Hoisington Investment Management – Quarterly Review and Outlook, Third Quarter 2014

John Mauldin | Oct 22, 2014

I featured the thinking of Dr. Lacy Hunt on the velocity of money and its relationship to developed-world overindebtedness and the potential for deflation in this week’s Thoughts from the Frontline,and I thought you’d like to peruse Lacy’s entire recent piece on the subject.

Lacy takes the US, Europe, and Japan one by one, examining the velocity of money (V) in each economy and bolstering the principle, first proposed by Irving Fisher in 1933, that V is critically influenced by the productivity of debt. Then, turning to the equation of exchange (M*V=Nominal GDP, where M is money supply), he demonstrates that we shouldn’t be the least bit surprised by sluggish global growth and had better be on the lookout for global deflation.

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 $5 billion under management and is the sub-adviser of the Wasatch-Hoisington US Treasury Fund (WHOSX).

I am writing this note in a car going to Athens, Texas, where I’ll join Kyle Bass and friends at his Barefoot Ranch for a huge macro fest. October is one of my favorite times of the year to be in Texas, and the ranch is a beautiful venue. I am sure I will have some challenging conversations.

Last night in Chicago I was picked up by Austyn Crites, who drove me downtown in rush-hour traffic, which gave us a lot of time to talk about his current passion, high balloons. I have been fascinated with them for some time, but there hasn’t been a lot of reliable information.

Basically, Google and Facebook are both planning to launch very large helium balloons full of radios and cameras and float them up to 60,000+ feet. The concept is working in several remote locations now. It’s a way to get full wireless internet coverage. With about 40,000 balloons you can blanket the earth. Literally. Full connectivity. Everywhere. Austyn wants to design a new type of balloon and be the manufacturer. It’s tricky as you need a VERY thin balloon envelope (that does not leak) the size of small house in order to get enough payload that high.

But he thinks the final cost of the balloons will fall dramatically and that you might be able eventually to pull off the operation for a billion or so a year (since balloons eventually come down and need to be replaced).

But if you are Google and you get the search revenue from connecting an additional five billion people? Chump change. Same for Facebook. But what if Apple or Samsung want to make it so that their phones are afforded free or very cheap access? A consortium of consumer companies could easily see free wifi as a tool for branding. Current telecoms will have to get in the business to compete.

The U.S. economy continues to lose momentum despite the Federal Reserve’s use of conventional techniques and numerous experimental measures to spur growth. In the first half of the year, real GDP grew at only a 1.2% annual rate while real per capita GDP increased by a minimal 0.3% annual rate. Such increases are insufficient to raise the standard of living, which, as measured by real median household income, stands at the same level as it did seventeen years ago (Chart 1).

 

I kept coming back to the costs and tech issues. There are new things that will have to be invented, but nothing as complex as some of the problems that have already been overcome. They will be rolling out in parts of the world in a few years. Coming to a region near you in 5-10 years. Total game changers. While a hundred other game changers are coming down the tunnel.

Austyn’s company’s challenge is to be the little guys who don’t know they can’t invent a new process that the big guys are working on as well. Can he pull it off? He has the passion and drive. I love meeting young people like him doing their part to change the world. They are everywhere, too. It’s why I’m optimistic about the future of the human experiment, if just a tad bearish on governments. You can follow Austyn at his website.

Time to hit the send button, as we are getting close and I don’t want to miss a minute. I will report back what I can. Have a great week.

Your dreaming of really, really cheap, ubiquitous connectivity everywhere analyst,


John Mauldin, Editor
Outside the Box
[email protected]

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Hoisington Investment Management – Quarterly Review and Outlook, Third Quarter 2014

Faltering Momentum

The U.S. economy continues to lose momentum despite the Federal Reserve’s use of conventional techniques and numerous experimental measures to spur growth. In the first half of the year, real GDP grew at only a 1.2% annual rate while real per capita GDP increased by a minimal 0.3% annual rate. Such increases are insufficient to raise the standard of living, which, as measured by real median household income, stands at the same level as it did seventeen years ago (Chart 1).

CHARTunnamed

Over the latest five years ending June 30, 2014, real GDP expanded at a paltry 2.2% annual rate. In comparison, from 1791 through 1999, the growth in real GDP was 3.9% per annum. Similarly, real per capita GDP recorded a dismal 1.4% annual growth rate over the past five years, 26% less than the long-term growth rate. A large contributor to this remarkable downshift in economic growth was that in 1999 the combined public and private debt reached a critical range of 250%-275% of GDP. Econometric studies have shown that a country’s growth rate will lose about 25% of its “normal experience growth rate” when this occurs. Further, as debt relative to GDP moves above critical threshold levels, some researchers have found the negative consequences of debt on economic activity actually worsens at a greater rate, thus becoming non-linear. The post-1999 record is consistent with these findings as the U.S. debt-to-GDP levels swelled to a peak as high as 360%, w ell above the critical level noted in various economic studies.

In terms of growth, it looks as if the second half of 2014 will continue to follow this slow growth pattern. Although all of the data has not yet been reported, it appears that the year-over-year growth in real GDP for the just ended third quarter period is unlikely to exceed the 2.2% pace of the past five years. Economic vigor is absent, and the final quarter of the year looks to be weaker than the third quarter.

Poor domestic business conditions in the U.S. are echoed in Europe and Japan. The issue for Europe is whether the economy triple dips into recession or manages to merely stagnate. For Japan, the question is the degree of the erosion in economic activity. This is

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