Karl Denniger at the Market Ticker writes that Duhigg has “blown the cover off the dark art” but thinks that the traders’ computer speed isn’t most important advantage they have. Rather, he says, the “algos,” rather than providing liquidity as they are supposed to, intentionally probe “the market with tiny orders that were immediately canceled in a scheme to gain an illegal view into the other side’s willingness to pay.” He explains:
Let’s say that there is a buyer willing to buy 100,000 shares of BRCM with a limit price of $26.40. That is, the buyer will accept any price up to $26.40.
But the market at this particular moment in time is at $26.10, or thirty cents lower.
So the computers, having detected via their “flash orders” (which ought to be illegal) that there is a desire for Broadcom shares, start to issue tiny (typically 100 share lots) “immediate or cancel” orders - IOCs - to sell at $26.20. If that order is “eaten” the computer then issues an order at $26.25, then $26.30, then $26.35, then $26.40. When it tries $26.45 it gets no bite and the order is immediately canceled.
Now the flush of supply comes at, big coincidence, $26.39, and the claim is made that the market has become “more efficient.”
Nonsense; there was no “real seller” at any of these prices! This pattern of offering was intended to do one and only one thing - manipulate the market by discovering what is supposed to be a hidden piece of information - the other side’s limit price!
With normal order queues and flows the person with the limit order would see the offer at $26.20 and might drop his limit. But the computers are so fast that unless you own one of the same speed you have no chance to do this - your order is immediately “raped” at the full limit price … as the fill price is in fact 30 cents a share away from where the market actually is.
A couple of years ago if you entered a limit order for $26.40 with the market at $26.10 odds are excellent that most of your order would have filled down near where the market was when you entered the order - $26.10. Today, odds are excellent that most of your order will fill at $26.39, and the HFT firms will claim this is an “efficient market.” The truth is that you got screwed for 29 cents per share which was quite literally stolen by the HFT firms that probed your book before you could detect the activity, determined your maximum price, and then sold to you as close to your maximum price as was possible.
Even if such trading isn’t illegal or inherently vile, Brett Steenbarger of TraderFeed notes, it certainly makes life hard for day-traders and others with slower access to data.
Because the high-speed algos are buying and selling quickly as a rule, their effects on the markets longer-term are unclear. A stock may still travel from point A to point B, but the computers will affect the path from A to B. This may help explain why traders I work with who are more selective in their intraday trades and who tend to hold for longer intraday swings on average have been doing better than very active daytraders.
When up to half of all stock market volume consists of these algorithmic trades, one has to wonder about the edge of very active traders. Interestingly, those that are successful may be trading new patterns that have emerged since the onslaught of the high-frequency computers. My hunch is that these new patterns would involve a keen reading of order flow, catching the shift in the bidding/offering and the location (bid/offer) of transactions in real time.
Monday, July 27, 2009
Thursday, July 16, 2009
Bob Rodriguez on WeathTrack
Consuelo Mack WealthTrack - July 10, 2009
CONSUELO MACK: This week on WealthTrack's "Great Investors" series: he races Porsches for fun and runs top performing stock and bond funds for his profession. What makes First Pacific Advisors' Robert Rodriguez step on the investment brakes or the accelerator? That's next on Consuelo Mack WealthTrack.
Hello and welcome to this "Great Investors" edition of WealthTrack. I'm Consuelo Mack. This week our great investor is Robert Rodriguez, a maverick money manager who has accomplished a feat no one else has. For the last 25 years, he has run not one but two top performing mutual funds, in not one but two asset classes, a stock fund and a bond fund. As widely followed personal finance columnist Jason Zweig put it, that is the investing equivalent of running two marathons at the same time, which is why Zweig calls him the best fund manager of our time.
Rodriguez is the CEO of Los Angeles-based First Pacific Advisors and co-portfolio manager of FPA Capital, a mid cap value fund, and FPA New Income, his bond fund, which just celebrated its 25th year in positive territory. Last year he and his co-manager Tom Atteberry were named Morningstar's fixed income managers of the year for their outstanding long-term stewardship. It is an honor Rodriguez has won two other times as well for both the stock and the bond fund, making him only the second fund manager to be honored three times. The first was last week's great investor, Bill Gross.
Rodriguez, who races Porsches as a hobby, has a high octane personality but a low tolerance for investment pain. He knows what it is like to lose. A first generation American, his paternal grandparents lost everything in the Mexican Civil War of 1910. His grandfather did not survive the war. His grandmother and six children nearly starved to death. It took them almost six years to come to the United States legally, a route his grandmother insisted on taking so her children could walk down the street with their heads held high.
Throughout his 39-year investment career, Rodriguez has taken the high integrity path, sometimes to his business detriment. He was one of the first to rail against the dot-com and credit bubbles, raising large defensive cash positions, early moves that lost him clients. He is an outspoken critic of the U.S. government's stimulus packages, burgeoning debt levels and business intervention. Four years ago he moved from California to Nevada to protest the golden state's budget excesses and income taxes, the highest in the nation. And he does not mince words in criticizing Wall Street and the mutual fund industry. In a wide ranging interview, I asked Rodriguez about his exceptional track record which he attributes to discipline and the ability to balance fear and greed.
ROBERT RODRIGUEZ: I think we have a healthy dose here of skepticism about our capabilities. When you've had some serious failures, it forces you to look inwardly, and I don't know of too many organizations where an investment professional puts his worst investment failure on his website. And it just tells you that no matter how skilled you are in this field, there are new ways to snatch defeat from the jaws of victory. So you have to balance these things. And we test ourselves daily on this, whether we're correct in our assumptions, but we don't want to let the day-to-day machinations in the marketplace disturb our long-term thinking.
CONSUELO MACK: You had in the Income Fund, you had your 25th straight up year, which is just unheard of. But in the FPA Capital Fund, in the stock fund, you had your worst year ever, down 35%, so what did you learn from last year?
ROBERT RODRIGUEZ: Well, we did as much as we could. I felt that by June of '08 there was nothing more we could do.
CONSUELO MACK: You had raised 45% cash?
ROBERT RODRIGUEZ: 45% cash, we're getting redeemed, you can't really take it any higher because the more higher you go, the faster the money goes out. So you have to strike a balance. And our largest exposure was to energy. We have a five and ten year horizon on, that we've been in the field for ten years after my being out of the sector for nearly 18 years. So there's the long-term view versus the short-term risk. And we did reduce our exposure in energy, prior to going into it. And we said now it's up to the gods. They went down with the market very hard and the first phase of an economic or stock market debacle, everything goes down. Then in the second phase they start to separate and in the third phase you start to see what really is going to work. Well, this year I would say what was taken away from us last year has been, a large part, has been given back to us this year for the right reasons. And so I have to think probably look at both years combined to say, all right, how did you go through this cycle, how did the others go through this? And then over the next five years, is your analysis correct? We happen to think it is, and if we are then our shareholders will be rewarded for that.
CONSUELO MACK: You've quoted in one of your speeches and one of your shareholder letters too that legendary economist John Maynard Keynes describing the long-term investor as eccentric, unconventional and rash in the eyes of the average opinion, which fits you to a tee, actually. So where does the eccentric and unconventional side of Bob Rodriguez come from? Where did you get this?
ROBERT RODRIGUEZ: I really don't like following the norm. If I follow the norm, I would never have been in this business. My last name is not a competitive advantage when I entered the field, and had to knock down a lot of doors, and you had to do things to separate yourself from the crowd, so that all started way back when I was very young. My first time I got anything to do with the investment field was writing a letter to the Federal Reserve chairman when I was ten. It was a school assignment.
CONSUELO MACK: And he wrote you back.
ROBERT RODRIGUEZ: And he wrote me back, and I said gee that's kind of neat, how many people would do that. What's the down side? So I started thinking differently about what the norm is, and then how can you turn that to your competitive advantage? So it's always been that way. I would say when I was in graduate school or just going into graduate school, I discovered Graham and Dodd during the summer before I was coming back to graduate school. And it really struck home, and I had the good fortune of meeting Charlie Munger in our investment course there.
CONSUELO MACK: Warren Buffett's kind of unknown partner.
ROBERT RODRIGUEZ: As Warren Buffett says, he's the smart one. And after the class I asked him, I said what can I do to make myself a better investor, beyond just what I'm doing here and researching, et cetera? And he said, read history. Read history. Read history. And if people had read history about the economic crises of before, not only the depression but even before then, they would have said this is an old friend, and so that helped. It's come from a number of different parts, but I think really not being afraid to fail and be different. That's what it took in order to differentiate in this business.
