Robert Rodriguez of First Pacific Advisors, who deftly avoided financials last year and earned praise for the strong performance of his bond fund, tells Barron’s that he remains hesitant about stocks, and thinks the government’s stimulus package is missing the point.
In 2008, Rodriguez’s FPA Capital equity fund lost 34.8% for the year despite his avoidance of financials, in part because energy companies got hit hard in the second half of the year. But he says the losses he sustained are different from those sustained by managers who got burned on financials. “For the value managers who owned, say, AIG, Lehman Brothers, Bear Stearns, Washington Mutual and on down the list, all of those are permanent losses of capital,” he explains. “But for the energy companies that we have owned and taken a hit on, they have cash, pristine balance sheets, virtually no debt, and their equipment is good for 25 years. … We see energy as just a deferral of performance, rather than a permanent loss of performance.”
Currently Rodriguez’s fund is 64% in equities and 36% in cash, and half of that 64% is in energy, with big bets in energy coming in the past few months.
Part of the reason for the spending spree was based on market mood — but part was also based on business risk. “That was very close to the high-water mark of fear and depression in the equity market,” Rodriguez says. “If we hadn’t deployed some capital, then the clients and shareholders and others, including the press, would be saying, ‘If that doesn’t get you to buy, what will?’ So we would always be on the defensive. And even if you were right longer-term, but you had a rally in between, you would look foolish. So I thought there is a business risk in there if we didn’t do something, and we thought a number of the securities had gotten pretty depressed.”
From the start of the buy program through Feb. 10, the S&P 500 lost 17%, the Amex Oil Index lost 3.2% and the Philadelphia Oil Service Sector Index lost 22.7%. Rodriguez says his entire purchase program for that period resulted in a loss of just 0.4%, however, with the energy purchases down 0.8%. Picks he likes include Ensco International, Patterson-UTI Energy, Arrow Electronics, and Avnet.
Rodriguez doesn’t have plans to continue his recent buying program. He’s made no buys since Dec. 23, and a few sells, and he thinks the credit crisis has a ways to go before he starts buying more. Commercial real estate could still drop 40% to 50%, and layoffs really kicked in only in the second part of last year. Earnings expectations are still too high, he says.
As for why Rodriguez’s equity fund lost so much last year despite his own prediction of the financial crisis, Rodriguez cites the increasing covariance among investment styles and investment products, something that played out when stocks — regardless of capitalization, foreign/domestic designation, or growth/value label — fell across the board in 2008. “I learned a long time ago that if I am going to get killed in something, I would rather get killed in something I already know than in something I am getting to know,” he says.
The increased co-variance will significantly change the investment world, with style-boxes falling by the wayside, Rodriguez says. He says his firm believes in the “land of tall trees”, and only invests in a select few industries. Others once said that was too risky and didn’t involve enough diversification, but ’08 has shown that a style-box diversification doesn’t really reduce risk as once thought.
Rodriguez also has some harsh warnings for the government regarding the $787 billion stimulus package. “They are trying to restart consumption and lending, but I have a news flash: It was excessive consumption and excessive debt creation that got us into this mess,” he says, saying the feds are trying to be “the consumer of last resort”.
“Rather than giving an $8,000 credit to buy homes, we should be reinvesting this money to change part of the industrial dynamic of the U.S. economy,” he said. “Over the next 10 to 15 years, exports as a percentage of GDP are going to have to go up. We are going to be in a donnybrook. If we do not increase exports to replace the contraction of consumption, we go to the government to be the consumer of last resort. And then GDP growth will be worse off.”