one.
Van Hoisington and Dr. Lacy Hunt give us a few thoughts on why they think it is deflation that will ultimately be the problem and not inflation we are dealing with today. This week's letter requires you to think, but it will be worth the effort.
And let me quote a few sentences in the middle of this letter about taxes which you need to think about.
"Thus Barro and Perotti are saying that each $1 increase in government spending reduces private spending by about $1, with no net benefit to GDP. All that is left is a higher level of government debt creating slower economic growth."
"The most extensive research on tax multipliers is found in a paper written at the University of California Berkeley entitled The Macroeconomic Effects of Tax Changes: Estimates Based on a new Measure of Fiscal Shocks, by Christina D. and David H. Romer (March 2007). (Christina Romer now chairs the president's Council of Economic Advisors). This study found that the tax multiplier is 3, meaning that each dollar rise in taxes will reduce private spending by $3."
Now, if you put all of the various inputs together, Hoisington and Hunt show that theory suggests we will soon be dealing with deflation. It's counter-intuitive to what we hear today, which is why the Bank for International Settlements used the stagflation word in a recent report. The transition that is coming will not be comfortable....