Bob Rodriguez’s Speech – “Caution: Danger Ahead”

In a period of rapidly rising stock markets, it is important to continue to pay attention to risk. Robert (Bob) Rodriguez of the FPA funds is one of those people whose views you do not want to dismiss lightly, and right now he is not at all bullish on his long-term view of the world economy.  We already covered his speech in an email to our clients, and now we are posting a condensed version of that discussion here.

Rodriquez wrote and spoke frequently about the coming dangers of both the tech bubble that peaked in 2000, and the recent credit collapse that resulted in the government bailout of our financial institutions. He gave a speech (transcript link) to the Institute for Private Investors on February 15, 2012. It is a good read if you are interested, but it’s long so we’ve summarized a few of his main points below.

1. If our nation’s unsound fiscal policies persist we may be on the cusp of a decade of extreme economic and financial market turbulence due mainly to out of control debt.
2. The European debt crisis is not over and will face additional tests until at least one or more members exit.
3. Japan faces a huge headwind due to a governmental debt to GDP ratio of about 200% and their generation of savers is now retiring and the household savings rate is likely to turn negative in the coming decade.
4. Both political parties in the US have shown incredible fiscal ineptitude and unwillingness to be truthful with the American people when it comes to dealing with the debt and deficit.
5. He fears if credible and material fiscal reforms are not implemented by the end of 2013, that between 2014 and 2016, this nation will confront a crisis similar to that of Europe
6. Time is running out because starting in 2018 and continuing between 2024, various entitlement trust funds will be either depleted or beginning the process of liquidation. Budgetary financial pressures will explode.
7. Treasury debt outstanding could easily rise to between $22 and $25 trillion by 2022. With just a 2% rise in the average funding rate, debt interest costs could rise to at least $1.2 trillion, thereby wiping out most of the savings from budget cuts.
8. The corporate earnings recovery surprised many, including him, particularly with near record pre-tax profit margins, despite substandard economic growth. But upon closer examination, 73% of the non-financial corporate pre-tax profit margin expansion resulted from lower interest (38%) and labor (35%) costs. Furthermore, approximately 45% of the S&P’s revenues are internationally sourced, so European and Japanese recessions pose additional risks.
9. Low to mid single-digit returns for stocks will be the norm for the next decade and this may prove to be optimistic.
10. Over the next decade, he expects low single-digit to negative total returns for intermediate and long-term bonds.
11. In his current investment strategy principal protection is uppermost in his mind.

We believe it is important to consider views like Rodriguez’s in an effort to strike the right balance between growth, income and capital preservation in our client portfolios.