The richest one percent of this country owns half our country's wealth, five trillion dollars. One third of that comes from hard work, two thirds comes from inheritance, interest on interest accumulating to widows and idiot sons and what I do, stock and real estate speculation. It's bullshit. You got ninety percent of the American public out there with little or no net worth. I create nothing. I own.
Monday, June 06, 2011
Bob Rodriguez: The man who sees another crash
He's the mutual fund manager with the best record in the past quarter-century, and he correctly predicted the last two stock market crashes. So why aren't people listening when Bob Rodriguez says another calamity is looming?
FORTUNE -- You have to see it from Bob Rodriguez's perspective. Twice he has spotted an approaching storm. Twice he has warned the world. Twice he has been pooh-poohed and seen investors abandon the two mutual funds he managed. Twice he has taken steps to shield his clients from the coming crisis.
And twice -- first with Internet stocks in the 1990s, and then with the financial crisis of 2008 -- Rodriguez has been right.
As the latter cataclysm unfolded, the man once mocked for missing out on the hottest markets of his lifetime was anointed as a seer. The Wall Street Journal pronounced Rodriguez one of the "doomsayers who got it right." Barron'slabeled him a "prophet." MarketWatch described him as one of the "four horsemen of the market."
Rodriguez, the CEO of $16 billion money management firm First Pacific Advisors, isn't the type to be satisfied with being right (though he's certainly not above that particular pleasure). He's seemingly compelled to share the hard truth. It's as if he has this terrible gift, and with that comes the obligation to tell the world when calamity is on the horizon.
So when he was invited to address more than 1,000 mutual fund managers at a conference held by Morningstar in May 2009 -- just when it looked as if the crisis had finally abated -- Rodriguez gave himself only a brief pat on the back. Then he launched into a tirade, ripping into all of the parties involved in the meltdown. Fund managers, he said, had "stunk." The federal stimulus programs were foolish and shortsighted, and regulators had lost all credibility. Worst of all, he said, was the ballooning U.S. debt, which had prompted him to stop buying long-term bonds from the "irresponsible and fiscally inept government."
He continued in that fiery vein for almost an hour. When he was done, he stared out into an awkward and complete silence. Then it came: a thunderous standing ovation from the very fund managers he had just excoriated.
Rodriguez is an anomaly in the sunny world of mutual funds, where the typical manager is perpetually optimistic and happy to welcome ever more investors. Indeed, he's almost an oxymoron: a buy-and-hold man with the stubborn, hard-boiled pessimism of a short-seller. While most money managers focus on attracting assets, Rodriguez closes his funds to new investors when he doesn't see opportunities -- which is often (including today).
His resistance to investing vogues has paid off richly over the long run: His stock fund, FPA Capital (FPPTX), has returned 15% annually over the past 25 years, beating every single diversified equity fund, according to Lipper. His bond fund, FPA New Income (FPNIX), has never posted an annual loss. "He'd rather lose his clients than position their money in a way that he feels is inappropriate," says Stephanie Pomboy, head of institutional research firm MacroMavens. "It's almost sad that you can count the number of people who are willing to do that on, probably, one finger."
Like most iconoclasts, Rodriguez often feels as though he is screaming into an abyss. But in the spring of 2009, he thought people were finally listening. Sobriety, it seemed, was back. Leverage was out. Frugality was hailed once again as a virtue. It appeared that the world had finally begun to understand risk.
Rodriguez decided he could take the break he'd been dreaming of for years. Then 61, he turned over the reins of his two mutual funds and embarked on a yearlong sabbatical. Rodriguez trekked with his wife in Patagonia, visited the Galápagos Islands, and took the Trans-Siberian Railway. Instead of obsessing about the news, he plowed through a stack of books (a favorite was Mark Twain's Roughing It), drove in 10 auto races on the Le Mans circuit in North America, and lost 20 pounds. The sabbatical was a time for reflection, a chance to think about the crisis that had just occurred and ponder how he could prepare his company for the changing world.
But when Rodriguez returned to FPA this January -- as CEO only -- he realized that, to his horror and disgust, almost nothing has changed. Risk taking is back in fashion, and the nation's debt load, which he believes is the single greatest threat facing investors today, has soared. Now, once again, Rodriguez is sounding the alarm.