I had a friend of mine who was a growth stock manager who got just before the debacle of 2000, we were having lunch together in January of 2000 and he was buying all this dot com, and I said why are you buying this crap? And he says, because you have to, he says yes, if I don't buy it we won't be competitive. I said, but don't you realize, you are at the epicenter of a debacle that's going to occur? And when you get destroyed, you know, you could either have cash or you can buy these things. If you have cash, you get fired. If you buy the dot-com and it blows up, you get fired. So in both cases you're fired. What's the difference? Over here the one with the cash, where you held your investment discipline, you can rebuild your business. Over here, you've destroyed your credibility, you can never rebuild.
CONSUELO MACK: Let's talk about some of your unconventional current calls. You're describing the current economic state that we're in as a repression, which it's not as bad as the Great Depression, but it's also worse than a recession. Where is this repression taking us? What's it going to feel like?
ROBERT RODRIGUEZ: Here in the firm, we're using a new term for the economy. We're calling it the caterpillar economy. Where it goes up and goes down, goes up and goes down, but it doesn't move forward very fast, after this waterfall collapse that we had. And this is different from any other kind of economic environment that we've been in since the depression. You don't destroy the consumer's balance sheet, like what's gone on. You don't have the leverage in the system that we have and expect to come out of it the way we've come out of other periods. The president, I argue, that I think he's on the wrong road and when I compare him to let's say FDR. When he came into power, the debt to GDP was barely 17% when FDR came here, whereas now we're now at 65% going to 75, going to 90% this year.
CONSUELO MACK: IMF says 100 some odd percent?
ROBERT RODRIGUEZ: Right. And by the way, those numbers when FDR came into power did not include, because we didn't have any, entitlements. So if you add on the entitlements, it's even far larger. So as I've argued, we do not have the balance sheet flexibility today as we did in FDR's time. So if they want to go down, they being the Congress and the executive branch et cetera, and they want to build up these larger programs, they're going to come at a price. And in our opinion that price will be in the debt market, and in the Treasury market longer term. With higher interest rates.
CONSUELO MACK: Bob, you saw the credit crisis coming about five, at least five years ago. And at that time you predicted that there was a new financial system that was going to be created and a new era. So what's this new financial system that we can look forward to?
ROBERT RODRIGUEZ: I think, first of all, about four years ago we started talking about the breakdown in underwriting standards, et cetera. With the demise of Bear Stearns in March of last year, and what the response was by the federal government and the Fed, that's when we wrote "Crossing the Rubicon," that we had crossed over into a new financial era, a new system. And little did we know how far that was going to occur, within six months.
So we're still in this process of defining what this new system is. As a result, it is very difficult to define what appropriate valuation levels are going to be, because the goal posts keep getting moved. Look at Chrysler- we were extremely vehement against Chrysler and what happened there, where senior secured creditors were treated in such a shabby manner, it really ran over, you know, the sanctity of contract. So we're in a new system. That means the government is a larger percentage of GDP. The larger the percentage of GDP, the more likely GDP will grow at a substandard rate for an elongated period of time.
We're in the group, and I'm in the group, where the new world order that you were referring to, that I've referred to, is that the U.S. is going to have to change its economic system; that our foreign counterparts that have basically grown on the backs of U.S. consumer have got to turn inwardly for their growth. As a result, as they turn inwardly for their growth, such as China, the U.S. has to expand its exports. I don't see anything like that coming out of the administration or the incentives or anything else. As a result, the more the government takes a larger share of the economy, the likelihood we will be in a substandard period of growth and profit margins will also be substandard.
CONSUELO MACK: So how do you invest in an environment that is going to be substandard growth, that you don't know what the rules of the game are because you don't know what the government is going to do next, what do you do?
ROBERT RODRIGUEZ: It's going to be very hard. As a result, on the fixed income side, we're still maintaining our highest levels of quality. We haven't gone into the lower rungs of the high yield area, even though there's been big rungs there, because we think this is a head fake of what's going on in the economy and this rebound, the green shoots that people talk about. So we're going to stay high quality and let other people destroy themselves.
On the equity side, we think you have to be very focused in terms of the industries you go after. So we have a natural decline rate in, let's say energy, supplies of energy. So we think longer term- three, five, ten years. Energy prices are going to be considerably elevated from where they are today. So we have a heavy exposure there.
CONSUELO MACK: Heavy, like 55% of the FPA Capital Portfolio, is that right, is in energy?
ROBERT RODRIGUEZ: Well, about 41% of the total portfolio, about 55% of the equity. Okay. So we're looking for other areas to deploy capital that will both benefit from the international side but also from the commodities side.
So we see, you have to be rifle shooting over the course of the next five years or ten years, and that's why I gave a speech in Chicago at Morningstar that in my opinion, a highly diversified equity fund in this new order will be at a competitive disadvantage, especially if it carries management fees, et cetera, so you're going to have to do something different from the rest of the market in order to differentiate again, and that's what we're doing.
CONSUELO MACK: So let's talk about the investment industry, which you have been highly critical of, and the OPM attitude, "other people's money" attitude that you feel that the industry has been excessively greedy, not really paying attention to shareholders interests.
ROBERT RODRIGUEZ: Let's say abusive. I mean, how are mutual funds sold? They're brought out when the particular area is the hottest. So you sell what you can sell, and most of the time that is the absolute wrong time to be marketing that kind of product. So it's not investment oriented, it's marketing oriented. It's a marketing mindset, and as long as we have a marketing mindset in the industry and managers are fearful of under performing their bogey and having what we call tracking error where you deviate too far from your benchmark and god forbid you have too much volatility: all of these things will work to hit the industry. With this collapse, with the technology collapse and now with the credit collapse, the question I'm asking is: if active managers could not identify the two greatest speculative blowoffs in the last 75 years, when will they? And secondly, what are you buying from an active manager if they can't identify these things? You might as well go to an index.
CONSUELO MACK: Talk to me though about the shakeup that you think is going to happen in the mutual industry. Tell me what kind of a shakeout you expect.
ROBERT RODRIGUEZ: I just think that first of all, we have too many funds. When you sit there with 8,000 funds, and then you have 25 different share classes, it's quite complicated. And what is the investor getting for all of that? There's an expense to that, and the higher the expense in a lower return environment means you have less margin of safety for a total return.
CONSUELO MACK: So let's also talk about the fact that you are a long-term investor, but you told me that you look out-- some people say long term like a couple of years, you're really talking about five to nine years. And you made a decision about six years ago to take a sabbatical next year from your firm in 2010. And one of the reasons that you decided to take a sabbatical as well is because you looked out beyond the current crisis and you see something even bigger and scarier coming?
ROBERT RODRIGUEZ: I see another crisis coming.
CONSUELO MACK: What is that and like when?
ROBERT RODRIGUEZ: It's the explosion in the treasury debt, and the finances of this country. We still have time. But to, shall we say, become fiscally responsible. Am I optimistic about us doing that? No. You're residing in the state of California that I left here four years ago, because in my opinion, the system was fundamentally broken and the state was going to experience a devastating recession on the down side.
CONSUELO MACK: Which it is right now.
ROBERT RODRIGUEZ: Which it is right now. I believe the system in
Washington is fundamentally broken. And as a result, the explosion in dealt that I foresee in the next three years and if other programs are added on it will accelerate it, then I think we have a real problem brewing in our finances here. I'm estimating somewhere in the neighborhood of five to seven years from here.
CONSUELO MACK: Do you envision any time in FPA Income basically going out the risk curve a little bit? I mean, is there anything-- you've got about 90% in triple A rated securities in the portfolio?
ROBERT RODRIGUEZ: We are 22% in cash and we're barely over a one-year duration. We've had as much as 25% of the fund in high yield. We would love to go out on the risk curve. In the last six months, eight months, it's been highly profitable, just like the stock market has rallied. Is this sustainable? We don't think so. We think there's other dominos to fall that can disrupt this. So we don't like the odds. Plus in New Income, people come into the bond fund in New Income because they can trust it. It's when they couldn't trust virtually anything else in this country, other than Treasuries, our bond fund grew in the neighborhood of 60 to 80%. People came in because they could trust it. Well, here we are saying, how do we be good stewards going forward? Do we bet with other people's money or do we invest as if it's our money? That's what we're doing, we're waiting for that opportunity.
CONSUELO MACK: Bob, what's your advice to individual investors who have had severe wealth destruction in their investment portfolios over the last couple of years? How can they rebuild that kind of wealth loss?
ROBERT RODRIGUEZ: I wish there was an easy, nice comforting answer to it. Unfortunately, there isn't. In my opinion it will take probably upwards of eight or ten years for the S&P 500 to get back to where it was in October of '07. And thus there has been severe capital destruction, and for some it's permanent because of where they are in their life cycle. If you're in your 20s and 30s and 40s, you have the benefit of time. If you're in your 60s and you're part of the baby boom generation and you got destroyed, guess what, you better be working. You better find a job. Those things there. You move in, you may become a renter out there.
