Gross: Life or Death Battle of Weakest Sovereigns

Thursday, March 4th, 2010

Bill Gross, co-founder and co-CIO of PIMCO, is to my mind one of the top money men around. His monthly newsletter, this month entitled “Don’t Care”, therefore always makes for thought-provoking reading. (On a personal note, it does sound if he should get out more often!)

Here are the last few paragraphs:

“Government bailouts and guarantees such as those evidenced and envisioned in Dubai and Greece, as well as those for the last 18 months with banks and large industrial corporations across the globe, suggest a more homogeneous ‘unicredit’ type of bond market. If core sovereigns such as the US, Germany, UK, and Japan ‘absorb’ more and more credit risk, then the credit spreads and yields of these sovereigns should look more and more like the markets that they guarantee. The Kings, in other words, in the process of increasingly shedding their clothes, begin to look more and more like their subjects. Kings and serfs begin to share the same castle.

“This metaphor doesn’t really answer the critical question of whether a debt crisis can be cured by issuing more debt. The answer remains: It depends - on initial debt levels and whether or not private economies can be reinvigorated. But it does suggest the likely direction of sovereign yields IF global policymakers are successful with their rescue efforts: Sovereign yields will narrow in spreads compared to other high-quality alternatives. In other words, sovereign yields will become more credit like.

“When sovereign issues become more credit-like, as evidenced in Greece, Spain, Portugal, and a host of others, they move closer in yield to the corporate and Agency debt that supposedly rank lower in the hierarchy. That process of course can be accomplished in two ways: high-quality non-sovereigns move down to lower levels or governments move up. The answer to which one depends significantly on future inflation, the aftermath of quantitative easing programs, and the vigor of the private economy going forward. But the contamination of sovereign credit space with past and future bailouts is a leveler, a homogenizer, a negative for those sovereigns that fail to exert necessary discipline. Only if global economies stumble and revisit the recessionary depths of a year ago should the process reverse direction and place Treasuries, Gilts, et al. back in the driver’s seat.

“Investors should obviously focus on those sovereigns where fundamentals promise lower credit or inflationary risk. Germany and Canada are amongst those at the top of our list while a rogues’ gallery of the obvious, including Greece, Euroland lookalikes, and the UK gather near the bottom. PIMCO’s ‘Ring of Fire’ remains white hot and action, as opposed to cocktail blather, is required to maintain or regain trust in sovereign credits approaching the rocks. Just last week Bank of England Governor Mervyn King said that it would be difficult to cut government spending quickly, but that there needs to be a clear plan for doing so. Not good enough, Mr. King. Don’t care. Show investors the money, not vice-versa. An investor’s motto should be, ‘Don’t trust any government and verify before you invest.’ The careful discrimination between sovereign credits is becoming more than casual cocktail conversation. A deficiency of global aggregate demand and the potential impotency of policymakers to close the gap are evolving into a life or death outcome for the weakest sovereigns, with consequences for credit and asset markets worldwide.”

Click here for the full article.

Gross has also just been interviewd by Bloomberg on the above. The clip is below.

Bloomberg (via YouTube), March 1, 2010.

Tags: Bill Gross, Bond Market, Credit Risk, Credit Spreads, Critical Question, Death Battle, Debt Crisis, Debt Levels, Gross Co, Industrial Corporations, Initial Debt, Money Men, Personal Note, PIMCO, Quality Alternatives, Rescue Efforts, Serfs, Sovereigns, Spain Portugal, Us Germany
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Investing for 2010: Ideas from Gross, MacAllaster & Witmer

Monday, February 1st, 2010

Three members of Barron’s roundtable, Bill Gross, Archie MacAllaster and Meryl Witmer shared their views on market outlook and investment ideas with Wall Street Journal.

The following is a recap with video links of the interviews.

Gross’ Three Market Drivers for 2010

Bill Gross, founder and co-chief investment officer at Pimco, believes the direction of short-term interest rates, inflation and quantitative easing will be the driving market forces in 2010.

Inflation: Contained & moving lower

Short-term Interest Rate is Central banks response to inflation.  He expects them to maintain the current near zero policy amid low inflation.

Quantitative Easing - Central banks withdrawal from buying mortgages and treasuries will have great impact on stocks, bonds and other riskier assets.

Note:  Bill Gross’ February 2010 Investment Outlook: The Ring of Fire is available at Pimco.com here.

MacAllaster Sees A “Good Size” Correction Coming

Archie MacAllaster, chairman of MacAllaster Pitfield MacKay, believes there will be a “good size” market correction in 2010 before rebounding later in the year with a possible 15% upside. He expects financials, particularly life insurance stocks to rise.

