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February 09, 2011 at 09:31 AM
Invigorated after a year-long sabbatical (see Research magazine’s interview with him as he was preparing to take his break), renowned fund manager Robert Rodriguez, CEO of First Pacific Advisors, sternly warns that markets and the economy are threatened by the government’s tardiness in addressing fiscal reform. Unless restructuring begins within seven months, he says, a new financial meltdown will likely befall us in a few years.
Rodriguez, whose firm manages assets of $15 billion, forecast the global financial crisis of 2008-09. In 2007, he moved to a cash level nearly 12 times that of the industry. Today, FPA equity funds are at all-time highs. The compounded rate of return of the FPA Capital Fund, Sept. 30, 2007, through Jan. 31, 2011, was 5.3%. The FPA New Income Fund hasn’t had a down year in 32.
After a 12-month holiday circling the globe, Rodriguez, 62, remains a managing partner of his Los Angeles-based firm. As planned, partners who ran Capital and New Income in his absence continue as day-to-day managers. Rodriguez is an advisor to both funds.
AdvisorOne chatted by phone for more than two hours with the value manager, who makes his office in Lake Tahoe, Nev. Here are excerpts from that conversation:
What is your most pressing concern?
When I left, I informed clients that if present trends continue, we’d face another financial crisis of equal or greater magnitude within three to seven years. Many of the questionable practices that were being employed are back in the game. Banks and investment firms that fed at the public trough — none of that’s changed. Too big to fail is still operating.
There are shifts that are positive, the question is: Will we proceed at a fast enough rate?
So are we going the way of Greece?
Yes. If we continue to grow our debt at a rate of more than double our GDP growth. We have a $15 trillion Treasury debt and a budget deficit of 9% of the economy. From June 2003 through December 2010, debt in the U.S. has grown 10.26% [per year], whereas nominal GDP has grown at 4.5%. That’s a non-sustainable trend.
But the government says that the economy is back to its pre-recession growth rate.
That’s the flow concept: the rate of change of GDP growth. The other is a stock concept — income statement vs. balance sheet. They don’t want you to look at the balance sheet. They want you to focus on the income statement. How many times have you heard that from corporations? It’s called bait-and-switch!
What needs to be done then — and when?
We need significant fundamental reductions in expenditures at the Federal level this year because they’re not going to happen in 2012, which is an election year. If not, by 2013 we’ll be sitting on more than $17 trillion in debt. Therefore, the window to start reform is only about seven months.
But President Obama has talked about saving $400 billion over a decade.
With a $3.5 trillion budget, that’s a joke!
What are the consequences if reform doesn’t begin within the next seven months?
It’s about: When does the market start to get uneasy? Where is the tipping point when these trends become destabilizing, and are you being compensated sufficiently in the capital markets for these uncertainties?
What do you suggest to solve the fiscal problem?
As I proposed some time ago, one solution is to increase our export position. That would require a whole host of things to be done in re-engineering and re-training. Instead, the government produced a temporary narcotics hit; i.e., short-term fixes: the cash-for-clunkers program and an $8,000 credit to buy a home.
How significant is the Dow Jones’ rising above 12,000?
Means very little. Are the balance sheets scrubbed clean of their problem loans? I doubt it. I look at investor sentiment, and it’s very high. The confidence factor has come in, and that’s one of the things the Federal Reserve was trying to create. But at what price?
How solid is the stock market rally?
A lot of what the market has been discounting is a large expansion of corporate earnings. But that’s a function of aggressive cost reduction, not top-line revenue growth. Now we’re engaging in a period of cost push. The $64,000 question is: Will companies be able to pass on the higher cost inputs to maintain margins?
What market sectors and stocks do you like?
In equities, we’re continuing to operate with a high degree of defensiveness. We’ve been reducing some exposure to energy. That has been our largest exposure and still is. There’s no hot new area that I’m saying, “God! I have to focus in on that!”
What are your concerns about the bond market?
We still won’t lend long-term money to the Federal government nor to other high-quality creditors because the interest-rate level remains inadequate to compensate. If we’re correct — that is, if present trends don’t change — we’ll be proven right about the conservative position we’ve taken on fixed income.
Why have you given liquidity such high priority?
You have to keep a margin of safety because you don’t know what the foolishness will be on the part of clients and shareholders. You never know the value of liquidity until you need it and don’t have access to it. That’s what a lot of people learned in the last crisis, but I fear many are forgetting again…Crises [remind] you that you have to set up a rainy day reserve account.
Should investors stay away from municipal bonds?
