After almost 30 years at FPA during which Bob Rodriguez has probably seen everything there is to see in Financial Markets, he now serves in an advisory capacity to offer much needed perspective to the new generation of investment managers who now oversee FPA’s assets.
Interviewed recently by Advisor Pespectives, he shared his thoughts about the current investment environment. He feels that the current environment is one of the most difficult of his career, particularly in the US. His actions echo his thoughts: FPA has high cash levels, and recently launched its first fund in more than 25 years to focus on international small and mid cap companies. He has made prescient, yet highly unpopular calls to hold large cash positions in the past, like in 2007 just before the Great Recession.
Bob expanded on his negative macro outlook for the US by touching on many factors –
i) Abnormally high profit margins being seen by Corporations in the US are unsustainable because 73% of these increases are due to low interest costs (which won’t last as interest rates rise) and lower labor expense (which won’t last as corporations pick up hiring).
ii) He likens the current environment to 2004-2006 when credit underwriting standards took a dive even as the world seemed safe. Today he feels that the financial leverage silently building up in our system because of monetary actions by the Government is unsustainable and extremely dangerous in the long run. Fixing this is not easy. He points to Canada, which was in a similar situation to the US in 1993, and worked to reduce its debt/GDP from 70 – 30% by taking approximately 7 dollars in expenditure cuts per revenue increase. Such choices are not easy as they have political ramifications for the leaders that make them.
iii) He admonishes against using historical P/E ratios as a crutch. At a current P/E of 12-13 (versus a historical average of 15-16), the market might look cheap. But in the past, the Debt/GDP ratio was much lower, and we had no off balance sheet liabilities. Comparing the US to a corporation with slow growth expectations, peak margins, he thinks a lower P/E is justified.
Though his macro views are increasingly bearish, Bob is long term bullish on energy because of its scarcity and the high costs of discovery. He believes that rising demands from emerging markets will drive a favorable long-term outlook for this sector.
An ardent student of history, Bob recommends financial advisors to focus on return of capital than return on capital. Investors would do well to heed his advice.