(MacAllaster interview video link here)

Witmer Expects Compass Mineral to Outperform

Meryl Witmer, general partner at Eagle Capital Partners, likes Compass Minerals (CMP), a salt and specialty potash maker. She expects its shares to have above trend growth over the next several years as it has one of the few expandable salt mines in the country.

Witmer sees Compass making $8-9 a share in 2011 or 2012, and should trade north of $100 in a year or so.

(Witmer video interview link here)

Video Source: WSJ.com

Tags: Archie Macallaster, Bill Gross, Central Banks, Chief Investment Officer, Compass Mineral, Compass Minerals, Eagle Capital, General Partner, Insurance Stocks, Interview Link, Investment Ideas, Investment Outlook, Market Drivers, Meryl Witmer, PIMCO, Salt Mines, Stocks Bonds, Video Link, Video Source, Wall Street Journal, Wsj
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The Deleveraging Has Begun

Wednesday, January 27th, 2010

The post below is a guest contribution by Comstock Partners, the highly regarded investment manager run by Charles Minter.

Barron’s magazine printed the first part of its annual Roundtable discussion of 2010 this past week.  We noticed that many of the participants were very concerned about the debt (mostly government debt while we think total debt is a much more useful metric).  Marc Faber, in fact, talked about a 7,000 word New York Times article by Professor Paul Krugman.  He stated that the article “How Did Economists Get It So Wrong?” never mentioned that excessive credit growth or leverage was the cause of monetary instability and brought about the financial crisis.  Bill Gross stated that by lowering interest rates we promote consumption instead of manufacturing.  Central bankers were forced to respond with liquidity to a problem that developed over the past 25 years.  There was more discussion of credit growth (another way to say debt growth) in the macro analysis that is always presented in the first part of the three Barron’s articles of the Roundtable.  The amazing thing to us is that most of the roundtable participants understand the same problems we talk about almost every single week, yet are mostly very positive on the market for 2010.

It seems that most of the roundtable participants understand the debt problem we have been talking about for the past 14 years. The worst period of the debt explosion started with the outrageous internet bubble in the late 1990s, continuing through the correction in the internet bubble, then the housing bubble which should have been obvious to everyone (even the Fed) and then the financial crisis of 2008.  We are astounded that we have the potential for another bubble in the stock market now.  We expected the rebound from a much oversold market in March of 2009, but not a 70% rebound from the lows.  We don’t believe it is possible to fool the investors in the U.S. stock market one more time. Especially this close to the 2003-2007 and 1996-2000 bubbles.

Hopefully, all of our regular viewers know that we have been, and still are, very concerned about the debt situation in this country– and many others.  Until balance sheets are repaired we don’t think the stock market will do well and expect the secular bear market to continue.  We really don’t know why the roundtable participants, or virtually anyone else for that matter, do not bring up the fact that the total debt in this country doubled from 2000 to present (from $26 trillion to $53 trillion).  This drove the debt (both public and private) to 375% of GDP in this country before recently declining to 370%.  This 370-375% number is the highest since the Great Depression when it reached 260% at the peak, even with a collapsing GDP. Even more incredible is that the present debt level does not include the entitlement and pension obligations that would just about double the total debt from where it is now.

This U.S. debt to GDP started accelerating in the 1960s (with the Vietnam War, Space Race and continuation of the Cold War) when it took $1.53 to generate an additional $1 of GDP.  Then during the 1970s, with the continuation of the Vietnam War, it took $1.68 to generate $1 of GDP.  In the 1980s (including Leveraged Buyouts and Star Wars) it took $2.93.  In the 1990s (with the internet bubble) the debt it took to generate $1 of GDP climbed to $3.12.  However, the most incredible of all was the first decade of this century when it took over $6 to generate an additional $1 of GDP.  That decade included the war on terror, two wars, private equity firms (new name for leveraged buyouts) and housing and another stock market bubble, as well as promises of entitlements that we have no possibility of being able to keep.  Clearly, needing over $6 to generate $1 of GDP is unsustainable.

We have been trying to compare the U.S. total debt to GDP to other countries for some time and have some figures that were just corroborated with a recent McKinsey report.  As high as our U.S. debt to GDP number is, believe it or not, it is not as bad as many other countries according to a recent report by McKinsey Global Institute (the research arm of McKinsey & Co.).  The UK debt to GDP is about 470%, Japan 460%, Spain 340%, South Korea 340%, Switzerland 315%, France and Italy about 300%, Germany 275%, and Canada 245% (all are records of debt to GDP).  The BRIC countries (Brazil, Russia, India, and China) all have debt to GDP under 160%.  We have been warning our viewers about the pain of deleveraging for some time (Special Reports-’Deleveraging the U.S. Economy” 8/09-comparing our deleveraging to Japan, and “Debt Dynamics Will Hold Back Economy” 11/09).  The McKinsey report agrees that the deleveraging will be painful and take years to resolve.

