Bob Rodriguez: Welcome to the 'End of the Capital Markets as We Know Them'

Q&A March 27, 2020 at 02:27 PM

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The coronavirus is "the pin that pricked the speculative bubble," but the Federal Reserve's pledge of unlimited quantitative easing and the passage of the $2 trillion stimulus package signals "the end of the capital markets as we know them," Robert Rodriguez, acclaimed former CEO of First Pacific Advisors who forecast the dot-com bust and the financial crisis of 2008-2009, tells ThinkAdvisor in an interview.

He blames the coming transformation of "the perversion and conversion to a dystopian capital market and economic system" on government manipulation and distortion.

Owing to his shrewd investing, Rodriguez, 71, who exited direct ownership of equities in 2016, not only hasn't been hurt by this month's sharp market decline, he made a profit during the carnage. Now, he says, he might buy equities "if there's more mayhem."

Rodriguez, who retired from FPA in 2016, has long predicted another financial crisis, based chiefly on consumer and government debt and the Fed's "insane monetary policy," as he called it.

In a 2009 speech to Morningstar, he said that "If we don't get our economic house in order, we will experience a crisis of equal or greater magnitude than the 2008-2009 period" and that this would occur after 2017.

Now he is forecasting a market rebound in the shape of a "lower-case "v"; that is, "not a rocket ship capital "V" — because of several changes that have occurred relative to the market; for example, stock buybacks by companies benefiting from the fiscal stimulus will be banned.

Rodriguez maintains that the market will not get back to its prior high "anytime soon" and that it will be necessary for companies, sure to suffer profit-margin pressure, to reevaluate management strategies.

In the interview, he also reveals what's in his 65% liquid personal portfolio, including where he deployed capital earlier this week.

During the 25 years that he was FPA's CEO, Rodriguez scored a remarkable record: The FPA Capital Fund, which he managed from 1984-2009, had an annualized return of 14.2% during that span, according to Morningstar. The FPA New Income Fund's annualized return came to an impressive 8.8% under his management.

In recent years, he has personally invested in — and intends to continue to buy — rare commodities and collectibles. His argument: "The public equity and debt markets are now nothing more than the greater fool markets that are led by the greatest fools of all, the Fed and the Congress," as he wrote in a note to colleagues on Tuesday.

He continued: "We have entered a far more dangerous environment where normal rules of analytics will likely not apply," where "the risk side of the equation" has been "truncated," making a "return-vs.-risk evaluation essentially meaningless" — because "everything is essentially socialized as to risk."

Thus, "There is no accurate pricing discovery in the capital markets because we have entered into a period of total manipulation," he wrote.

ThinkAdvisor interviewed Rodriguez on Wednesday. He was speaking from his home in Lake Tahoe, Nevada. After discussing his deep disappointment with the Fed and the chaotic market, he commented: "My mind is running at warp speed about the repercussions and implications of all this." In December 2018, he told ThinkAdvisor that the likelihood of another calamitous financial crisis was a "a near certainty."

Here are excerpts from Wednesday's interview:

THINKADVISOR: How have you been impacted financially by the market decline?

BOB RODRIGUEZ: I haven't been affected by this mayhem one iota. I've avoided 100% of the market carnage — and I'm also profitable. During the last 10 years, I've been a turtle, and the stock market has been a rabbit. Right now, the turtle is ahead of the rabbit.

What are you invested in?

Treasury bonds and a bond fund that, until last week, was down 1%, which I'd call a rounding error. The other areas of my portfolio are doing just fine. I haven't had direct ownership of equities since 2016. Now, by having liquidity, I can decide what to do. If I'll decide to commit capital to the equity market, I'll probably want to see more mayhem.

Broadly, what's your investment strategy, and what are those other areas of your portfolio?

I want to invest in areas where there's a minimum of governmental interference. An obvious one has been the gold market.

Where did you deploy capital this week?

I was buying gold and silver closed-end funds.

There were massive margin calls going on, and one market you could see that in was gold because gold prices were falling rather dramatically. I've been following the closed-end fund "Sprott Physical Gold Trust (PHYS) for the last decade. I wouldn't call it an equity, as people perceive equities. Two weeks ago Friday, when all the mayhem was occurring, the discounted net asset value went to 4.4%, a big discount. I wish I had bought more.

Do you have any bonds in addition to the Treasurys?

I invest in the FPA New Income Fund, a fund from my former company, First Pacific Advisors. I also own a small exposure in their international fund, run by Pierre Py. And I still own a small residual amount in the FPA Capital Fund.

What's your forecast for a stock market rebound?