His new prophecy: If we don't fix the budget – soon -- the economy faces disaster. "I believe that within two to five years we'll have a crisis of equal or greater magnitude of what we just went through," he says. "And it will emanate from the federal level."
Either a crank or a man of principle
For a doomsayer, Bob Rodriguez is surprisingly affable. When he gets excited, which is often, he breaks into bouts of wheezing laughter, whether he's talking about financial earthquakes or his fondness for plaid shirts (he wears one most days, he says, because the patterns conceal stains). He makes apocalyptic pronouncements even as he is trailed around his home by a trio of rescued pets: a mutt, Wrigley, and two cats, Purrsia and Callie.
You can view Rodriguez as a bit of a crank or a man of principle -- or both. He has long opposed efforts in California to raise taxes on the wealthy. At one moment in 2006, when such debate was particularly intense, he was quoted in a Los Angeles Times article -- the only millionaire willing to attach his name to his comments -- arguing that such initiatives would drive affluent people out of the state. Almost as if to prove his prediction correct, he left L.A. a few days after the article came out and moved to the Nevada side of Lake Tahoe.
Truth be told, Lake Tahoe provides Rodriguez with a more profound benefit: isolation. Living away from his industry confreres, he says, helps him think independently. A similar impulse motivated him to make his home in bohemian Venice, Calif., back when he was starting out in finance. Even when Rodriguez discusses racing -- he owns seven Porsches -- he raves about solitude, not speed. "When you're racing," he says, "the rest of the world can't get to you."
Rodriguez spends three weeks each month working from his lakefront home, in a small office equipped with a Bloomberg terminal connected by T-1 cables. The location is rustic enough -- with shimmering views of the lake and snow-capped mountains -- that when the cables were first installed, he says, they were chewed through by animals. In his living room on a recent day, after his wife, Sue, prepares a breakfast of French toast and bacon, Rodriguez tells his life story. It is a classic American tale: the immigrant's son who made good.
Rodriguez is a genial doomsayer, prone to bursts of laughter even as he makes his apocalyptic pronouncements.
Rodriguez grew up in a working-class neighborhood in Los Angeles. His father, Joseph, was a Mexican immigrant who plated jewelry for a living (the family's otherwise modest house had gold-plated doorknobs). Though neither the mother nor the father, now both deceased, went to college, they taught Rodriguez and his older brother, Dick, about history and ethics. Joseph used to carry a copy of the Constitution in his pocket and would quiz his sons on it.
Joseph refused to teach the boys Spanish. "He was adamant that we be Americans," Rodriguez says. "He did not want my brother or me to grow up with an accent. It was not a good time to be of Mexican or Spanish heritage." Rodriguez's father proudly hung his certificate of U.S. citizenship in a "place of honor" in the family's den.
Rodriguez was an obsessive boy, especially when it came to money. He began collecting coins at age 6. He would memorize which vintages of pennies, nickels, and dimes were most valuable, and then convince gas station managers to trade with him. (He also collected stamps and insisted that his friends use tweezers if they wanted to pick them up.) When Rodriguez received a school assignment to write a letter to an important person at age 10, he chose the chairman of the Federal Reserve. He was even a (very) small-time banker: Rodriguez slowly accumulated savings, then lent money to his high-school-age brother -- at usurious rates -- when Dick needed cash to go on dates.
When Rodriguez was 12, he had a major operation on his teeth that, for two years, left him with a heavy speech impediment. Classmates teased him -- so he gave a speech on the topic of elocution to show that he could make fun of himself. "Most people, when they're different, they become self-conscious," says Dick. "Bob hasn't been one to sacrifice his ethics or his intellect to fit in."
Los Angeles in the 1950s could be a hostile place for an immigrant's son. Rodriguez recalls riding his bike past NO MEXICANS signs. And when the self-described B+ student told his high school guidance counselor that he wanted to go to college, he says, the counselor said he would be a better fit for trade school. "I told him to go to hell," he bristles.
Rodriguez worked his way through college and business school at the University of Southern California. He sold encyclopedias door-to-door and toiled nights as a file clerk at Transamerica, where he met his future wife. ("I let him walk me to my car," she says, "and I thought to myself, 'Is this guy ever going to shut up?'")
After getting his MBA, he struggled to find a job in finance before eventually becoming a stock trader at Transamerica. He then worked himself up to analyst by taking over sectors, such as forest products, that colleagues dropped. Says Rodriguez's FPA colleague, Steven Romick: "There weren't any 'ez' last names at the firms." He adds, "Bob has always had to prove himself, again and again."