CONSUELO MACK: If can you sell your house.
ROBERT RODRIGUEZ: Well no, the house gets taken, at least if they would allow it to go. But there is no God given right to an easy retirement. It was a fool's paradise out there. My parents and grandparents did not have an easy retirement. The world is unsafe and unstable. We had in this country, I believe, a perverse view of what reality truly was, and now that veil is being lifted, and I'm sorry, but it's going to take a long time and that nice retirement home or continuous vacations may not be there.
CONSUELO MACK: You told me that you see things that other people don't see.
ROBERT RODRIGUEZ: Sometimes.
CONSUELO MACK: So what are you seeing now that other people aren't seeing?
ROBERT RODRIGUEZ: I think the difference is many of us see the buildup of federal liabilities. But there's this feeling, well, it'll be okay, we'll get through it. Well, that was the same not too long ago when the house prices were going through and people would raise the question, what happens if housing prices get hit? Don't worry about it, we'll get through it. There's always that element. So I think the question is, as you have to place the odds, what are the odds that we'll get through this with the least amount of pain? I think that's where the difference comes.
If you want to be on the optimistic side and say we'll get through it and you're wrong, your shareholders pay for it and your clients pay for it. If we're right and we've done our job correctly, we protect capital in the negative side, and if we're wrong, we just don't earn as much as our competition. I think that's a better combination than destroying your clients and saying, well, we'll go out and get some more new clients out there. I don't like that one.
CONSUELO MACK: That's a great way actually to end the interview. So Bob Rodriguez, thank you so much for giving us your time.
ROBERT RODRIGUEZ: Thank you.
CONSUELO MACK: Next week in our "Great Investors" series, we are devoting our program to the late Peter Bernstein, one of the giants of the financial world who died in June at the age of 90. Bernstein, an economist, historian and seminal financial thinker and prolific author, appeared on WealthTrack exclusively several times. Next week we share his timeless wisdom.
In the meantime, to access the collective wisdom of our other great investors, go to our website, weathtrack.com. Have a great weekend and make the week ahead a profitable and a productive one.
CONSUELO MACK: This week on WealthTrack's "Great Investors" series: he races Porsches for fun and runs top performing stock and bond funds for his profession. What makes First Pacific Advisors' Robert Rodriguez step on the investment brakes or the accelerator? That's next on Consuelo Mack WealthTrack.
Hello and welcome to this "Great Investors" edition of WealthTrack. I'm Consuelo Mack. This week our great investor is Robert Rodriguez, a maverick money manager who has accomplished a feat no one else has. For the last 25 years, he has run not one but two top performing mutual funds, in not one but two asset classes, a stock fund and a bond fund. As widely followed personal finance columnist Jason Zweig put it, that is the investing equivalent of running two marathons at the same time, which is why Zweig calls him the best fund manager of our time.
Rodriguez is the CEO of Los Angeles-based First Pacific Advisors and co-portfolio manager of FPA Capital, a mid cap value fund, and FPA New Income, his bond fund, which just celebrated its 25th year in positive territory. Last year he and his co-manager Tom Atteberry were named Morningstar's fixed income managers of the year for their outstanding long-term stewardship. It is an honor Rodriguez has won two other times as well for both the stock and the bond fund, making him only the second fund manager to be honored three times. The first was last week's great investor, Bill Gross.
Rodriguez, who races Porsches as a hobby, has a high octane personality but a low tolerance for investment pain. He knows what it is like to lose. A first generation American, his paternal grandparents lost everything in the Mexican Civil War of 1910. His grandfather did not survive the war. His grandmother and six children nearly starved to death. It took them almost six years to come to the United States legally, a route his grandmother insisted on taking so her children could walk down the street with their heads held high.
Throughout his 39-year investment career, Rodriguez has taken the high integrity path, sometimes to his business detriment. He was one of the first to rail against the dot-com and credit bubbles, raising large defensive cash positions, early moves that lost him clients. He is an outspoken critic of the U.S. government's stimulus packages, burgeoning debt levels and business intervention. Four years ago he moved from California to Nevada to protest the golden state's budget excesses and income taxes, the highest in the nation. And he does not mince words in criticizing Wall Street and the mutual fund industry. In a wide ranging interview, I asked Rodriguez about his exceptional track record which he attributes to discipline and the ability to balance fear and greed.
ROBERT RODRIGUEZ: I think we have a healthy dose here of skepticism about our capabilities. When you've had some serious failures, it forces you to look inwardly, and I don't know of too many organizations where an investment professional puts his worst investment failure on his website. And it just tells you that no matter how skilled you are in this field, there are new ways to snatch defeat from the jaws of victory. So you have to balance these things. And we test ourselves daily on this, whether we're correct in our assumptions, but we don't want to let the day-to-day machinations in the marketplace disturb our long-term thinking.
CONSUELO MACK: You had in the Income Fund, you had your 25th straight up year, which is just unheard of. But in the FPA Capital Fund, in the stock fund, you had your worst year ever, down 35%, so what did you learn from last year?
ROBERT RODRIGUEZ: Well, we did as much as we could. I felt that by June of '08 there was nothing more we could do.
CONSUELO MACK: You had raised 45% cash?
ROBERT RODRIGUEZ: 45% cash, we're getting redeemed, you can't really take it any higher because the more higher you go, the faster the money goes out. So you have to strike a balance. And our largest exposure was to energy. We have a five and ten year horizon on, that we've been in the field for ten years after my being out of the sector for nearly 18 years. So there's the long-term view versus the short-term risk. And we did reduce our exposure in energy, prior to going into it. And we said now it's up to the gods. They went down with the market very hard and the first phase of an economic or stock market debacle, everything goes down. Then in the second phase they start to separate and in the third phase you start to see what really is going to work. Well, this year I would say what was taken away from us last year has been, a large part, has been given back to us this year for the right reasons. And so I have to think probably look at both years combined to say, all right, how did you go through this cycle, how did the others go through this? And then over the next five years, is your analysis correct? We happen to think it is, and if we are then our shareholders will be rewarded for that.
CONSUELO MACK: You've quoted in one of your speeches and one of your shareholder letters too that legendary economist John Maynard Keynes describing the long-term investor as eccentric, unconventional and rash in the eyes of the average opinion, which fits you to a tee, actually. So where does the eccentric and unconventional side of Bob Rodriguez come from? Where did you get this?
ROBERT RODRIGUEZ: I really don't like following the norm. If I follow the norm, I would never have been in this business. My last name is not a competitive advantage when I entered the field, and had to knock down a lot of doors, and you had to do things to separate yourself from the crowd, so that all started way back when I was very young. My first time I got anything to do with the investment field was writing a letter to the Federal Reserve chairman when I was ten. It was a school assignment.
CONSUELO MACK: And he wrote you back.
ROBERT RODRIGUEZ: And he wrote me back, and I said gee that's kind of neat, how many people would do that. What's the down side? So I started thinking differently about what the norm is, and then how can you turn that to your competitive advantage? So it's always been that way. I would say when I was in graduate school or just going into graduate school, I discovered Graham and Dodd during the summer before I was coming back to graduate school. And it really struck home, and I had the good fortune of meeting Charlie Munger in our investment course there.
CONSUELO MACK: Warren Buffett's kind of unknown partner.
ROBERT RODRIGUEZ: As Warren Buffett says, he's the smart one. And after the class I asked him, I said what can I do to make myself a better investor, beyond just what I'm doing here and researching, et cetera? And he said, read history. Read history. Read history. And if people had read history about the economic crises of before, not only the depression but even before then, they would have said this is an old friend, and so that helped. It's come from a number of different parts, but I think really not being afraid to fail and be different. That's what it took in order to differentiate in this business.
I had a friend of mine who was a growth stock manager who got just before the debacle of 2000, we were having lunch together in January of 2000 and he was buying all this dot com, and I said why are you buying this crap? And he says, because you have to, he says yes, if I don't buy it we won't be competitive. I said, but don't you realize, you are at the epicenter of a debacle that's going to occur? And when you get destroyed, you know, you could either have cash or you can buy these things. If you have cash, you get fired. If you buy the dot-com and it blows up, you get fired. So in both cases you're fired. What's the difference? Over here the one with the cash, where you held your investment discipline, you can rebuild your business. Over here, you've destroyed your credibility, you can never rebuild.
CONSUELO MACK: Let's talk about some of your unconventional current calls. You're describing the current economic state that we're in as a repression, which it's not as bad as the Great Depression, but it's also worse than a recession. Where is this repression taking us? What's it going to feel like?
