Today’s stock market has been labeled everything from sizzling hot to a runaway freight train. Legendary money manager Robert Rodriguez, who famously forecast the dot-com bust and the global financial crisis of 2008-2009, calls the situation “Alice in Wonderland” populated by a plethora of irrational Mad Hatters, in an interview with ThinkAdvisor conducted on Jan. 26.
During the past six years, Rodriguez — for 25 years CEO of First Pacific Advisors, from which he retired in December 2016 — has warned of another looming dreadful financial crisis. The man hasn’t changed his tune. In fact, he has moved most of his personal assets out of the market and into other types of investments.
Rodriguez points to an asset bubble, along with ever-building consumer and government leverage that, left unchecked, will turn what has been a dreamy melt-up into a nightmarish meltdown.
Forecasting “a dark time for the economy longer term” — particularly if the government fails to reform its spending — he is certain that the Federal Reserve, in an effort to avert a crisis, will institute the wrong policies and “blow it,” just as the central bank has in crises past, he says.
Rodriguez, 68, scored a stunning record at Los Angeles-based First Pacific. The FPA Capital fund, which he managed from 1984 to 2009, had an annualized return of 14.2% during those years, according to Morningstar. It outperformed the market indexes by 500 to 600 basis points compounded during his 25 years with the firm, the former manager says. The FPA New Income Fund’s annualized return came to a striking 8.8% under Rodriguez’s management.
In the interview, he discusses the biggest threat to the market, as he sees it; offers up a negative view of Trump’s tax cuts; and then candidly assesses the president’s first year in office.
ThinkAdvisor recently interviewed Rodriguez, on the phone from his home in Lake Tahoe, Nevada. Bearishly blunt as ever, he is, above all, concerned with investors emerging from the Rabbit Hole intact. Here are highlights from our conversation:
THINKADVISOR: What’s the state of the stock market?
BOB RODRIGUEZ: We’re all in “Alice in Wonderland,” and some of us may be the Mad Hatter — delusional about what’s going on. For people in the equity market, enjoy the party! The music’s playing. It’s late evening — and how lucky do you feel? We have a king-size party going on. So long as the music plays, you’ve got to get up and dance. We’re in a melt-up.
What are the implications?
We’ve been in a market driven by P/E expansion. So it’s a market that can do no wrong. CalPERs announced they’re taking their cash down to all-time record lows. Bank of America says their asset allocation is at all-time record high to equities. TD Ameritrade said their clients are at record low cash levels. Mutual funds are at record low cash levels. So it’s “all good.” As for me personally, I’m at record [high] cash levels.
Do you see a bubble?
Yes, a bubble in assets. The Federal Reserve has created another asset bubble thorough asset-price inflation. The Fed is spiking the punch bowl! The present state of continued [P/E] expansion and leverage at a pace faster than economic growth is a nonsustainable trend that will lead to outcomes people aren’t prepared for.
What’s one of the downsides to this up market?
Because of the melt-up, there’s a huge amount of optimism built into the capital markets. The pressures on active managers to be invested are intense: If you’re not invested, you’re fired. But if there’s a hiccup, the question is: To whom do you sell? How much cash does an index fund or an ETF carry? None.
What’s the greatest threat to the stock market?
It has always been and continues to be excessive leverage. Whether it’s in the consumer sector or the government sector, we’re on a leveraged basis in this country and the same worldwide. Along with that, valuations are only exceeded by those of late 1999 during the tech bubble. How much more can you keep leveraging up the financial system both here and abroad before it’s in trouble?
What do you see happening in the future?
This is a dark time for our economy longer term. Nearly 75% of the U.S. is on cruise control. As a result, I have no interest in participating in a market that’s been manipulated by the Federal Reserve and its interest rate policy. I’ve moved assets away and am continuing to do so. I want to be as far away from this monstrosity as possible. In the next correction, they’re going to have to institute even more aggressive policies than they did during the last crisis.
What are your expectations for the new Fed chair, Jerome Powell?
A lot of people expect that he’ll continue the policies of the former chairperson, Janet Yellen. I’m not so sure. But rather than worry about whether he’ll do two or three interest rate increases, I would argue with great confidence that the Fed will blow it again, as they have in every crisis. They focused on inflation, but we didn’t get inflation in the numbers that they used to drive policy.
You’ve been saying for five years now that “if the United States doesn’t get its balance sheet together” between 2013 and 2018, there’ll be “a crisis of equal or greater magnitude” than the 2008-2009 calamity. Do you still feel that way?
Yes. The rubber band keeps getting stretched. Valuation metrics in the marketplace are at or near all-time highs, and worldwide debt leverage to GDP has increased by over $50 trillion since the peak of the last crisis. This is all a replay of what preceded that crisis.
But the consensus on the outlook for the economy is chiefly positive.
Count me highly skeptical about the economic forecasts and earnings expectations for nearly double-digit or double digit-growth over the next couple of years. Some of that is being driven by expectations about tax benefits. The S&P 500 is now past the 2014 number of corporate profits, but analysts use operating earnings, not reported earnings, because reported earnings look a lot lower.
So, you don’t think that jibes with reality?
We have an expectation that we’re going to accelerate growth in terms of revenues and profits in the ninth year of an economic recovery when we’re at supposedly full employment — and they’re still stimulating?
You obviously don’t agree with that.
We’re in a period of expanding budget deficits. In the ninth year of an economic recovery, tax cuts are increasing the deficits. But nobody in Washington cares about that — there’s no fiscal responsibility. We’re just going to continue with the borrowing cycle.