Even today, Rodriguez is one of only a handful of Hispanic mutual fund managers in the country. A fervent believer in the power of the individual, Rodriguez downplays the effect of discrimination in his own life. Still, his thinking is revealing: He says he fell in love with investing in the first place (as opposed to architecture, another early interest) because it was a field where success isn't based on subjective opinions. "I said, 'Gee, there's an exam every day. And whether you're good or bad is independent of somebody else,' " he says. "If they say, 'That's a lousy idea,' and it works out, that's not their judgment -- the market has judged."
Rodriguez's formative investing experience occurred during the stock bubble of the early 1970s. Like many at the time, he says, he thought anyone who posted annual returns of less than 25% was an idiot. Then the market crashed in 1974. Rodriguez owned shares of an RV maker called Executive Industries, whose stock plunged from $22 to less than a dollar. Unsure of what to do, he ventured into the USC library, where he discovered a book that would forever change his investing outlook: Graham and Dodd's Security Analysis. "It helped me understand what was going on with the stock," he says. "It was selling at less than 50% of the cash on the balance sheet." His calculation of the company's fundamental value convinced him that Executive Industries' share price was baseless. He held on and eventually rode it back above $22. From then on, he was a committed value investor.
In 1983 Rodriguez joined First Pacific Advisors, then a burgeoning money-management firm with $1.6 billion in assets, and launched FPA Capital, a stock fund, and FPA New Income, a bond fund. His approach has been the same ever since. In his equity fund he maintains a highly concentrated portfolio of about 30 stocks and holds them for many years, buying and selling on dips and bumps. He spends months researching before taking the plunge; when he was thinking about buying more shares of Michaels, the craft-supply chain, in the '90s, he called dozens of store managers to find out whether the company's turnaround strategy was feasible. (It was: He bought shares in 1996 and watched them triple.)
By the mid-'90s, Rodriguez had achieved one of his goals as a fund manager: His stock fund had finished in the top 10 of its category over the previous decade (his bond fund ranked 11th). His other objective? "I said, I have a simple goal," he recalls, laughing. "I just want to be the best goddamn money manager in the country."
Trouble spotter: Two for two
Bob Rodriguez never liked Internet stocks. As the dotcom bubble swelled in the late '90s, it made him nervous to see money-losing companies trading at higher multiples than cash cows. In 1999 he described the phenomenon as "nothing more than speculation masquerading in the costume of investment." Afraid of a coming bust, he began trimming his technology holdings.
That decision cost his fund in the short term. Rodriguez's stock fund underperformed and shareholders bolted. The fund's assets shrank from $800 million to $350 million. He received an anonymous letter, which he can still recite from memory more than a decade later: "It said, 'Rodriguez: You couldn't manage your way out of a paper bag with both ends open. I am gone.' " Observes Don Phillips, president of fund research for Morningstar: "There was growing pressure during the late '90s from people saying, 'Bob Rodriguez has lost it. For heaven's sake, man, you live in California. Can't you understand tech stocks?'"
But when the bubble finally burst, Rodriguez was vindicated: From 2000 through 2002, FPA Capital returned 29% vs. -38% for the S&P 500 (SPX). After the crash Rodriguez was the toast of the investing world, and both of his funds steadily accrued assets over the next few years.
Then, in 2005, he began detecting signs of trouble again. Rodriguez and his co-manager at FPA New Income, Tom Atteberry, noticed unusually high quantities of defaults in supposedly safe mortgage pools. They quickly dumped those investments and began improving the credit quality of the portfolio. By 2006, Rodriguez was haunted with anxiety. He sold every Fannie Mae and Freddie Mac bond his fund owned not long after a particularly vivid nightmare: He dreamed he was on trial, with a prosecutor grilling him as to why he had invested in a pair of companies that didn't even have their financial statements audited.
Even as the subprime-mortgage market was starting to crumble in 2007, most stock managers were still fully invested. Rodriguez, by contrast, had shifted 40% of FPA Capital's assets to cash and invested the rest in oil and gas companies with strong balance sheets. "Many experts believe that the housing cycle is at or nearing a trough or at least is at a stable level," he said in a speech that summer. "We are not of this opinion." He concluded: "We are willing to bet our firm and our reputation to be right." Once again investors punished him. In 2007 and 2008, his stock fund was hit with $711 million in net redemptions.