You may think that since China and the other BRIC countries are not as leveraged as the more developed countries that they could grow enough to pull up the global economy. But you have to remember the McKinsey report was as of 2008.  China had a stimulus package that was three times the size of the U.S. stimulus package relative to GDP.  This means the U.S. stimulus package of $787 billion would have been over $2 trillion if we had a package as large as China.  Also, the Chinese government encouraged bank lending, and banks loaned out $1.3 trillion during 2009.  They could now be more leveraged than the United States.  China also could be the next bubble as they are building up their economy to sell products to a world that is deleveraging.

As we stated in many commentaries and “special reports” in the past we expect the deleveraging of America, as well as many other countries, to be the primary focus of central banks worldwide-not the escape from the financial crisis, not the earnings that are supported by cost cutting, and not the economic rebound supported by the stimulus and inventory rebuild.  The deleveraging of America and much of the global economy will trump everything else.

In the past when a nation’s total debt rose to unsustainable levels it would just debase its currency enough to try to export its way to prosperity, and even this didn’t always work.  However, when all its major trading partners also need to debase their currencies, it becomes an impossible task.  This takes us to the “Cycle of Deflation” chart (attached) which we authored and point to in almost every discussion of our debt problem.  We are still in the competitive devaluation part of the cycle; however, you can only devalue or debase your currency relative to other countries in order to gain a competitive advantage. And when all of your trading partners are in the same boat as you, then you are forced to take more drastic measures, and that brings you down the “Cycle of Deflation” to “Beggar-thy-Neighbor policies.  This essentially means that the country in trouble will do whatever it takes to sell its products abroad.  When a country needs to keep its plants open it might have to sell its products at less than cost, or put restrictive tariffs on imports and/or subsidize exports.

Essentially, we believe we are still in a continuation of the financial crisis we entered in 2008.  We have been headed for this crisis for a few decades but are just now realizing the consequences of the debt build up over the years. Before this is over we expect the private debt in the U.S. to drop substantially (from $40 trillion now towards $30 trillion or even as low as $20 trillion) while the government debt explodes to at least double the $15 trillion presently.  And since most of our trading partners are in the same boat as we are, they will also be forced to become more protectionists.  This does not bode well for the global economy.

In conclusion, we cannot emphasize enough that the total debt to GDP is so onerous for the economies of most mature countries as well as China, that the global economy will suffer tremendously over the next few years.  We have discussed this over and over again and, in fact, with a little “tongue in cheek” stated in many comments and “special reports” that when Obama realizes what he inherited he will “demand a recount” of the 2008 election.  The masses don’t trust the liberals and they don’t trust the conservatives -they don’t like Democrats and they don’t like Republicans-they don’t like any institution be it government, journalism, or anything else-they just want things to CHANGE.  The regulation of the banking industry, the tea parties, the populist demands, the election in Massachusetts, the healthcare reform, even the employment situation all take a back seat to the enormous amount of debt relative to GDP.  The masses want a change because of the pain they are going through presently and just don’t understand the invisible hand of the interest on the debt absorbing so many dollars that could have been used to support the economy.

This invisible hand is causing the masses to want change even though they don’t understand why they feel so uncomfortable and don’t know who is to blame.  They are just “mad as hell and can’t take it anymore” (from the movie, “Network”).  All of this causes the deleveraging as shown in our Cycle of Deflation as the private sector pays down debt or defaults. This process is very painful while taking many years to resolve.  The process has already started as business loans and consumer credit are shrinking at record rates while the government debt is expanding at record rates.  This deleveraging we expect will take place on a global scale and will take many years to resolve.  Japan has already suffered two “lost decades” and has still not solved its problem.   We expect this to take place globally and will continue to be painful.  We honestly don’t want to be correct in this assessment for the global economy, but we can’t see how this deleveraging process and the consequences of the process be avoided.

Tags: Barron, Barron S Magazine, Bill Gross, BRIC, Canada, Charles Barron, China, Debt Growth, Debt Problem, Emerging Markets, Financial Crisis, Government Debt, Housing Bubble, India, Internet Bubble, Investment Manager, Lows, Macro Analysis, Marc Faber, Minter, Monetary Instability, New York Times, Paul Krugman, Professor Paul, Roundtable Participants, U S Stock Market, York Times Article
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Bill Gross: Beware the Ring of Fire

Wednesday, January 27th, 2010

Bill Gross, co-founder and co-CIO of PIMCO, is to my mind one of the shrewdest money men around. His monthly newsletter, this month entitled “The Ring of Fire”, therefore always makes for thought-provoking reading.