What are the risks of excessive leverage?
When you leverage up a system, your margin of safety for unexpected events goes down. Preceding virtually every major market decline has been a period of investment excess, and misguided Fed monetary policies have been a factor.
The Trump administration doesn’t appear too concerned about the federal deficit. And Speaker Paul Ryan has just said he won’t address entitlements this year.
At no point in the [debate] about cutting taxes was there a discussion: Should we cut expenditures? We’re going down the road that I feared almost a decade ago: the road of fiscal irresponsibility with a Federal Reserve that’s inflating assets. Ben Bernanke said in 2010 that the whole purpose of QE2 was to inflate stock market values so they would create a wealth effect to revive the economy. That didn’t happen.
What are your thoughts about the tax cuts?
I don’t agree with Trump’s tax program. You always get the cuts before you get the reform. Government takes the goodies first and defers the pain. The question is: How much of the tax cut is really going to flow thorough [to corporations]? The other question: Will this tax cut drive economic growth on a sustainable basis at 3% or higher? In both cases, the expectations are far greater than what the reality will be.
What do you think of President Trump’s first year in office?
Obviously, he’s very crude in many ways. But he’s saying things that resonate with a large part of the country that isn’t typically represented. When you’ve had half a century of effectively zero median income growth, the heartland is hurting.
But what about Trump’s promises? Apart from the tax cuts, how do his accomplishments stack up?
Health care is still a mess. I was incredibly critical of [President Obama] for instituting a misguided health care program and an ineffective tax-cut policy. I said that Cash for Clunkers and one-time home [buyers'] credits would be fruitless — basically narcotics that would stimulate the economy short term but would have no lasting effect, which they didn’t. So I’m not a happy camper with either party.
But hasn’t Trump made headway in cutting back regulations?
His intentions about going after regulation insanity are good. We’ve heard him say he’s done that aggressively. He said that upwards of 22 have been cut for every regulation that’s come in. I have no idea how to validate that. I’ll take him at his word.
What would dispute it?
I did a little unscientific [anecdotal] survey: My legal counsel, in regulation and mergers and acquisitions, says he’s seen no diminution in regulations or regulatory filings. My former COO at First Pacific says that his filings haven’t changed, except that the concept of “broken windows” in compliance seems to have been taken away. A person I know in medical health care equipment says that regulatory filings are up. My physician is fed up with health care regulations. My dentist is spending more than half his time filling out regulatory filings.
So you think nothing much has been done to decrease regulation?
My guess is that maybe environmental regulations are down because we’re going to have off-shore oil drilling in Alaska and other places.
What about Trump’s promise to rebuild U.S. infrastructure? That plan isn’t moving forward, it seems.
They’re talking about in excess of $1 trillion in spending. Well, if you’re going to spend that and it’s the critical [issue], what isn’t critical in the budget? Why isn’t there a prioritization of spending in the federal government, like in any company that wants to be profitable?
Since you retired, you’ve been investing in collectibles of historic importance. What’s your latest project?
We’re doing [high-tech] research to extract information about one of our nation’s most historic coins to provide a better understanding of how our initial coinage was designed and who did it. We’re hopeful to discover something very meaningful, and then my colleague and I will publish a paper on it.
Are you investing in the securities markets at all?
I’ve been redeploying assets into areas that are not part of the financial market but will be beneficiaries of long-term inflation — not gold. I want to own rare, fully paid-for assets that aren’t subject to calls [by others], and the vagaries of the banking system and the financial markets. In the system today, where asset valuations are high, leverage is high and the margin of safety is low, you want to hold assets that aren’t subject to the calls of other people. So I’m not worrying about whether Mr. Dow or Mr. S&P are going to be up or down tomorrow.
How would you sum up what investors need to be wary of in the market right now?
Today, it’s about: Are you going to be right? Are you going to be right for the right reasons? Or are you just lucky? When I was managing money, I watched more than 50% of my assets flow out the front door for doing the right thing. If I were managing money today, I probably would have lost at least 50% to 75% of my assets because clients would say, “Oh, you’re just a one-trick pony.” That’s what I went through in the 2007-2009 debacle and the 1998-2000 period.
When do you think the long bull market will finally end?
The history of this period has not yet been written. We know about the upside, but we don’t know what the downside is or what the price is for the excesses. On a bell curve, we’re close to the peak. Are we going to go down the other side? Or are we still early on the uptake? When I look at the numbers, they’re only more richly valued than they were before.
What’s your view about Bitcoin?
I would argue that fear of what might be developing in government has led to people experimenting with alternative forms of currency. Those who have gone into Bitcoin thought they were buying things that are rare because only so many coins can be created. However, you can create infinite numbers of Bitcoin-type vehicles. That’s a problem.
Many have put money into Bitcoin without knowing exactly what they’re investing in.
Last November, I was in a café in a tiny berg, and the server-hostess said she bought some Bitcoin because her friend told her about it and she’d heard that people were making money in it. She didn’t even know what Bitcoin was. That reminded me of Ambassador Joseph Kennedy in 1929, when a shoeshine guy gave him some stock tips, and he said: “If a shoeshine boy is in the stock market, who’s left?” So he liquidated. It would be three or four years before he started redeploying capital into the market, which bolstered the Kennedy fortune. So, in Kennedy’s time it was the shoeshine guy. Maybe now it’s the Bitcoin waitress.
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