The views expressed in this commentary are those of Hoisington Investment Management Company, the sub-advisor to the Fund, and may differ from the views of Wasatch Advisors.
The continued slowing in economic growth coupled with minimal inflation led to a continuation of the decline in long-term interest rates and last year’s bond-market rally into the first quarter of 2015. Accentuating the move to lower interest rates was the decline in inflation. The subdued inflation environment was supported by commodity prices extending their decline. Further, dollar strength, which causes the lowering of import prices, was an important factor in the favorable bond-market environment. On March 31, 2015, 30-year Treasury bond yields closed at 2.54%, down from 2.75% on December 31, 2014, 3.20% on September 30, 2014 and 3.56% on March 31, 2014.
Details of the Quarter
For the quarter, six-month and 12-month periods ended March 31, 2015, the Wasatch-Hoisington U.S. Treasury Fund gained 5.16%, 16.95% and 27.92%, respectively. These returns far outpaced the gains in the benchmark Barclays Capital U.S. Aggregate Bond Index, which were 1.61%, 3.43% and 5.72%, respectively.
For the three-, five- and 10-year periods ended March 31, 2015, the Fund returned 9.07%, 13.14% and 8.96%, respectively, versus 3.10%, 4.41% and 4.93%, respectively, for the Index. Thus in all major time spans, the Fund provided considerably larger returns than the benchmark.
Outlook for the Year
It appears that U.S. economic growth was weaker in the first calendar quarter of 2015 than in the final calendar quarter of 2014, which showed a nominal growth rate of only 2.2%.
Nominal gross domestic product (GDP)† is the most reliable of all the economic indicators since, as the sum of cash-register receipts, it constitutes the top-line revenues of the economy. From this stream of receipts everything must be paid, including wages, dividends, light bills, etc. Unfortunately the growth rate of this broad economic indicator has been slowing. The change over the four quarters ended December 31, 2014 was only 3.7%, which is barely above the average entry point for all recessions since 1948. On only two occasions over the unprecedentedly weak expansion since 2009 has growth reached 4.7%, but in both cases the growth rate quickly fell back below 4.4%, which happens to be the U.S. economy’s growth rate when the recession began in 2008.
Nominal GDP can be divided into two parts. The first is the implicit price deflator, which measures price changes in the economy, and the second is the change in the volume of goods, which is termed real GDP. Both of these components are volatile, but recent experience is that they have both failed to reflect any stronger momentum in economic activity. In the past 15 years, real per-capita GDP (nominal GDP divided by the price deflator and population) grew a paltry 1% per annum. This subdued growth rate should be compared to the average expansion of 2.5%, which has been recorded since 1940. The reason for this sharply slower expansion over the past decade and a half has to do with the accumulation of too much debt. Numerous studies indicate that when total indebtedness in the economy reaches certain critical levels, there is a deleterious impact on real per-capita growth. Those important over-indebtedness levels were crossed in the late 1990s, which is the root cause for the underperformance of the economy in this latest expansion.
It is interesting to note that in this period of slower growth and lower inflation, long-term Treasury bond yields did have periods of rising interest rates as inflationary psychology shifted. However, the slow growth meant that the economy was too weak to withstand higher interest rates, and the result was a shift to lower rate levels as the economy slowed.
Our expectation for economic growth in 2015 is for further slowing in the growth rate over the course of the year. Nominal GDP should rise no more than 3% this year on a fourth quarter to fourth quarter basis. This slower pace in nominal GDP would be a continuation of the pattern of 2014 when nominal GDP decelerated from 4.6% in 2013 to 3.7% in 2014 measured on a fourth quarter to fourth quarter basis. Such slow top-line growth suggests that real growth and inflation should both be slower than last year.
In this slower economic-growth environment, we believe the outlook for lower inflation and lower bond yields remains most probable. Thus, the Fund continues to be invested in U.S. Treasury securities with maturities longer than 20 years.
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**The Barclays Capital U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market, including government and corporate securities, agency mortgage pass-through securities, and asset-backed securities. You cannot invest directly in this or any index.
†Gross domestic product (GDP) is a basic measure of a country’s economic performance and is the market value of all final goods and services made within the borders of a country in a year. Debt-to-GDP ratio is a measure of a country’s federal debt in relation to its GDP. The higher the debt-to-GDP ratio, the less likely the country will be to pay back its debt, and the higher its risk of default.