Like virtually every fund, FPA Capital tumbled in 2008. But unlike most, it had huge cash reserves. As prices cratered, Rodriguez was able to double down on his stocks. The result: The stock fund returned a whopping 54% in 2009, outpacing the index by 27 percentage points.
Rodriguez's self-assurance is striking. When he decides something is true he pursues it wholeheartedly, regardless of whether the call will pay off in five months or five years. His bond fund, for example, has been buying only low-duration, high-quality debt for years. Though that benefited the fund in 2008, it caused it to lag the rally in 2009 and 2010.
That has spurred criticism that Rodriguez has sometimes confused what he thinks should happen in the bond market with what is actually happening. "Bob had a lot invested in the idea that things were going to hell in a hand basket," says Morningstar analyst Chris Davis of the 2009-10 period. Davis credits him for being right about housing market excesses, but adds, "there's evidence suggesting he was too wedded to that idea to see the opportunities in front of him."
Rodriguez scoffs at that notion, pointing out that FPA Capital leaped back into stocks when the market bottomed in 2009; in the past he's done the same with FPA New Income. This time, he refused to invest in a bond market that he believed was distorted by government interference. "If I roll the dice and buy, and high-yields rally like crazy, I'm a star," he says. "On the other hand, if I roll the dice and it comes up craps ... I had a hard time intellectually with that." The fund's risk-averse stance may not have borne fruit in 2009 and 2010, but FPA is sticking with it -- and he thinks it will pay off soon.
The looming debt crisis
Standard & Poor's has just announced that it's downgrading the outlook for U.S. debt, and Bob Rodriguez couldn't be cheerier. It's another sign, he says, that at least some people are waking up to the looming debt disaster. As he paces FPA's offices in Santa Monica on a spring day, he sips coffee from a stained green-plastic mug. It's a 20-year-old souvenir from a company called Green Tree Financial; Rodriguez keeps it because it reminds him of one of his worst investing losses.
Since coming back to work on Jan. 1, he has found himself galled once again by what he sees. Fund managers, emboldened by their mammoth gains, clamor for risk. Junk bonds remain wildly popular. Even more stunning, says Rodriguez, is the government's failure to address its debt. "I know one thing from business," he says, his voice quavering as he tries, mostly successfully, not to yell. "Unless you correct the problems that are already occurring, you don't add on new leverage and new, other responsibilities until you correct the old! All you're going to do is capsize the ship!"
Rodriguez argues that the U.S. debt as a percentage of GDP ratio (currently 64%) is massively underreported because it doesn't count off-balance-sheet entitlements such as Medicare, and debt owed by Fannie and Freddie. If you factor in those liabilities, he says, the actual ratio is greater than 500% and growing. The U.S. must reduce that before 2012, Rodriguez says, because it's unlikely to accomplish anything during the election year. If nothing changes, he adds, investors will start to get nervous about the amount of debt on the U.S. balance sheet. As lenders balk at buying Treasuries, rates will spike, causing borrowing costs to skyrocket across the financial system. "The financial system is held together with a very thin filament called confidence," says Rodriguez. "When you clip that, all hell breaks loose."
The situation isn't irreparable; Rodriguez believes the government can keep rates from climbing too high if it starts making cuts of $350 billion to $500 billion per year. But he has little faith in its willingness to do so. If it were up to him, there would be serious tax reform, with all tax deductions (including mortgage interest) on the table. A former Republican, he describes himself as a "fiscal conservative but social moderate" who has grown disgusted with both parties: "I say, 'A pox on both their houses.'"
So FPA's managers, guided by Rodriguez, are battening down again, trimming risk. FPA Capital now has 30% of its portfolio in cash and 38% in energy stocks because he believes the world's oil supply is declining. Still, even in that sector, he doesn't see many opportunities. (Forget other sectors.) He refuses to buy most bonds or long-term government debt. His restraint has rankled some investors: FPA New Income has begun to shrink again, and a few FPA Capital clients are grumbling.
It takes thick skin to be a contrarian. Rodriguez is used to losing his shareholders' faith, but he seems weary of it. "I don't think you get rewarded in this business for doing the right thing," he says. "It's a love-hate relationship. You could feel bitter about it, but then I ask, 'What would I do differently?' The