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.