Once again, bonds beckon to the risk-averse

The Dow Jones Industrial Average is down for the sixth month in a row, to a four-year low. Where, oh where, can an investor go?

To a mutual fund invested in long-term government bonds, suggests Lacy Hunt, an economist and fund manager with Hoisington Investment Management Co. in Austin, Texas. "Interest rates are going to go lower and remain down for several years. There's a lot of value in long Treasuries."

You might expect that assessment from Mr. Hunt, who helps manage $3.5 billion invested in bonds for institutional investors, such as pension funds, and also for well-to-do investors.

Many mutual-fund investors turn to bonds when the economy is troubled. In August, taxable and municipal bond funds had a total inflow of $17.4 billion, while funds invested in corporate stock saw an outflow of $2.9 billion. Investors are searching for a safe harbor.

"There is an awful lot of risk out there," says David Wyss, an economist with Standard & Poor's, the investment-advisory group. "Iraq is making everybody nervous. Cash looks pretty good right now."

Individuals who bought shares of the Wasatch-Hoisington US Treasury Bond Fund have been escaping the financial storm. Its shares were up 17.5 percent this year at the end of September, and 12.4 percent a year for the past three years. That makes the fund, with $70 million in assets and which is open to small investors, a top performer in its category. The fund gets a four-star rating from Morningstar, a mutual-fund research firm in Chicago.

Managers of bond funds often tend to have gloomy outlooks on the economy. Bad news is, in a way, good news for them, at least in the short run. When the economy is weak and interest rates are falling, bond prices rise. Inversely, if the economy takes off and interest rates rise, the price of outstanding bonds fall. That's because investors can buy newly issued bonds with higher interest rates, making old lower-interest bonds less valuable to them.

Hunt sees disinflation – prices going up a bit – already, but at a lower rate. Over the past four quarters the price index for the entire economy has risen merely 1 percent. And, Hunt maintains, there is a possibility of deflation – prices falling. That would make the price of old bonds rise further.

Corporate profits, he says, are "in bad shape." There's a glut of goods-producing capacity in the United States and abroad. So firms can't raise prices. Indeed, the price of goods has been falling.

Households and business are burdened by unprecedented levels of debt. Debt held by households or businesses other than banks and other nonfinancial firms is now equivalent to 160 percent of the nation's GDP, its total output of goods and services. In 1990, at the time of the previous recession, the comparable figure was 145 percent. High debt levels prompt financial institutions to be more cautious in making loans.

Already this year, a record $140 billion of corporate bonds have gone into default as more firms become bankrupt. Hunt figures mutual funds invested in corporate bonds, as opposed to Treasuries, face more risk.

Hunt predicts a "consumer recession" ahead. Since consumer spending has propped up the economy this year and last year, that would be bad news.

Though interest rates are way down from a year ago, Hunt still sees "a lot of value" in Treasury bonds with a maturity horizon of 20 years or so. The current yield of about 4.7 percent on long-term Treasuries remains above the 130-year average of 4.2 percent.

"We haven't bought into the notion that the economy is healing," he says, because the economy is still reeling from excessive capital spending in the 1990s.

Most economists expect GDP to grow at a real 3 percent or so in the year ahead. But Hunt likens today with the investment boom in the 1920s, which was followed by the Great Depression.

Stock-doubting investors have support from Robert Parks, a Wall Street economist who advises institutional investors. Stocks, he says, are headed lower, and corporate-earnings forecasts by Wall Street analysts remain too rosy.

S&P's Wyss has been telling pension-fund managers that 60 percent in US stocks is about right. Some of the remaining money could be put into bonds.