Legendary fund manager Robert Rodriguez, who forecast the global financial crisis, sees money managers and advisors in peril. They will be victims of their own heedlessness, he says.
The day of reckoning will come within three years in a financial crisis at least as big and pernicious as The Great Recession, he told ThinkAdvisor in a recent, exclusive interview. The country is treading a tenuous path toward another disaster of massive proportions, according to Rodriguez.
Today, the investor’s stance is ever-cautious, as evidenced by his personal portfolio, which he discusses in the interview, as well as his five-prong formula for investing success and the essential research he relies upon.
Rodriguez continues to identify the horsefly in the ointment as the federal government’s ineffective monetary and fiscal policies, as he calls them, and the failure to attack critical structural issues.
For years now, he has warned of a looming crisis, even as the financial services industry has ignored, he argues, the enormously changed landscape since the global meltdown.
The outspoken CEO-managing partner of Los Angeles-based First Pacific Advisors (FPA), which has $33 billion in assets under management, is the firm’s strategic advisor. In 2011 he turned over day-to-day management of key funds to his partners, as planned, following a year-long sabbatical.
The FPA Capital Fund boasts a compounded rate of return from July 1984 through Sept. 30, 2014, of 14.65%. The FPA New Income Fund has not had a negative year in three decades.
Seeing all too clearly the handwriting on the wall, Rodriguez, in 2007, moved FPA to a cash level nearly twelve times that of the industry.
This month, he spoke with ThinkAdvisor from his Lake Tahoe, Nevada, base during a violent wind storm and power outage there. It was on Oct. 15, the day the Dow plunged 460 points before rallying somewhat to end down 173.
“We’re having a little bit of a blow in the marketplace and a little bit of blow in Lake Tahoe,” he quipped. Here are highlights of the conversation:
THINKADVISOR: What’s your take on the market and the economy?
ROBERT RODRIGUEZ: We’re living on borrowed time. When this market breaks, you’re going to see so many money managers and others washed out to sea who will never see land again. It will happen between now and 2018.
The federal government isn’t controlling their spending. For the past two years, 60% of investment returns have been a function of P/E expansion. Earnings growth is being driven by a fair amount of financial engineering on the part of the Federal Reserve and corporations. I’m sitting here for two years saying, “Hel-lo! Doesn’t anybody get this?”
You must be frustrated.
For some time, I’ve hated the financial market. When the history of this period is written, the Fed presidents and those who have deployed quantitative easing will be glorified as great snake-oil marketers.
How would you characterize the economy right now?
Is this a vibrant economy? Absolutely not. I don’t know what people are smoking! No amount of monetary stimulus that’s driving up the illusion of stock prices is going to get back to the basic elements of improving fundamental elements in the economy. Debt and entitlements are growing at more than twice the rate of nominal GDP growth. It’s an absurdity! Doesn’t the financial services industry realize what’s happening?
I get on a tangent; but I sit here in utter amazement that all this goes on, and the industry proceeds as usual. Hel-lo! The world has changed! It changed in 2008. We’re in a different and fundamentally more volatile environment than any we’ve seen prior to 2008.
What’s your advice to advisors?
I don’t live in the here and now; I live five and 10 years in the future and always have. Lots of things will be coming together in the next two years. Your readership [could] be deployed in risky assets: Do you believe the assets you’re invested in compensate you with sufficient margin of safety for the volatility of what’s likely to transpire in the next two to three years? If the answer is yes, be happy. If the answer is no, then maybe you need more cash or liquidity in your asset-allocation structure.
What’s in your own portfolio?
I sold my last direct ownership stock in July of this year. So, for the first time in 43 years, I don’t own any equities directly. I own stocks through our mutual funds.
You got out of individual equities entirely?
Yes. The underlying fundamentals of equities are deteriorating. So I think exposure should be low.
What about bonds?
Bond exposure should be maintained only in the highest quality areas. The big spread expansion and deterioration in credit quality is something that you’ll see more frequently in the next couple of years. The high-yield market is going to get hammered.
What do you own personally in bonds?
One area of that market that I went into in August of last year was the five-year Treasury in the 175-180 [basis points] range. I figured that was probably going to be a good yield for a period of time. Five years meant that my bonds would mature ahead of time in the event that the [government’s] fiscal ineptitude continued in conjunction with its unsound monetary policy.