Here is the audio version, read by Bill Gross himself:

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The following are a few excerpts from the report:

“In this New Normal environment it is instructive to observe that the operative word is ‘new’ and that the use of historical models and econometric forecasting based on the experience of the past several decades may not only be useless, but counterproductive. When leveraging and deregulating not only slow down, but move into reverse gear encompassing deleveraging and reregulating, then it pays to look at historical examples where those conditions have prevailed. Two excellent studies provide assistance in that regard - the first, a study of eight centuries of financial crisis by Carmen Reinhart and Kenneth Rogoff titled This Time is Different, and the second, a study by the McKinsey Global Institute speaking to ‘Debt and deleveraging: The global credit bubble and its economic consequences.’

“… banking crises are followed by a deleveraging of the private sector accompanied by a substitution and escalation of government debt, which in turn slows economic growth and (PIMCO’s thesis) lowers returns on investment and financial assets. The most vulnerable countries in 2010 are shown in PIMCO’s chart ‘The Ring of Fire’. These red zone countries are ones with the potential for public debt to exceed 90% of GDP within a few years’ time, which would slow GDP by 1% or more. The yellow and green areas are considered to be the most conservative and potentially most solvent, with the potential for higher growth.

“What then is an investor to do? If, instead of econometric models founded on the past 30-40 years, an analysis must depend on centuries-old examples of deleveraging economies in the aftermath of a financial crisis, how does one select and then time an investment theme that can be expected to generate outperformance, or what professionals label “alpha?” Carefully and cautiously with regard to timing, I suppose, but rather aggressively in the selection process under the assumption that it’s never “different this time” and that history repeats as well as rhymes. Reinhart and Rogoff’s book, if anything, points to the inescapable conclusion that human nature is the one defining constant in history and that the cycles of greed, fear and their economic consequences paint an indelible landscape for investors to observe. If so, then investors should focus on the following 30,000-foot observations in the selection of global assets:

1.     Risk/growth-oriented assets (as well as currencies) should be directed towards Asian/developing countries less levered and less easily prone to bubbling and therefore the negative deleveraging aspects of bubble popping. When the price is right, go where the growth is, where the consumer sector is still in its infancy, where national debt levels are low, where reserves are high, and where trade surpluses promise to generate additional reserves for years to come. Look, in other words, for a savings-oriented economy which should gradually evolve into a consumer-focused economy. China, India, Brazil and more miniature-sized examples of each would be excellent examples. The old established G-7 and their lookalikes as they delever have lost their position as drivers of the global economy.

2.     Invest less risky, fixed income assets in many of these same countries if possible. Because of their reduced liquidity and less developed financial markets, however, most bond money must still look to the ‘old’ as opposed to the new world for returns. It is true as well, that the ‘old’ offer a more favorable environment from the standpoint of property rights and ‘willingness’ to make interest payments under duress. Therefore, see #3 below.

3.     Interest rate trends in developed markets may not follow the same historical conditions observed during the recent Great Moderation. The downward path of yields for many G-7 economies was remarkably similar over the past several decades with exception for the West German/East German amalgamation and the Japanese experience which still places their yields in relative isolation. Should an investor expect a similarly correlated upward wave in future years? Not as much. Not only have credit default expectations begun to widen sovereign spreads, but initial condition debt levels … will be important as they influence inflation and real interest rates in respective countries in future years. Each of several distinct developed economy bond markets presents interesting aspects that bear watching: 1) Japan with its aging demographics and need for external financing, 2) the US with its large deficits and exploding entitlements, 3) Euroland with its disparate members - Germany the extreme saver and productive producer, Spain and Greece with their excessive reliance on debt and 4) the UK, with the highest debt levels and a finance-oriented economy - exposed like London to the cold dark winter nights of deleveraging.

“Of all of the developed countries, three broad fixed-income observations stand out: 1) given enough liquidity and current yields I would prefer to invest money in Canada. Its conservative banks never did participate in the housing crisis and it moved toward and stayed closer to fiscal balance than any other country, 2) Germany is the safest, most liquid sovereign alternative, although its leadership and the EU’s potential stance toward bailouts of Greece and Ireland must be watched. Think AIG and GMAC and you have a similar comparative predicament, and 3) the U.K. is a must to avoid. Its Gilts are resting on a bed of nitroglycerine. High debt with the potential to devalue its currency present high risks for bond investors. In addition, its interest rates are already artificially influenced by accounting standards that at one point last year produced long-term real interest rates of 1/2 % and lower.”