ROBERT RODRIGUEZ: Here in the firm, we're using a new term for the economy. We're calling it the caterpillar economy. Where it goes up and goes down, goes up and goes down, but it doesn't move forward very fast, after this waterfall collapse that we had. And this is different from any other kind of economic environment that we've been in since the depression. You don't destroy the consumer's balance sheet, like what's gone on. You don't have the leverage in the system that we have and expect to come out of it the way we've come out of other periods. The president, I argue, that I think he's on the wrong road and when I compare him to let's say FDR. When he came into power, the debt to GDP was barely 17% when FDR came here, whereas now we're now at 65% going to 75, going to 90% this year.
CONSUELO MACK: IMF says 100 some odd percent?
ROBERT RODRIGUEZ: Right. And by the way, those numbers when FDR came into power did not include, because we didn't have any, entitlements. So if you add on the entitlements, it's even far larger. So as I've argued, we do not have the balance sheet flexibility today as we did in FDR's time. So if they want to go down, they being the Congress and the executive branch et cetera, and they want to build up these larger programs, they're going to come at a price. And in our opinion that price will be in the debt market, and in the Treasury market longer term. With higher interest rates.
CONSUELO MACK: Bob, you saw the credit crisis coming about five, at least five years ago. And at that time you predicted that there was a new financial system that was going to be created and a new era. So what's this new financial system that we can look forward to?
ROBERT RODRIGUEZ: I think, first of all, about four years ago we started talking about the breakdown in underwriting standards, et cetera. With the demise of Bear Stearns in March of last year, and what the response was by the federal government and the Fed, that's when we wrote "Crossing the Rubicon," that we had crossed over into a new financial era, a new system. And little did we know how far that was going to occur, within six months.
So we're still in this process of defining what this new system is. As a result, it is very difficult to define what appropriate valuation levels are going to be, because the goal posts keep getting moved. Look at Chrysler- we were extremely vehement against Chrysler and what happened there, where senior secured creditors were treated in such a shabby manner, it really ran over, you know, the sanctity of contract. So we're in a new system. That means the government is a larger percentage of GDP. The larger the percentage of GDP, the more likely GDP will grow at a substandard rate for an elongated period of time.
We're in the group, and I'm in the group, where the new world order that you were referring to, that I've referred to, is that the U.S. is going to have to change its economic system; that our foreign counterparts that have basically grown on the backs of U.S. consumer have got to turn inwardly for their growth. As a result, as they turn inwardly for their growth, such as China, the U.S. has to expand its exports. I don't see anything like that coming out of the administration or the incentives or anything else. As a result, the more the government takes a larger share of the economy, the likelihood we will be in a substandard period of growth and profit margins will also be substandard.
CONSUELO MACK: So how do you invest in an environment that is going to be substandard growth, that you don't know what the rules of the game are because you don't know what the government is going to do next, what do you do?
ROBERT RODRIGUEZ: It's going to be very hard. As a result, on the fixed income side, we're still maintaining our highest levels of quality. We haven't gone into the lower rungs of the high yield area, even though there's been big rungs there, because we think this is a head fake of what's going on in the economy and this rebound, the green shoots that people talk about. So we're going to stay high quality and let other people destroy themselves.
On the equity side, we think you have to be very focused in terms of the industries you go after. So we have a natural decline rate in, let's say energy, supplies of energy. So we think longer term- three, five, ten years. Energy prices are going to be considerably elevated from where they are today. So we have a heavy exposure there.
CONSUELO MACK: Heavy, like 55% of the FPA Capital Portfolio, is that right, is in energy?
ROBERT RODRIGUEZ: Well, about 41% of the total portfolio, about 55% of the equity. Okay. So we're looking for other areas to deploy capital that will both benefit from the international side but also from the commodities side.
So we see, you have to be rifle shooting over the course of the next five years or ten years, and that's why I gave a speech in Chicago at Morningstar that in my opinion, a highly diversified equity fund in this new order will be at a competitive disadvantage, especially if it carries management fees, et cetera, so you're going to have to do something different from the rest of the market in order to differentiate again, and that's what we're doing.
CONSUELO MACK: So let's talk about the investment industry, which you have been highly critical of, and the OPM attitude, "other people's money" attitude that you feel that the industry has been excessively greedy, not really paying attention to shareholders interests.
ROBERT RODRIGUEZ: Let's say abusive. I mean, how are mutual funds sold? They're brought out when the particular area is the hottest. So you sell what you can sell, and most of the time that is the absolute wrong time to be marketing that kind of product. So it's not investment oriented, it's marketing oriented. It's a marketing mindset, and as long as we have a marketing mindset in the industry and managers are fearful of under performing their bogey and having what we call tracking error where you deviate too far from your benchmark and god forbid you have too much volatility: all of these things will work to hit the industry. With this collapse, with the technology collapse and now with the credit collapse, the question I'm asking is: if active managers could not identify the two greatest speculative blowoffs in the last 75 years, when will they? And secondly, what are you buying from an active manager if they can't identify these things? You might as well go to an index.
CONSUELO MACK: Talk to me though about the shakeup that you think is going to happen in the mutual industry. Tell me what kind of a shakeout you expect.
ROBERT RODRIGUEZ: I just think that first of all, we have too many funds. When you sit there with 8,000 funds, and then you have 25 different share classes, it's quite complicated. And what is the investor getting for all of that? There's an expense to that, and the higher the expense in a lower return environment means you have less margin of safety for a total return.
CONSUELO MACK: So let's also talk about the fact that you are a long-term investor, but you told me that you look out-- some people say long term like a couple of years, you're really talking about five to nine years. And you made a decision about six years ago to take a sabbatical next year from your firm in 2010. And one of the reasons that you decided to take a sabbatical as well is because you looked out beyond the current crisis and you see something even bigger and scarier coming?
ROBERT RODRIGUEZ: I see another crisis coming.
CONSUELO MACK: What is that and like when?
ROBERT RODRIGUEZ: It's the explosion in the treasury debt, and the finances of this country. We still have time. But to, shall we say, become fiscally responsible. Am I optimistic about us doing that? No. You're residing in the state of California that I left here four years ago, because in my opinion, the system was fundamentally broken and the state was going to experience a devastating recession on the down side.
CONSUELO MACK: Which it is right now.
ROBERT RODRIGUEZ: Which it is right now. I believe the system in
Washington is fundamentally broken. And as a result, the explosion in dealt that I foresee in the next three years and if other programs are added on it will accelerate it, then I think we have a real problem brewing in our finances here. I'm estimating somewhere in the neighborhood of five to seven years from here.
CONSUELO MACK: Do you envision any time in FPA Income basically going out the risk curve a little bit? I mean, is there anything-- you've got about 90% in triple A rated securities in the portfolio?
ROBERT RODRIGUEZ: We are 22% in cash and we're barely over a one-year duration. We've had as much as 25% of the fund in high yield. We would love to go out on the risk curve. In the last six months, eight months, it's been highly profitable, just like the stock market has rallied. Is this sustainable? We don't think so. We think there's other dominos to fall that can disrupt this. So we don't like the odds. Plus in New Income, people come into the bond fund in New Income because they can trust it. It's when they couldn't trust virtually anything else in this country, other than Treasuries, our bond fund grew in the neighborhood of 60 to 80%. People came in because they could trust it. Well, here we are saying, how do we be good stewards going forward? Do we bet with other people's money or do we invest as if it's our money? That's what we're doing, we're waiting for that opportunity.
CONSUELO MACK: Bob, what's your advice to individual investors who have had severe wealth destruction in their investment portfolios over the last couple of years? How can they rebuild that kind of wealth loss?
ROBERT RODRIGUEZ: I wish there was an easy, nice comforting answer to it. Unfortunately, there isn't. In my opinion it will take probably upwards of eight or ten years for the S&P 500 to get back to where it was in October of '07. And thus there has been severe capital destruction, and for some it's permanent because of where they are in their life cycle. If you're in your 20s and 30s and 40s, you have the benefit of time. If you're in your 60s and you're part of the baby boom generation and you got destroyed, guess what, you better be working. You better find a job. Those things there. You move in, you may become a renter out there.
CONSUELO MACK: If can you sell your house.
ROBERT RODRIGUEZ: Well no, the house gets taken, at least if they would allow it to go. But there is no God given right to an easy retirement. It was a fool's paradise out there. My parents and grandparents did not have an easy retirement. The world is unsafe and unstable. We had in this country, I believe, a perverse view of what reality truly was, and now that veil is being lifted, and I'm sorry, but it's going to take a long time and that nice retirement home or continuous vacations may not be there.
CONSUELO MACK: You told me that you see things that other people don't see.
ROBERT RODRIGUEZ: Sometimes.
CONSUELO MACK: So what are you seeing now that other people aren't seeing?