What strategy do you live by to make money in the market?
Being successful in longer-term investing requires five elements. The first is discipline: You have to have discipline in how you analyze your securities. The second is patience to wait for those securities to present themselves in an attractive way. Next is the most difficult: courage. You have to have the courage to execute when all else says don’t. Then you need patience again — to allow those investments to work out over a period of time.
You need discipline again to sell because you’ve been correct or to sell because your analysis has been incorrect. So you have to have double doses of discipline, double doses of patience; and then you mix in courage. With that concoction, the odds are you’ll be a successful investor longer term.
What research do you rely on?
I believe the most important chart to look at is the dollar index, DXY Index GP. When monetary policy fails with QE, the only thing left in the bag of arrows will be currency. That is, how do you cheapen your currency to improve the competitiveness of your product to sell it? We will see aggressive currency realignment and at some point, if it gets out of control, currency war. When could that happen?
We’ll find out in approximately two or three years whether the Fed’s monetary policies have worked their magic. By that time the U.S. will have been on QE of some type for going on nine years.
You’ve been critical about the president’s Keynesian economic policy for years now.
In June 2009, I said that the one-time home credits and cash-for clunkers programs would only give a temporary blip to economic growth and would dissipate as if you’d never seen them. Now we’ve wasted five years and nearly $14 trillion in economic stimulus. Instead, we should have been providing tax-incentive programs for private corporations to rebuild and retrain our workforce, and a host of other things.
What’s your forecast for the stock market in 2015?
Lower! It will be easily 20% or 30% lower from what it is now.
What specifically do you see happening in the economy in 2015?
The unintended consequences of monetary policy and lack of fiscal resolve in this country, as well as in other countries, is only expanding the balloon. Nothing I was concerned about in 2009 has been addressed. GDP is not going to be a 3% growing number. It will be weaker again. The quality of the growth recovery in employment is questionable. That’s reflected in the fact that incomes are not really improving. Median income is still below where it was in 1999. We’re going along a road that’s not healthy. It will lead to sluggish GDP growth that will result in pressures on the system.
Any sectors that you or FPA actually like for next year?
It’s been more of a one-off, a name here and there. We find very little in the small/mid-cap range that’s truly rip-snortin’ attractive. The value screen that I’ve used for years went to a new all-time record low earlier this year: 27. The low prior to the 2007-2009 debacle was 35. Three days ago it was 32. I’ve used this screen for 30 years, and it’s been pretty good.
How is FPA positioned for 2015?
Across the firm, we have high levels of liquidity. We’ve been that way for the better part of over a year. FPA is sitting on about 30%-35% cash and has reduced their energy exposure by about 50%.
What’s the biggest threat to the market next year?
The realization that earnings expectations are far too optimistic. They’re not going to be up 7% to 10%. They’ll be more in line with nominal GDP — depending upon how much financial engineering is done by corporate America in stock buybacks. Right now buybacks are just a shade under the dollar amount that was spent in 2006 and 2007, and the number of companies repurchasing shares is at the same level as 2007. Does that give me a warm-and-fuzzy feeling? Absolutely not!
What’s driving this?
The Federal Reserve, in its insane way, has forced people to go out on the risk curve. This is from people who couldn’t identify the world’s greatest bubble in real assets back in 2005 and 2006. Why on earth would anybody follow the directions of such an incompetent, misguided institution? You don’t have much confidence in the Fed!
No, not in our fearless leaders in the Fed. By the way, little Timmy Geithner, back when he was president of the New York Fed, made comments that they were unaware of what was going on at the major New York banks and brokerage firms and how things were spinning out of control. But it was right there for everyone to see! At the time, I even identified the page they should be looking at in the 2007 Citibank 10-K [SEC filing].
What are your thoughts about the upcoming November elections and the presidential election of 2016?
They’re the most important elections in 80 years. I would like to see a revolt of nine to 10 senators shifting from Democrat to Republican/Independent. I guarantee that would send shock waves through many of the elites in Washington and set up for a major presidential outcome in 2016. Then the elected representatives may finally get around to dealing with what they should be dealing with — addressing out-of-control government spending and the complexity of our tax codes, which are starting to work in ways that aren’t positive. But if the shift is just in the four-to-six range, then it’s business as usual, and nothing will happen.
