Robert Rodriguez, the legendary fund manager and CEO of First Pacific Advisors who forecast the global financial crisis, does not mince words in disagreeing with the policies of the federal government. And in a wide-ranging interview with ThinkAdvisor, he held true to form.
Beyond the debt default deadlock, the value investor warns of rough sailing ahead for the nation and the securities markets.
Back in 2007, Rodriguez moved to a cash level nearly 12 times that of the industry. Today, the Los Angeles-based First Pacific manages assets of $26 billion. Its Capital Fund has a compounded rate of return from July 1984 through Sept. 30, 2013, of 14.8%. The New Income Fund has not had a down year in almost 30 years.
In 2011, Rodriguez handed over day-to-day management to his First Pacific partners. A managing partner, he remains an advisor to both funds.
The value contrarian spoke with ThinkAdvisor from his office in Lake Tahoe, Nev. Here are highlights of that conversation.
ThinkAdvisor: Your thoughts on the impasse and government shutdown?
Robert Rodriguez: We have a lot of passion on both sides. The question is: Who’s going to be the lead dancer in this governmental tango? Obviously, the length of the dance will have negative impact on Q4 GDP — anywhere from a tenth of a percentage point to as much as 1%. This is the precursor to the battles that will occur between now and November 2014.
What’s the likelihood of a stock market crash next year?
It’s impossible to forecast, but I can tell you that the course we’re on is non-sustainable. It’s very much like blowing up a balloon. You blow it up and — Ahh, hasn’t popped. You blow it up some more — Ahh, we’re still good. It hasn’t popped. And then you finally hit that moment, and — bang! There it goes. That’s how financial crises typically happen. When we face the next crisis, liquidity will be very limited, and price reactions will be quite sharper.
What’s the biggest threat to the market in 2014?
Governmental surprises. Economic growth will be weaker than expected, and governmental chaos will be a key factor in it.
What are your thoughts about the nomination of the Federal Reserve’s vice chairwoman Janet L. Yellen to head the Fed?
An extension of Ben Bernanke — and more rules-based. The Federal Reserve is a temple with divine entities. But how confident are you in this group? Given that we’ve had the two biggest bubbles in the last 15 years and the Fed didn’t appear to be aware of either one, doesn’t give me a lot of confidence! In 2005, Chairman Bernanke didn’t think there was a housing bubble and that subprime wouldn’t be a contagion. [Yellen] will have to bring in a wider array of economic speed limits. But will this improve Fed policy outcome? I doubt it. How do you rate the Obama administration overall?
I give the last two administrations — which covered most of the two greatest bubbles — an “F” – as in failure. I’m a harsh grader.
Do you see more regulation coming now that Mary Jo White is helming the SEC?
Yes. But have any of the regulations that have occurred over the last 42 years that I’ve been in the business really helped? No. The captain of the ship, whether it was the Federal Reserve chairman or the regulatory heads, were off the bridge when the new S.S. Titanic hit the iceberg in 2007. So we’re piling on more regulations but aren’t getting any better outcomes.
What’s the current state of the stock market?
Since February 2012, the market has been driven primarily by [price/earnings] expansion, not robust earnings growth. Much of the improvement has been a function of reductions in labor costs as well as in interest rates. It’s still a function of risk-on, risk-off and the nature of quantitative easing. We’re already at eye-popping profit margins that are vastly above historical norms and the peaks of 2007. The odds of earnings disappointments next year have a reasonably high probability.
How do things generally look, then, for the long-term investor?
None of the fiscal issues that are steamrolling toward this country have been addressed with any real substance. In 2009 and again in 2011, I said that if things don’t change course, we will likely see an increase in the fiscal crisis within the 2014-to-2018 timeframe. And that’s how it’s playing out.
Please elaborate on your view about tapering and stimulation.
In 2009 I argued that fiscal policy would effectively be a failure. They were assuming that with fiscal policy stimulation, unemployment would fall to 5%. I think they missed that one!
We saw an extreme reaction last spring when Chairman Bernanke raised the mere possibility of tapering, didn’t we?
I think the Fed had to be completely shocked by the magnitude of the interest rate rise. The bond market had an 84% rise in rates in the 10-year bond from May 2 to Sept. 6. That’s the sharpest rise in interest rates in the shortest period of time in the last 25 years.
So you believe that the substandard growth we’ve seen for almost four years will continue next year?
I don’t see any reason why we should grow at a more historical 3% or 3-1/2% in 2014. All the Federal Reserve forecasts have been consistently overly optimistic — they’ve had to reduce their expectations. That will be the case again next year. We are now at approximately 100% debt-to-GDP. Are we going to be able to grow ourselves out of this conundrum? I just don’t see how we do. Keeping interest rates down for a progressively longer period over the next two to four years only blows the bubble up larger and larger — and it will pop. Just what is the crux of the problem with the U.S. economy?
In many ways we’re going through future shock: events are coming in such a way that you have difficulty evaluating them. The future shocks today are quantitative easing and ad hoc governmental intrusion into the system. We also face a continuing period of higher volatility in terms of economic trends — and then you layer on new regulations that are coming out of Dodd-Frank.
Are there any sectors and/or stocks that you like for next year?
We don’t find this an attractively valued environment because valuations are driven by non-sustainable monetary and fiscal policy. Therefore, I would want a higher margin of safety — a lower valuation to risk capital. Throughout the firm, we’re carrying elevated levels of liquidity. Defensive positions and liquidity levels are in the top quartile, much more defensive than they would be otherwise. [First Pacific] has been reducing its exposure to energy for the last two years. We’ve been primarily net sellers of stock. Pretty much the entire firm has more of a cautious attitude, and this has been the case for several years. No sectors pop out. It’s very one-off. Two recent additions to Capital Fund were Apollo Group and Centene Corp.
What’s the firm’s strategy concerning bonds?
We continue to stay short — approximately two years — in our bond portfolio. And that has been successful. We don’t like the long-term outlook for bonds. They don’t provide a safe haven. With interest rates and long-term yields at these levels, it’s a fool’s paradise. We just had a quick notification of that. We could go back to lower yield levels if the Fed accelerates quantitative easing, which I think is a reasonable possibility: Rather than taper, they buy for a longer period of time.
What would that do?
It might lead to somewhat of a bond market rally. But with each year that we continue to expand the debt or liabilities and keep interest rates down, the odds of unintended negative consequences rise.
Is it a good strategy for investors to move out of bonds and into equities?
There again, one is going to have to take a considerable amount of volatility. As you saw with the brief attempt in June, just trying to think about marginally retrenching from QE, the markets got hit. Volatility in bonds is very high, and volatility in stocks will be very high over the next couple of years. If you’re not prepared for that, you’re going to be in for a rude awakening.
A final thought on the debt ceiling impasse?
Children must play.
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