“The last decade - the ‘aughts’ - were remarkable in a number of areas: jobless recoveries in major economies, negative equity returns in US and other developed markets, and of course the financial crisis and its aftermath. If an investment manager and an investment management firm proved to be good stewards of capital markets during the turbulent but vapid ‘aughts’, they may be granted a license to navigate the rapids of the “teens,” a decade likely to be fed by the melting snows of debt deleveraging, offering life for unlevered emerging and developed economies, but risk and uncertainty for those overfed on a diet of financed-based consumption. Beware the ring of fire!”

Click here for the full article.

Source: Bill Gross, PIMCO - Investment Outlook, February 2010.

Tags: Bill Gross, Canada, Carmen Reinhart, China, Credit Bubble, Econometric Models, Economic Consequences, Emerging Markets, Escalation, Financial Assets, Fire Bill, Global Credit, Government Debt, Gross Co, India, Mckinsey Global Institute, Money Men, Operative Word, PIMCO, Public Debt, Red Zone, Returns On Investment, Ring Of Fire, Vulnerable Countries
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Bill Gross: Investment Outlook (January 2010)

Thursday, January 7th, 2010

Bill Gross, co-Chief, PIMCO, has just released his latest instalment of his newsletter, titled, “Let’s Get Fisical.”

In it, Gross discusses the theme, that 2010 will be a year of “exit strategies,” of breaking free of government assistance. As usual, Gross’ outlook is captivating, and like others requires some interpretation as well as look-through.

Here is an excerpt:

“If 2008 was the year of financial crisis and 2009 the year of healing via monetary and fiscal stimulus packages, then 2010 appears likely to be the year of “exit strategies,” during which investors should consider economic fundamentals and asset markets that will soon be priced in a world less dominated by the government sector. If, in 2009, PIMCO recommended shaking hands with the government, we now ponder “which” government, and caution that the days of carefree check writing leading to debt issuance without limit or interest rate consequences may be numbered for all countries.”

and,

Additionally, if exit strategies proceed as planned, all U.S. and U.K. asset markets may suffer from the absence of the near $2 trillion of government checks written in 2009. It seems no coincidence that stocks, high yield bonds, and other risk assets have thrived since early March, just as this “juice” was being squeezed into financial markets. If so, then most “carry” trades in credit, duration, and currency space may be at risk in the first half of 2010 as the markets readjust to the absence of their “sugar daddy.” There’s no tellin’ where the money went? Not exactly, but it’s left a suspicious trail. Market returns may not be “so fine” in 2010.

I find it unusual that the discussion of carry trades is seldom discussed in depth, especially when it is such an integral, and functional, moving part of both the credit and equity markets. There has been a noticeable amount of press on the dollar carry trade ending, and the threat that poses, but very little on the subsequent presence and resumption in the yen carry trade, our Japanese “sugar-daddy.” As Hosein Askari recently asked, “Whose paying for the beer?”

Gross doesn’t mention it. There has been a reversal of the inverse relationship between the U.S. dollar and equity markets, emerging markets, commodities,  and the Canadian dollar, et al., since the U.S. dollar recovered off its late November lows. Where is the mysterious support coming from? Perhaps its too early to tell, OR, those who do know about it, are exploiting the opportunity, and keeping their lips tightly sealed.

Read the whole newsletter here.

Tags: Asset Markets, Bill Gross, Canada, Check Writing, China, Commodities, Debt Issuance, Economic Fundamentals, Emerging Markets, Exit Strategies, Financial Crisis, Financial Markets, Fiscal Stimulus, Government Assistance, Government Checks, Government Sector, Gross Co, Gross Investment, High Yield Bonds, Instalment, Investment Outlook, PIMCO, Shaking Hands, Sugar Daddy
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Bill Gross: Fed to Keep Rates at Zero Through 2010

Tuesday, December 8th, 2009

The Federal Reserve will keep interest rates near zero in 2010, but longer-term rates will gradually tick higher because of supply and demand, Bill Gross, founder of Pimco, told CNBC Monday.

“We have a lot of supply and perhaps not as much demand to satisfy that supply, and that may actually reinforce the move towards higher rates on the longer end of the yield curve,” he said.

Gross said that stocks will perform “alright” in the long term, but investors should not expect double-digit returns as the Fed pulls excess liquidity out of the markets.