ROBERT RODRIGUEZ: I think the difference is many of us see the buildup of federal liabilities. But there's this feeling, well, it'll be okay, we'll get through it. Well, that was the same not too long ago when the house prices were going through and people would raise the question, what happens if housing prices get hit? Don't worry about it, we'll get through it. There's always that element. So I think the question is, as you have to place the odds, what are the odds that we'll get through this with the least amount of pain? I think that's where the difference comes.
If you want to be on the optimistic side and say we'll get through it and you're wrong, your shareholders pay for it and your clients pay for it. If we're right and we've done our job correctly, we protect capital in the negative side, and if we're wrong, we just don't earn as much as our competition. I think that's a better combination than destroying your clients and saying, well, we'll go out and get some more new clients out there. I don't like that one.
CONSUELO MACK: That's a great way actually to end the interview. So Bob Rodriguez, thank you so much for giving us your time.
ROBERT RODRIGUEZ: Thank you.
CONSUELO MACK: Next week in our "Great Investors" series, we are devoting our program to the late Peter Bernstein, one of the giants of the financial world who died in June at the age of 90. Bernstein, an economist, historian and seminal financial thinker and prolific author, appeared on WealthTrack exclusively several times. Next week we share his timeless wisdom.
In the meantime, to access the collective wisdom of our other great investors, go to our website, weathtrack.com. Have a great weekend and make the week ahead a profitable and a productive one.
Ron Paul Thoughts
US REPRESENTATIVE RON PAUL HAS PRUDENT THOUGHTS ON HOW TO FIX THE ECONOMY. I AGREE WITH MANY OF THE THINGS HE SAYS. HOWEVER, WE WON'T BE GOING BACK TO THE GOLD STANDARD. IF WE STOPPED PRINTING MONEY, IT WOULD ACHIEVE THE SAME THING.
How a "Very Pessimistic" Ron Paul Would Fix the Economy
Posted Jul 16, 2009 11:20am EDT by Aaron Task in Newsmakers, Recession, Banking
Long a proponent of small government and a staunch opponent of the Federal Reserve system, Paul's main point is that increased spending and higher deficits are not the solution to our problems, but their cause.
"You can take care of people, but never with a deficit, never by expanding the spending," the Texas Republican says in this exclusive video interview, taped in the Capitol Hill Rotunda in Washington D.C. "The more we do to interfere with the correction - the longer it lasts."
Had he been elected, Paul said he would be doing "a lot less" than President Obama and blames Keynesian economics - which advocates increased government borrowing and spending during times of duress -- for our nation's current ills.
While admitting a transition to what he views an "ideal society" won't be quick or simple, Paul's economic prescription includes:
* Allowing bankruptcies to occur vs. rewarding failure with bailouts.
* Stop inflation by dismantling the Fed and returning to the gold standard.
* Encourage savings and liquidate debt.
* Deregulate.
* Give tax credits to those who take care of themselves, or the doctors who provide their care.
* Cut government spending, especially on international endeavors. "We spend hundreds of billions of maintaining our empire around the world. Let's bring that money home," he says.
These recommendations will be familiar to anyone who followed (or supported) Paul's run for the Presidency in 2008. Given all that's transpired in the past year, one suspects he'd be getting a lot more votes if the campaign were happening today.
How a "Very Pessimistic" Ron Paul Would Fix the Economy
Posted Jul 16, 2009 11:20am EDT by Aaron Task in Newsmakers, Recession, Banking
Long a proponent of small government and a staunch opponent of the Federal Reserve system, Paul's main point is that increased spending and higher deficits are not the solution to our problems, but their cause.
"You can take care of people, but never with a deficit, never by expanding the spending," the Texas Republican says in this exclusive video interview, taped in the Capitol Hill Rotunda in Washington D.C. "The more we do to interfere with the correction - the longer it lasts."
Had he been elected, Paul said he would be doing "a lot less" than President Obama and blames Keynesian economics - which advocates increased government borrowing and spending during times of duress -- for our nation's current ills.
While admitting a transition to what he views an "ideal society" won't be quick or simple, Paul's economic prescription includes:
* Allowing bankruptcies to occur vs. rewarding failure with bailouts.
* Stop inflation by dismantling the Fed and returning to the gold standard.
* Encourage savings and liquidate debt.
* Deregulate.
* Give tax credits to those who take care of themselves, or the doctors who provide their care.
* Cut government spending, especially on international endeavors. "We spend hundreds of billions of maintaining our empire around the world. Let's bring that money home," he says.
These recommendations will be familiar to anyone who followed (or supported) Paul's run for the Presidency in 2008. Given all that's transpired in the past year, one suspects he'd be getting a lot more votes if the campaign were happening today.
Wednesday, July 15, 2009
Bob Rodriguez
ON GURUFOCUS.COM
Robert Rodriguez is the first one among our gurus to report his second quarter portfolio. We have just update his recent stock buys and sells and portfolio. Here we would like to point out some most le moves he had with his portfolio for the second quarter.
Who is Robert Rodriguez?
If you are not familiar with Robert Rodriguez, he is the CEO of FPA Advisors and manager of FPA Capital Fund. During the past 20 years, his fund averaged 12.85%, outperforming S&P500 by more than 5% a year.
Robert Rodriguez uses absolute value screen to pick stocks for his portfolio. When he cannot find stocks, he is willing to park funds in cash. This was proved in the years of 2007 and 2008, while he froze buying and had more than 50% of money in cash.
As a bottom up investor, Robert Rodriguez seems to have good understanding on the overall market valuation and sector allocations. In 2007 he had only 3% of his portfolio in financials, and more than 30% in energy stocks. The indicator he used was the ratio of sector total market cap relative to sector GDP. He said: “Financial service stocks represent nearly 22% of the S&P 500 and 28% of its earnings. If one adds in the financial subsidiaries of GE, GM and others, it is quite easy to get the financial share of the S&P 500’s earnings above 30%. This segment’s profitability is at risk.” (see: Robert Rodriguez's Perspective on Financial Stocks and Sub-Prime Loans )
Here we like to point out that Warren Buffett uses total market cap relative to GNP as the indicator of the overall market valuation. We have developed an Broad Market Valuation Indicator, which shows that the market is probably modestly undervalued at current level.
He wrote in 2006: “the financial-services sector currently represents over 22% of the S&P 500. After nearly 25 years of interest-rate declines and the explosion in financial derivatives and questionable lending practices, we prefer to be invested in energy rather than in financial services.” This has helped Robert Rodriguez avoided the loss in financial stocks.
Energy is by far the most weighted sector
As Robert Rodriguez discussed many times in his shareholder letters and speeches, he is very bullish with energy sector and heavily weighted in energy stocks. Since 2005, he has had energy as his largest holding, and his fund had a terrific run with the energy stocks. This is a recap of what he wrote about energy stocks over the past few years.
Experiences With Energy Stocks in 1979, Reduced Exposure From Over 40% to 3%
Robert Rodriguez: We remain very optimistic toward the outlook for energy prices. Before discussing why, I would like to take you back many years into an earlier part of my career. It was 1979, the Iran/Iraq war was taking place and oil was approaching $40 per barrel. There were many “experts” who were calling for $100-per-barrel oil within ten years. I had the good fortune to participate in a high-level corporate meeting at a former employer, where the longterm outlook for energy prices was discussed. At the conclusion of that meeting, the firm’s senior energy analyst concluded that oil would likely be at $80 in ten years. I asked a simple question as to what might be the effects of this forecast on our life, property and casualty, and consumer finance operations, should he be correct. At the end of this discussion, it was estimated that nearly 90% of the company’s operations would probably be bankrupt before we even reached the ten-year mark. My associate and I walked out of that meeting and began selling our energy holdings the following day since, if our company experienced this bankruptcy scenario, this outcome would have serious negative implications for the economy. Over the next two years, we reduced our investment exposure from over 40% to nearly 3%, just before I left the company. I revisit this period because, during this discussion, supporting documentation was presented that indicated oil production would not peak for at least another 25 to 50 years. I never forgot that chart.
After Almost 20 Years, Robert Rodriguez Revisited Energy Stocks and Bought First Energy Stock Since 1981
Robert Rodriguez: In 1997, I began pondering how the long-term outlook for oil consumption and oil prices may have changed since that fateful meeting nearly 18 years earlier. One would think that, after all this time, energy companies and investors should have a better understanding of the situation. It appears that this was generally not the case, since oil prices and share prices were low and heading lower. In thinking about this, I began to realize that, fundamentally, nothing had really changed, in that no major new fields had been discovered and that consumption had continued to grow. At the beginning of 1998, my associate, Dennis Bryan and I, began a search for an energy analyst. We were very fortunate to have found and hired Rikard Ekstrand. He joined us at the beginning of 1999 and our first energy investment entered the portfolio two months later. This was my first investment in energy since 1981. The point in reviewing this is that we consider energy to be a strategic investment area for us. We expect it to be a large percentage of your Fund for many, many years to come and, therefore, we tend to look through the short-term price variations of our holdings. If share prices rise too rapidly, we may trim a portion of our holdings, but if they decline, we will add to them, aggressively.