The permutations that will evolve from this are mind-boggling. To believe that you go back to where you were prior to all this mayhem would be foolish. So I have a lower-case "v" shape [recovery] in mind. I don't see a rocket-ship capital "V." I have a very hard time envisioning how the market gets back to its previous high anytime soon because there have been changes.

Such as?

One of the key supports of the stock market over the last five years — buybacks — has been taken away. Consumers have had devastation in their accounts. Are they going to run back and buy stocks? I don't think so. The median stock prior to this recent rally was down over 50%. That wiped out pretty much all of the stock market run.

But weren't investors who are diversified protected somewhat?

Diversified portfolios have had much of their returns of the last seven to 10 years washed away. I don't think they're going to recover 100% of what was lost. Will the foreign sector come in and buy a ton of stocks? They've got their own problems.

What will companies need to do in this new world?

Reevaluate the operational management strategy they were using prior to the dislocation. Profit margins are going to be under pressure. They'll have to reassess how they source goods. I argue that whatever they choose is going to be a higher-cost option.

What else will they have to review?

Will they try to have a higher level of liquidity on their balance sheets for a rainy day? I'm not so sure because if the government will come in again to provide loans, why not just operate without any cash? And when an emergency hits, the companies will think, "Oh, we'll just get a loan from the federal government."

Will all companies have that mindset?

No. Some will say, "If we don't have as dramatic a situation and the government doesn't come in to the same degree it did last time, we should carry more liquidity. But as you carry more cash and more inventory, it means your working-capital efficiency starts to go down and you have to finance that. Therefore, it will have a negative effect on profit.

What else will companies need to do?

There's probably going to be a critical assessment of staffing and labor policies — and that [would] mean higher operational cost.

For decades, you've had a big bone to pick when it comes to the Federal Reserve. What about right now?

With the events of the past three weeks, the perversion and conversion to a dystopian capital market and economic system is virtually complete. The system is even more manipulated and distorted than it was before. And this is what managers have to think about. The Fed taking rates to zero and the European Central Bank's going to negative rates have totally distorted the financial operations of the economic system.

What's the perversion you refer to?

We have two that are going on: unlimited quantitative easing and the Fed's [plan] to give $4 trillion in loans — bringing in BlackRock as manager. In a sense, they're guaranteeing to provide capital to anyone who shows up. These numbers are so astronomical and off the charts!

You're including the $1,200 checks that will go to consumers?

Yes, the helicopter money that's being thrown to them. So with all of that, how can you say that our capital markets will be the same as they were prior to this? No way! This is the end of the system as we have come to know it. What we're going through is a total reformation of the economic system, and we won't know the long-term effects for some time.

Where will the money for consumers come from?

The Treasury will borrow it. Who will be buying those bonds? Effectively, the Fed. Then the money is sent to the consumer. It's going to be a loop.

What are the implications?

The bonds will be standing around for several years. That's stealing from a future generation. If you keep borrowing, you can't service the debt unless you continue to print money — and that gets you into monetary inflation. The Fed is out there ready to print money with zeros and ones. Magic! It's called a computer.

Do you have any respect at all for what the Fed is doing?

I've been outraged at the incompetence of the Federal Reserve starting with [former chair] Alan Greenspan. He started this perversion — the socialization of risk — and the Fed has been continuing to build it for over 30 years. Here we are now basically guaranteeing everything. If that's not a distortion of the system, I don't know what is!

Before Alan Greenspan was chair, did the Fed meet your expectations?

There have been only two great Fed chairmen: Paul Volcker and William McChesney Martin. [Regarding interest rates] Martin said that [the Fed's job was] "to take away the punch bowl just as the party gets going." The chairmen of today spike the punch bowl!

What did the Fed do wrong before the current debacle; that is, in the 10 years following the 2008-2009 financial crisis?

The reason we're [in the spot we're in] today is because discipline — real central bank control — has evaporated. I've been disappointed by what the Feds have done in the last decade. They had an opportunity to reverse course, but they didn't.

What impact does this bear market have on workers' pension plans?

Every single state and local pension system and private system has been crucified. Pension plans had said that bonds weren't yielding enough, so they went out on the damn risk curve into alternative asset categories. Today, those are getting crushed.

Over the last several years, you've been focused on investing in rare commodities and collectibles. As for the latter, you have a project that's investigating three dismes — dimes — minted in 1792, which you own. They must be worth quite a bit.

I believe that one of them is priceless. [Eventually] I'll probably donate it because of its importance, and as a thank you to a country that has been wonderful to me and my family [Mexican immigrants]. But in the interim, I view these coins as a hedge against uncertainty. I'm also working on another research project — two coins that could be even more important than the dismes.

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