Source: CNBC, December 7, 2009.

Tags: Advertisement, Bill Gross, Cnbc, Excess Liquidity, Federal Reserve, interest rates, Investors, Move Towards, Stocks, Supply And Demand, Yield Curve
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WealthTrack: Robert Rodriguez – concerned about the future

Tuesday, December 1st, 2009

This week Consuelo Mack is joined on WealthTrack by Robert Rodriguez of First Pacific Advisors. His 25-year track record of running both a top performing stock and bond fund has earned him the accolade “best fund manager of our time”. The outspoken Rodriguez - who sheltered shareholders from the credit crisis - explains why he is even more worried about the future and how he intends to invest as a result.

Note: The transcript of this interview is below:

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.

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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 once again to one of the money managers we have identified as the next generation of great investors. AQR Capital Management’s outspoken managing and founding principal, Cliff Asness, will discuss how he is applying his value oriented and computer driven hedge fund strategies to the mutual fund world.
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.

Source: Wealthtrack, November 27, 2009.

Tags: Accolade, Advertisement, Asset Classes, Atteberry, Bill Gross, Bond Fund, China, Commodities, Consuelo Mack, Credit Crisis, Emerging Markets, First Pacific Advisors, Gold, Investor Bill, Jason Zweig, Mack, Mid Cap Value, Mid Cap Value Fund, Money Manager, Personal Finance, Robert Rodriguez, Running, Shareholders, Stock And Bond, Stock Fund, Term Stewardship, Time Rodriguez, Top Performing Mutual Funds, Top Performing Stock, Wealthtrack
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Rob Arnott: Deficits, Debt, and Demographics Will Impede Real Returns For Next 25 Years

Thursday, November 26th, 2009

In his latest newsletter (November 2009), The “3-D” Hurricane Force Headwind, Robert Arnott (founder, Research Affiliates) examines how Deficit, National Debt, and Demographics, the 3 Ds, mean that we should lower our expectations for real return from markets over the next 25 years. Arnott, a fundamental indexing academic and innovator, has been warning, via his papers, that investors be modest. For example, it is interesting, given that Research Affiliates, the creators of fundamental equity indices, that its founder, Arnott, has spent most of the last year discussing bonds, and reversion to mean.

Here are a few excerpts from the latest newsletter.

In this issue we examine three critical long-horizon issues — the deficit, the national debt, and demographics—and find a disturbing structural headwind that will impede the real returns we can expect from financial assets in the years ahead. The coming quarter century will be very, very different from the past quarter century; the lessons we’ve learned in the past generation may lead us astray in the coming  generation.

On the (D)eficit:

The latest year shows a deficit of 10% of GDP, but even this isn’t a problem as long as it’s a oneoff deficit incurred to help avert a major financial and economic crisis. Right? Right… if the past average really was 2.4% and the current deficit really is temporary.

But …

The average increase in our national debt, including unfunded obligations and GSEs, soars to 9.8% of GDP for the past 25 years. The latest 12 months saw our public debt and unfunded obligations grow by 18% of GDP! No wonder the debt seems to have grown crushingly large.

Arnott’s case is compelling, and sounds quite similar to what his Newport Beach bond market peer, Bill Gross, calls the “New Normal,” though Gross has not elaborated on it as specifically, as Arnott does here and in past letters. Whether you agree with this or not, its a must-read.

For more on Debt and Demographics, and to read Rob Arnott’s complete newsletter, click here.

Tags: Bill Gross, Bond Market, Coming Generation, Demographics, Economic Crisis, Financial Assets, Fundamental Indexing, GDP, Headwind, Horizon Issues, Hurricane Force, Innovator, National Debt, Newport Beach, Public Debt, Quarter Century, Research Affiliates, Reversion, Rob Arnott, Robert Arnott, Soars
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Bill Gross: Investment Outlook (December 2009)

Friday, November 20th, 2009

Bill Gross, Co-Chief at PIMCO has just released his latest investment outlook, titled Anything but 0.1%. Gross reveals that he is worried that bubbles are forming as a result of zero interest rate policy. This is a must read issue.

Listen to the newsletter, read by Bill Gross:

Audio clip: Adobe Flash Player (version 9 or above) is required to play this audio clip. Download the latest version here. You also need to have JavaScript enabled in your browser.

On one hand Gross says it is prohibitive to stay for too long in money market instruments yielding next to nothing. On the other hand Gross says that zero interest rates are forcing investors back out on to the risk spectrum.