Why We Are So Positive About Energy Stocks
Robert Rodriguez: Why are we so positive? Despite the price runup in energy stocks during the past five years, this sector represents barely 10% of the S&P 500. This is up from a low of approximately 5%, but it is down from the 1979 peak of over 30%. Notice that the energy sector topped out at a level that was very close to where the technology sector peaked in 2000. Though it has been a strong performer these past five years, its significance, as a percentage of the major averages, is still substantially less than other periods when a sector has become “the” sector to own.
Oil Prices in the Past Century
Robert Rodriguez: When I entered the investment industry in 1971, worldwide oil consumption was approximately 45 million barrels per day versus 84 million today. The last major oil fields to be discovered were in 1968 at Prudhoe Bay , Alaska and the Shaybah offshore field in Saudi Arabia . We are on the verge of doubling consumption and yet, there have been no other major fields discovered. In the case of the Shaybah field, production began in 1998, so this has helped Saudi Arabia to maintain its daily production. After nearly forty years of searching, with the most advanced technology available and no major fields to show for it, does this not raise a question as to the likelihood of a continuation of low-cost energy prices? Between 1933 and 1970, the price per barrel of oil increased at approximately a 10% compound growth rate, from 10 cents to $3.39. With huge oil discoveries in the 1930s, 40s and 60s, oil prices were low and controlled by the U.S. For many of these years, the price was maintained between $1 and $2 per barrel. With the peak in U.S. oil production in 1970, the world entered a new era. Between 1970 and 2006, oil prices have grown at about an 8.6% annual rate. Much of this rise has occurred in short time periods. As demand grew into the available supply, oil prices began to escalate. For the entire 73-year period, oil prices have grown at approximately a 9.3% annual rate. Given that there have been no major oil discoveries since the late 1960s, this raises the question of what might the rate of growth be in oil prices going forward. If we are to be conservative, possibly a 5% growth rate might be appropriate. This would be a little more than half the rate of growth for the last 73 years. If this were to occur, a barrel of oil would cost approximately $100 in ten years. For consumers not to experience an increase in their energy spending as a percentage of total spending, either their incomes have to grow in line with energy prices or they will have to reduce their energy use. Either way, this could affect the nature and growth of the economy considerably.
World Oil Production May Have Reached Its Peak
Robert Rodriguez: In the case of supply, within the next five years, three countries may reach a peak in oil production: Mexico , China and Russia . Several analysts estimated that Mexican oil production would likely peak around 3.4 million barrels per day and that this event would occur in 2004. Mexico ’s largest oilfield, Cantarell, appears to have peaked and if this is the case, so has Mexican oil production, since six of every ten barrels produced by Mexico comes from this one field. Earlier this year, a 3% decline rate was forecast for Cantarell’s production. This has proved incorrect since it is now estimated that the decline rate is 8%. Obviously, this is likely to be of some concern to Mexico . Should this forecast of peak oil production for these three countries be correct, an additional 35% of non-OPEC oil production will have peaked, and together with the 41% from eleven major countries and others that have experienced a peak in production rates, 76% of non-OPEC oil production might have peaked by 2012. If this occurs, it will give the middle-eastern countries even more clout in the setting of oil prices. This is not a pleasant thought.
As for the possibility of Saudi Arabia and OPEC riding to the rescue, there is a major debate occurring within energy circles as to whether they will be able meet rising oil demand. Saudi Arabia says that they will have no problem meeting incremental oil demand for years to come. They estimate that they have over 250 billion barrels of reserves. This estimate has not changed since 1988, despite their producing over 3 billion barrels per year for nearly twenty years. Saudi Aramco, the Saudi state oil company, has acknowledged that its gross depletion rate is now approaching eight percent. If true, Saudi Arabia needs to bring on 800,000 barrels per day of new oil production each year to offset declines in existing fields. Several OPEC nations appear to have already peaked in their production capabilities. We wonder whether the margin of safety is as great as what Saudi Arabia would have us believe. The last independent audit of their reserves was done nearly thirty years ago and at that time, their reserves were estimated to be 110 billion barrels. It does raise a question.
The Energy Sector Will Remain a Strategic Investment Area for Us
We view the energy sector as both a store of value and a hedge against a future inflation. It is one of the few sectors where we believe the underlying fundamentals will continue to improve despite the worldwide economic contraction. With worldwide oil depletion rates of 9% annually for those fields past peak and U.S. natural gas first-year production decline rates of between 30% and 50%, these trends should be supportive of energy prices longer term.
Again, within three to five years, we believe oil prices will be back above $100 or even higher than $150 per barrel. Our recent asset deployments reflect our typical strategy of being “out of step” with the general consensus, especially with an energy exposure that is nearly 50% of all of our equity holdings.
We deployed more capital than at any other period in the last 25 years, late last year and early this year, with 67% directed into energy stocks. This added to FPA Capital Fund’s hefty energy exposure that existed prior to the market collapse. Over 50% of the Fund’s equity investments are currently in energy.
The Worry on National Debt and Inflation
I estimate that by the close of 2011, Treasury debt outstanding will be between $14.6 and $16.6 trillion and that the U.S. debt to GDP ratio will rise to between 97% and 110%. By comparison, the highest ratio ever attained was 121% at the end of WW2. Furthermore, my estimates do not include entitlement liabilities or the effective guarantee of trillions of dollars of Fannie Mae and Freddie Mac obligations. Treasury debt service will likely rise by 50% to 100% above the present $450 billion rate and this is with interest rate levels near record lows. A critical question is, “How do we finance all this debt?” Assuming consumers save an additional $650 billion in 2009, we will still be more dependent on foreign sources of financing. Should foreign investors retain their present amount of Treasury debt ownership and then let it increase proportionally to our debt growth this year, additional purchases between $719 and $862 billion are required versus last year’s $724 billion. This appears doubtful, given the deterioration in their domestic economies along with rapidly declining exports. To make up the difference, the Fed will be forced to print an additional $800 billion to $1.5 trillion of new money to buy these bonds. Unless Americans increase their personal savings per my estimates and foreign investors boost their Treasury ownership by 39% to 57% between 2009 and 2011, the Fed could be forced to print additional money. This possibility may unnerve some of our trading partners, particularly the Chinese and the oil exporting countries.
Robert Rodriguez is the first one among our gurus to report his second quarter portfolio. We have just update his recent stock buys and sells and portfolio. Here we would like to point out some most le moves he had with his portfolio for the second quarter.
Who is Robert Rodriguez?
If you are not familiar with Robert Rodriguez, he is the CEO of FPA Advisors and manager of FPA Capital Fund. During the past 20 years, his fund averaged 12.85%, outperforming S&P500 by more than 5% a year.
Robert Rodriguez uses absolute value screen to pick stocks for his portfolio. When he cannot find stocks, he is willing to park funds in cash. This was proved in the years of 2007 and 2008, while he froze buying and had more than 50% of money in cash.
As a bottom up investor, Robert Rodriguez seems to have good understanding on the overall market valuation and sector allocations. In 2007 he had only 3% of his portfolio in financials, and more than 30% in energy stocks. The indicator he used was the ratio of sector total market cap relative to sector GDP. He said: “Financial service stocks represent nearly 22% of the S&P 500 and 28% of its earnings. If one adds in the financial subsidiaries of GE, GM and others, it is quite easy to get the financial share of the S&P 500’s earnings above 30%. This segment’s profitability is at risk.” (see: Robert Rodriguez's Perspective on Financial Stocks and Sub-Prime Loans )
Here we like to point out that Warren Buffett uses total market cap relative to GNP as the indicator of the overall market valuation. We have developed an Broad Market Valuation Indicator, which shows that the market is probably modestly undervalued at current level.
He wrote in 2006: “the financial-services sector currently represents over 22% of the S&P 500. After nearly 25 years of interest-rate declines and the explosion in financial derivatives and questionable lending practices, we prefer to be invested in energy rather than in financial services.” This has helped Robert Rodriguez avoided the loss in financial stocks.
Energy is by far the most weighted sector
As Robert Rodriguez discussed many times in his shareholder letters and speeches, he is very bullish with energy sector and heavily weighted in energy stocks. Since 2005, he has had energy as his largest holding, and his fund had a terrific run with the energy stocks. This is a recap of what he wrote about energy stocks over the past few years.