What’s your expectation if it’s the latter case?
The outcomes in our financial markets will get even more intense because nothing of a fiscal policy nature will be addressed until 2021 — and I believe then it will be too late.
What do you foresee for international economies next year?
It’s a volatile period both here and abroad. Like the U.S., neither Europe nor Japan is willing to attack the structural impediments in their economic systems. China has its issues: one of the indicators I look at is Shanghai rebar pricing, and it’s been going through the floorboards for the last six months. Rebars [reinforcing steel bars] have a direct play into construction activity in China. The Shanghai rebar prices really got hit and just this past week set new lows, lower than in 2009.
In the U.S., do you foresee rising inflation next year?
I feel as if we’re at a train station, but I can’t see the signs for which train is the local and which is the express. I jump on one train. Am I on the express to inflation, or the local that stops at disinflation before it finally gets to Inflationville? I believe we’re on the local. We’ll be going through disinflation in some countries.
But hasn’t the Fed tried to generate inflation here?
The inflation that the Fed has been attempting to stimulate has occurred in Mr. Dow and Mr. S&P. It’s been trying to get into a more normal economic cycle through the benefits of the wealth effect. That’s not reality. Reality is when corporations spend money on plants, equipment and training. We’re at 50-year lows in five-year moving averages on productivity. We’re at 50-year lows in net real capital investment in the corporate sector. This is not indicative of a system that’s on the verge of improving its productivity dramatically.
What are your thoughts about Dodd-Frank?
It’s insanity. The Act is 14,000 pages long; I believe the [Securities] Act of 1933 establishing the SEC was something like 30 pages. The third-year anniversary of Dodd-Frank was on July 21, 2013; and at that point, only 52% of the Act had been written. Do you honestly believe that creating something as massively complex and involved as Dodd-Frank is going to increase the security and stability of our financial markets? If you do, then I have a bridge I don’t own residing in Brooklyn that I’d love to sell you! What will be the fallout from Dodd-Frank?
When we get into tough times, Dodd-Frank will actually lead to greater instability and higher volatility in the marketplace, with fewer bids and greater illiquidity. There won’t be bids because as you’ve raised the capital standards on banks and others, you’ve seen them [cut] back their bond and other types of trading operations and move into entities that aren’t in the financial institutions, like hedge funds.
What’s your view of the Affordable Care Act?
This was an incredibly ill-thought-out bill and will not stand the test of time. It’s having negative effects on employment. And there were boldfaced lies that were conveyed about it, which I can prove — excuse me, Mr. President. Either he was lying, or he was totally ill-informed. I have the IRS Bulletin of July 19, 2010, that specified what was going to happen with health care — that you wouldn’t be able to keep your doctor, that most people couldn’t keep their insurance. It was right there in black and white. Will Affordable Care hold down health care expenditures? I don’t believe so.
How is FPA prepared should there be a bear market next year?
Whether the market goes up or down, we’re extremely well positioned from the standpoint of diversification and liquidity. That doesn’t mean we’re not going to get hit hard. If my negative scenarios were to play out, it wouldn’t surprise me to see us experience sizeable redemptions.
You’ve been through that before.
Yes. When I alerted the world to what was coming — both the 2000 debacle and the 2007-2009 debacle — I was considered a paranoid quack. In each case, my assets were redeemed to the tune of 50%. So, for doing the right thing the reward was to have my business cut in half. I’m not talking about just performance — I’m talking actual dollars going out. [Today], if we were to experience a large-scale exit of assets in a short period of time, will we be able to operate effectively without massive layoffs, as we have through the major debacles of the last 30 years? Whether we’ll be [that] successful in the next one is debatable, but it’s something that’s in our thinking much of the time.
Do you have anything at all optimistic to say?
When I look at the transformation of our country between 1776 and 1792 — when the first U.S. coin was stamped — and what was accomplished in those 16 short years, it gives me hope that with guidance, sound judgment and courage, we can transition this country that, at present, is in danger.
Final question: Do you still race sports cars as a hobby?
Yes. In about a week and a half, I’ll be running around the track chasing myself in circles — kind of like what people do in the financial markets!
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