Ah, but this is not a vindictive diatribe, although to me, money changers resemble Mammon more than archangels, and they all make too much money, including PIMCO. My point is to recognize, and to hope that you recognize, that an effective zero percent interest rate, as a price for hiding in a foxhole, is prohibitive. Like the American doughboys near France’s future Maginot line in WWI – slumping day after day in a muddy, rat-infested pit – when the battalion commander finally blew his whistle to charge the enemy lines, it probably was accompanied by some sense of relief; anything, anything but this! Anything but .01%!

Recently, approximately $20 billion a week has been exiting those payless, seemingly godless funds in search of a higher-yielding Nirvana. Yet, as Will Rogers knew, and Lehman Brothers demonstrated to another generation, the pain of the foxhole can immediately transition to the dodging of real bullets on the investment battlefield. Moving out on the risk asset spectrum has worked wonders since March of this year, but it comes with the risk of principal loss – failing to receive the return of your money. When viewed from 30,000 feet, there is even a systemic risk that new asset bubbles are in the formative stages – perhaps because of the .01%. Gold at $1,130 an ounce, global equity markets up 60-70% from their 2009 lows, a cascading dollar now 15% lower against a basket of global currencies just 12 months ago, oil at 80 bucks, mortgage rates at 4% thanks to a $1 trillion dollar credit card from the Fed; the list goes on. The legitimate question of the day is, “Is a 0% funds rate creating the next financial bubble, and if so, will the Fed and other central banks raise rates proactively – even in the face of double-digit unemployment?” As Chicago Fed President Charles Evans said in a recent speech, “This notion is often described as an imperative to ‘lean against a bubble,’ meaning that a central bank should act to lower asset prices that by historical standards seem unusually high.”

Gross makes the interesting point, that in the “New Normal,” of lower growth, with companies transforming into low-growth utilities-like businesses, rather than looking like Boardwalk and Park Place, why not simply opt for the utilities? Buffett, for example, has taken down all of Burlington Northern.

In a low growth environment, it seems to me that a company’s stock should yield more than its less risky debt, and many utilities provide just that opportunity. Utilities and even quasi-utility telecommunication companies now yield between 5 and 6%, whereas their 10- and 30-year bond yield less and at a higher tax rate to you the investor.

Read the whole letter here, download the PDF here.

Tags: Archangels, Battalion Commander, Bill Gross, Doughboys, Formative Stages, Foxhole, Global Currencies, Global Equity Markets, Gold, Gross Co, Gross Investment, Interest Rate Policy, Investment Outlook, Lehman Brothers, Maginot Line, Money Market Instruments, oil, PIMCO, Risk Spectrum, Systemic Risk, Will Rogers, Zero Percent
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Bill Gross: Investment Outlook (October 2009)

Thursday, October 29th, 2009

Bill Gross, co-founder and co-CIO of PIMCO, is to my mind one of the shrewdest money men around. His monthly newsletter, this month entitled “Midnight Candles”, therefore always makes for thought-provoking reading.

He concludes the newsletter as follows:

“Asset appreciation in US and other G-7 economies has been artificially elevated for years. In order to prevent prices sinking even lower than recent downtrends averaging 30% for stocks, homes, commercial real estate, and certain high yield bonds, central banks must keep policy rates historically low for an extended period of time. If policy rates are artificially low then bond investors should recognize that artificial buyers of notes and bonds (quantitative easing programs and Chinese currency fixing) have compressed almost all interest rates.

“But while this may support asset prices - including Treasury paper across the front end and belly of the curve, at the same time it provides little reward in terms of future income. Investors, of course, notice this inevitable conclusion by referencing Treasury Bills at .15%, two-year Notes at less than 1%, and 10-year maturities at a paltry 3.40%. Absent deflationary momentum, this is all a Treasury investor can expect. What you see in the bond market is often what you get.

“Broadening the concept to the US bond market as a whole (mortgages + investment grade corporates), the total bond market yields only 3.5%. To get more than that, high yield, distressed mortgages, and stocks beckon the investor increasingly beguiled by hopes of a V-shaped recovery and ‘old normal’ market standards. Not likely, and the risks outweigh the rewards at this point.

“Investors must recognize that if assets appreciate with nominal GDP, a 4-5% return is about all they can expect even with abnormally low policy rates. Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets - while still continuously supported by Fed and Treasury policymakers - is likely at its pinnacle. Out, out, brief candle.”

Click here for the full article.

Source: Bill Gross, PIMCO - Investment Outlook, November 2009.