Experiences With Energy Stocks in 1979, Reduced Exposure From Over 40% to 3%
Robert Rodriguez: We remain very optimistic toward the outlook for energy prices. Before discussing why, I would like to take you back many years into an earlier part of my career. It was 1979, the Iran/Iraq war was taking place and oil was approaching $40 per barrel. There were many “experts” who were calling for $100-per-barrel oil within ten years. I had the good fortune to participate in a high-level corporate meeting at a former employer, where the longterm outlook for energy prices was discussed. At the conclusion of that meeting, the firm’s senior energy analyst concluded that oil would likely be at $80 in ten years. I asked a simple question as to what might be the effects of this forecast on our life, property and casualty, and consumer finance operations, should he be correct. At the end of this discussion, it was estimated that nearly 90% of the company’s operations would probably be bankrupt before we even reached the ten-year mark. My associate and I walked out of that meeting and began selling our energy holdings the following day since, if our company experienced this bankruptcy scenario, this outcome would have serious negative implications for the economy. Over the next two years, we reduced our investment exposure from over 40% to nearly 3%, just before I left the company. I revisit this period because, during this discussion, supporting documentation was presented that indicated oil production would not peak for at least another 25 to 50 years. I never forgot that chart.
After Almost 20 Years, Robert Rodriguez Revisited Energy Stocks and Bought First Energy Stock Since 1981
Robert Rodriguez: In 1997, I began pondering how the long-term outlook for oil consumption and oil prices may have changed since that fateful meeting nearly 18 years earlier. One would think that, after all this time, energy companies and investors should have a better understanding of the situation. It appears that this was generally not the case, since oil prices and share prices were low and heading lower. In thinking about this, I began to realize that, fundamentally, nothing had really changed, in that no major new fields had been discovered and that consumption had continued to grow. At the beginning of 1998, my associate, Dennis Bryan and I, began a search for an energy analyst. We were very fortunate to have found and hired Rikard Ekstrand. He joined us at the beginning of 1999 and our first energy investment entered the portfolio two months later. This was my first investment in energy since 1981. The point in reviewing this is that we consider energy to be a strategic investment area for us. We expect it to be a large percentage of your Fund for many, many years to come and, therefore, we tend to look through the short-term price variations of our holdings. If share prices rise too rapidly, we may trim a portion of our holdings, but if they decline, we will add to them, aggressively.
Why We Are So Positive About Energy Stocks
Robert Rodriguez: Why are we so positive? Despite the price runup in energy stocks during the past five years, this sector represents barely 10% of the S&P 500. This is up from a low of approximately 5%, but it is down from the 1979 peak of over 30%. Notice that the energy sector topped out at a level that was very close to where the technology sector peaked in 2000. Though it has been a strong performer these past five years, its significance, as a percentage of the major averages, is still substantially less than other periods when a sector has become “the” sector to own.
Oil Prices in the Past Century
Robert Rodriguez: When I entered the investment industry in 1971, worldwide oil consumption was approximately 45 million barrels per day versus 84 million today. The last major oil fields to be discovered were in 1968 at Prudhoe Bay , Alaska and the Shaybah offshore field in Saudi Arabia . We are on the verge of doubling consumption and yet, there have been no other major fields discovered. In the case of the Shaybah field, production began in 1998, so this has helped Saudi Arabia to maintain its daily production. After nearly forty years of searching, with the most advanced technology available and no major fields to show for it, does this not raise a question as to the likelihood of a continuation of low-cost energy prices? Between 1933 and 1970, the price per barrel of oil increased at approximately a 10% compound growth rate, from 10 cents to $3.39. With huge oil discoveries in the 1930s, 40s and 60s, oil prices were low and controlled by the U.S. For many of these years, the price was maintained between $1 and $2 per barrel. With the peak in U.S. oil production in 1970, the world entered a new era. Between 1970 and 2006, oil prices have grown at about an 8.6% annual rate. Much of this rise has occurred in short time periods. As demand grew into the available supply, oil prices began to escalate. For the entire 73-year period, oil prices have grown at approximately a 9.3% annual rate. Given that there have been no major oil discoveries since the late 1960s, this raises the question of what might the rate of growth be in oil prices going forward. If we are to be conservative, possibly a 5% growth rate might be appropriate. This would be a little more than half the rate of growth for the last 73 years. If this were to occur, a barrel of oil would cost approximately $100 in ten years. For consumers not to experience an increase in their energy spending as a percentage of total spending, either their incomes have to grow in line with energy prices or they will have to reduce their energy use. Either way, this could affect the nature and growth of the economy considerably.
World Oil Production May Have Reached Its Peak
Robert Rodriguez: In the case of supply, within the next five years, three countries may reach a peak in oil production: Mexico , China and Russia . Several analysts estimated that Mexican oil production would likely peak around 3.4 million barrels per day and that this event would occur in 2004. Mexico ’s largest oilfield, Cantarell, appears to have peaked and if this is the case, so has Mexican oil production, since six of every ten barrels produced by Mexico comes from this one field. Earlier this year, a 3% decline rate was forecast for Cantarell’s production. This has proved incorrect since it is now estimated that the decline rate is 8%. Obviously, this is likely to be of some concern to Mexico . Should this forecast of peak oil production for these three countries be correct, an additional 35% of non-OPEC oil production will have peaked, and together with the 41% from eleven major countries and others that have experienced a peak in production rates, 76% of non-OPEC oil production might have peaked by 2012. If this occurs, it will give the middle-eastern countries even more clout in the setting of oil prices. This is not a pleasant thought.
As for the possibility of Saudi Arabia and OPEC riding to the rescue, there is a major debate occurring within energy circles as to whether they will be able meet rising oil demand. Saudi Arabia says that they will have no problem meeting incremental oil demand for years to come. They estimate that they have over 250 billion barrels of reserves. This estimate has not changed since 1988, despite their producing over 3 billion barrels per year for nearly twenty years. Saudi Aramco, the Saudi state oil company, has acknowledged that its gross depletion rate is now approaching eight percent. If true, Saudi Arabia needs to bring on 800,000 barrels per day of new oil production each year to offset declines in existing fields. Several OPEC nations appear to have already peaked in their production capabilities. We wonder whether the margin of safety is as great as what Saudi Arabia would have us believe. The last independent audit of their reserves was done nearly thirty years ago and at that time, their reserves were estimated to be 110 billion barrels. It does raise a question.
The Energy Sector Will Remain a Strategic Investment Area for Us
We view the energy sector as both a store of value and a hedge against a future inflation. It is one of the few sectors where we believe the underlying fundamentals will continue to improve despite the worldwide economic contraction. With worldwide oil depletion rates of 9% annually for those fields past peak and U.S. natural gas first-year production decline rates of between 30% and 50%, these trends should be supportive of energy prices longer term.
Again, within three to five years, we believe oil prices will be back above $100 or even higher than $150 per barrel. Our recent asset deployments reflect our typical strategy of being “out of step” with the general consensus, especially with an energy exposure that is nearly 50% of all of our equity holdings.
We deployed more capital than at any other period in the last 25 years, late last year and early this year, with 67% directed into energy stocks. This added to FPA Capital Fund’s hefty energy exposure that existed prior to the market collapse. Over 50% of the Fund’s equity investments are currently in energy.
The Worry on National Debt and Inflation
I estimate that by the close of 2011, Treasury debt outstanding will be between $14.6 and $16.6 trillion and that the U.S. debt to GDP ratio will rise to between 97% and 110%. By comparison, the highest ratio ever attained was 121% at the end of WW2. Furthermore, my estimates do not include entitlement liabilities or the effective guarantee of trillions of dollars of Fannie Mae and Freddie Mac obligations. Treasury debt service will likely rise by 50% to 100% above the present $450 billion rate and this is with interest rate levels near record lows. A critical question is, “How do we finance all this debt?” Assuming consumers save an additional $650 billion in 2009, we will still be more dependent on foreign sources of financing. Should foreign investors retain their present amount of Treasury debt ownership and then let it increase proportionally to our debt growth this year, additional purchases between $719 and $862 billion are required versus last year’s $724 billion. This appears doubtful, given the deterioration in their domestic economies along with rapidly declining exports. To make up the difference, the Fed will be forced to print an additional $800 billion to $1.5 trillion of new money to buy these bonds. Unless Americans increase their personal savings per my estimates and foreign investors boost their Treasury ownership by 39% to 57% between 2009 and 2011, the Fed could be forced to print additional money. This possibility may unnerve some of our trading partners, particularly the Chinese and the oil exporting countries.
Monday, July 6, 2009
BAD NEWS FOR HIGH END REAL ESTATE
THIS IS THE NEWS THAT I'VE BEEN WAITING FOR. THEY SAID THAT REAL ESTATE WOULDN'T DROP IN SANTA MONICA (WHERE I LIVE). BOY, WERE THEY WRONG.
Has the housing market scraped bottom? Not in some of the wealthier neighborhoods--places like New York City's Greenwich Village, Santa Monica, Calif. and Chicago's Lincoln Park. They held up nicely while the rest of the country slumped last year. This year such Tiffany zip codes are on track to fall 15% to 25%.
Why haven't you heard about this? Statistics lag. With relatively low unemployment, high-end addresses don't have foreclosures to hasten capitulation. If they've attracted luxury high-rise developers, these markets may be propped up by recent condo closings at foolish prices agreed to two years ago. But talk to experts who know the regions block by block--or to people who've sold (or tried to sell) a home or co-op. There is a still-growing supply of wildly overpriced, unsold homes--60,000 U.S. properties priced above $2 million listed on Realtor.com. Experts get these gloomy vibes by dividing inventory by the current monthly rate of purchases. "Any result over seven months generally means falling prices," says David Stiff, chief economist at Fiserv ( FISV - news - people ) in Brookfield, Wis. In some tony neighborhoods the level of glut is higher than the national average of ten months.
Unsold inventories in Manhattan are at their highest levels in a decade. You can't tell by looking at data about its condo market. According to Radar Logic, which generates national realty info from its New York City office, condo values fell only 4% last year--far less than the 12% drop for the city as a whole. It's been held aloft by new-construction condo sales above the $1,200-per-square-foot level, says Radar Logic founder Michael Feder, reflecting deals struck a year or two ago. Once they pass through the system, the average price of a condo will plummet to $900 a square foot, reckons Feder.
In addition to the 10,500 properties already listed, there are another 9,500 in the wings, estimates Manhattan appraiser Jonathan Miller. Some 2,500 of these shadow listings belong to sellers who have some flexibility to keep their listings off the market in hopes of better pricing. Developers hold the rest. Both groups are likely to rush their listings onto the market once it's clear prices are falling. Some folks can't wait. Françoise Pourcel, 62, listed her 2,100-square-foot Tribeca loft last August at $3.5 million, in line with the sale price of a similar unit on a lower floor of her building. In June she accepted a bid for $2.5 million.
Condo prices in Manhattan would have to fall 50% to return to values relative to rents they had in 1999, a relatively sane year in real estate. A condo owner could then lease his home and garner net rental income (rent minus property taxes, insurance and fix-up costs) equal to about 7% of the property's fair market value. The current yield is around 3.3%. Far too low.
It's a similar story in Lincoln Park, where single-family home prices slipped only 2.2% last year, far less than in the rest of Chicago. But inventory has since tripled. Wagner Appraisal Group figures there's a 16-month supply. A year ago "I was almost cocky about our position compared to the rest of the market," says Jennifer Ames. No longer. After 11 months of lowering the $2.1 million asking price on her 3,400-square-foot house, Ames sold it in June for $1.6 million.
Given the glut of unsold homes, Lincoln Park's prices may well slide at least 15% this year--as Chicago's did in 2008. If you look at Fiserv data going back many years, you find values in Lincoln Park track the rest of Chicago pretty closely with a one-year lag.
In Santa Monica's coveted "north of Montana" area overlooking the Pacific, listings are up 60% since last year and the number of days on the market for those listings has doubled to 140. Homes once sold in as little as a week here. Closer to Main Street, Bill H. Meyers has struggled for more than a year to sell his condo. In April 2008 L.A. was hurting, but Santa Monica values hovered around their peaks. So Meyers tried to unload his property for $850,000, roughly in line with what another unit in his building sold for. He turned down bids near $800,000 after he found a renter at $3,500 a month.
Now that his tenant is gone, Meyers hasn't found a replacement at that price, and getting another $800,000 bid is impossible. The data still say Santa Monica is stronger than other nearby markets. It's just 14% off peak prices, versus Los Angeles, down 38%. But the beach city's inventory of unsold homes has just crossed the 15-month level, as high as Los Angeles' were last year. By that grim logic, Santa Monica's values are likely to tumble as far as those in Los Angeles did last year, 27%.
Like Meyers, anyone who can afford to will hang on as long as possible, banking on the faith, he says, that "the market is going to come back." Meantime, excess supply is piling up.
States of Collapse?
Last year the housing crash spared some of the nation's fanciest enclaves. But mounting inventories suggest they may drop as much this year as their metros did in 2008.
-------------------
Has the housing market scraped bottom? Not in some of the wealthier neighborhoods--places like New York City's Greenwich Village, Santa Monica, Calif. and Chicago's Lincoln Park. They held up nicely while the rest of the country slumped last year. This year such Tiffany zip codes are on track to fall 15% to 25%.
Why haven't you heard about this? Statistics lag. With relatively low unemployment, high-end addresses don't have foreclosures to hasten capitulation. If they've attracted luxury high-rise developers, these markets may be propped up by recent condo closings at foolish prices agreed to two years ago. But talk to experts who know the regions block by block--or to people who've sold (or tried to sell) a home or co-op. There is a still-growing supply of wildly overpriced, unsold homes--60,000 U.S. properties priced above $2 million listed on Realtor.com. Experts get these gloomy vibes by dividing inventory by the current monthly rate of purchases. "Any result over seven months generally means falling prices," says David Stiff, chief economist at Fiserv ( FISV - news - people ) in Brookfield, Wis. In some tony neighborhoods the level of glut is higher than the national average of ten months.
Unsold inventories in Manhattan are at their highest levels in a decade. You can't tell by looking at data about its condo market. According to Radar Logic, which generates national realty info from its New York City office, condo values fell only 4% last year--far less than the 12% drop for the city as a whole. It's been held aloft by new-construction condo sales above the $1,200-per-square-foot level, says Radar Logic founder Michael Feder, reflecting deals struck a year or two ago. Once they pass through the system, the average price of a condo will plummet to $900 a square foot, reckons Feder.
In addition to the 10,500 properties already listed, there are another 9,500 in the wings, estimates Manhattan appraiser Jonathan Miller. Some 2,500 of these shadow listings belong to sellers who have some flexibility to keep their listings off the market in hopes of better pricing. Developers hold the rest. Both groups are likely to rush their listings onto the market once it's clear prices are falling. Some folks can't wait. Françoise Pourcel, 62, listed her 2,100-square-foot Tribeca loft last August at $3.5 million, in line with the sale price of a similar unit on a lower floor of her building. In June she accepted a bid for $2.5 million.
Condo prices in Manhattan would have to fall 50% to return to values relative to rents they had in 1999, a relatively sane year in real estate. A condo owner could then lease his home and garner net rental income (rent minus property taxes, insurance and fix-up costs) equal to about 7% of the property's fair market value. The current yield is around 3.3%. Far too low.
It's a similar story in Lincoln Park, where single-family home prices slipped only 2.2% last year, far less than in the rest of Chicago. But inventory has since tripled. Wagner Appraisal Group figures there's a 16-month supply. A year ago "I was almost cocky about our position compared to the rest of the market," says Jennifer Ames. No longer. After 11 months of lowering the $2.1 million asking price on her 3,400-square-foot house, Ames sold it in June for $1.6 million.
Given the glut of unsold homes, Lincoln Park's prices may well slide at least 15% this year--as Chicago's did in 2008. If you look at Fiserv data going back many years, you find values in Lincoln Park track the rest of Chicago pretty closely with a one-year lag.
In Santa Monica's coveted "north of Montana" area overlooking the Pacific, listings are up 60% since last year and the number of days on the market for those listings has doubled to 140. Homes once sold in as little as a week here. Closer to Main Street, Bill H. Meyers has struggled for more than a year to sell his condo. In April 2008 L.A. was hurting, but Santa Monica values hovered around their peaks. So Meyers tried to unload his property for $850,000, roughly in line with what another unit in his building sold for. He turned down bids near $800,000 after he found a renter at $3,500 a month.
Now that his tenant is gone, Meyers hasn't found a replacement at that price, and getting another $800,000 bid is impossible. The data still say Santa Monica is stronger than other nearby markets. It's just 14% off peak prices, versus Los Angeles, down 38%. But the beach city's inventory of unsold homes has just crossed the 15-month level, as high as Los Angeles' were last year. By that grim logic, Santa Monica's values are likely to tumble as far as those in Los Angeles did last year, 27%.
Like Meyers, anyone who can afford to will hang on as long as possible, banking on the faith, he says, that "the market is going to come back." Meantime, excess supply is piling up.
States of Collapse?
Last year the housing crash spared some of the nation's fanciest enclaves. But mounting inventories suggest they may drop as much this year as their metros did in 2008.
-------------------
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