Tags: Asset Appreciation, Asset Prices, Bill Gross, Bond Investors, Central Banks, Chinese Currency, Commercial Real Estate, Gross Co, Gross Investment, High Yield Bonds, Inevitable Conclusion, Investment Grade, Investment Outlook, Maturities, Money Men, Nominal Gdp, PIMCO, Rage Rage, Treasury Bills, Us Bond Market
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Weak dollar is protectionist barrier, says Bill Gross

Thursday, October 29th, 2009

The dollar is likely to continue depreciating and the “new normal” will see consumers shedding debt in an attempt to balance their books, Bill Gross, the influential manager who runs top bond fund Pimco, told CNBC Wednesday.

“I think the dollar is an over-owned currency. The Chinese, the Asians have basically owned too many dollars for too long,” Gross told “Squawk Box”.

The government has increased borrowing and this will make the dollar “more and more owned and less and less desirable” but this is necessary for balancing the world economy, as it may result in higher production in the US and lower production in China.

Source: CNBC, October 28, 2009.

Tags: Asians, Bill Gross, Bond Fund, Books, China, Cnbc, Consumers, Currency, Dollar Bill, Emerging Markets, PIMCO, Squawk Box, Weak Dollar, World Economy
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Julian Robertson’s Inflationary Perspective - Bloomberg Transcript

Tuesday, October 6th, 2009

We recently featured Julian Robertson’s CNBC interview, in which Robertson outlines the consequences of a scenario where China stops financing the US Treasury. The ongoing debate that is playing out between the deflationists and inflationists is reaching a fever pitch. Last week we discussed Bill Gross’ deflationist decision to exchange his high grade corporate bond holdings in favour of long-dated treasuries. Robertson’s scenario is a variation of other inflationist outlooks that includes the more extreme ‘what if’ chance that China could opt to stop buying Treasuries.

He explodes the less-than-well-known idea that China cannot abandon its symbiotic marriage to the US. This is where Robertson’s perspective is controversial. At the very least, it is a political play on Robertson’s part, in that it may be his attempt to induce a more serious attitude in government to focus on fixing what is truly wrong with the financial system rather than flushing the system with liquidity. Robertson’s IF, THEN, ELSE doomsday scenario is correct IF China stops buying treasuries, THEN the dollar will crash without support, resulting in hyperinflation that would be destructive - ELSE the government adopts economic policy that are real fixes that address the real systemic problems of America’s overindebtedness.

Bill Gross’ latest investment outlook ” Doo-Doo Economics,” addresses the ELSE agenda as well. Both Robertson and Gross seem to share the same concerns, but differ on what the semantics and treatments need to be, now that the US economy is out of the ER and in the ICU. The debate between the inflationists and deflationists seems to rest on how and what will happen next - Falling prices or falling dollar?

TIGER MANAGEMENT CHAIRMAN JULIAN ROBERTSON ON BLOOMBERG, OCTOBER 2, 2009
SPEAKERS:  JULIAN ROBERTSON, CHAIRMAN, TIGER MANAGEMENT
MATT MILLER, BLOOMBERG NEWS ANCHOR
TOM KEENE, BLOOMBERG NEWS ANCHOR
(This is not a legal transcript.  Bloomberg LP cannot guarantee its accuracy.)

15:07

MATT MILLER, BLOOMBERG NEWS ANCHOR:  He is known as one of the most successful fund managers of all time.  Julian Robertson started Tiger Management in the early ’80s with $8 million and built it to over $22 billion at its peak in 1998.  Now though, all eyes are on Tiger Management 2.0., a unique structure he created housing dozens of independently run hedge funds that Julian financed in his offices at 101 Park Avenue.  Julian has been described as the greatest identifier, backer, encourager, and developer of talent that the hedge fund business has ever seen.  He joins me now onset along with Tom Keene, the host of “BLOOMBERG SURVEILLANCE.”

Julian, thanks so much for coming on.

I find that the new structure that you have developed very interesting.  And I’m wondering, you don’t just find them at the Ivy Leagues, you get a lot of your talent at the University of Virginia and UNC.  And you do not just go with the tried and true, you’ve given, apparently, money to guys as young as 26.  What is it that you see in a young manager that proves to you, that shows you that he’s going to be talented and make money?

JULIAN ROBERTSON, CHAIRMAN, TIGER MANAGEMENT:  Well, we look very hard at being sure that everyone will partner with are thoroughly honest.  We want them to be intelligent.  And we have found through the tests that we give that very competitive people are very good in this business.
Oftentimes, people who are excellent athletes of some sort make great fund managers.

I think also, there is a very good probability, although we have not measured this in tests, that there is a great change by the best hedge fund managers, a strong feeling that they should change the world.  And I think that shows up on the people on Wall Street.

TOM KEENE, BLOOMBERG NEWS ANCHOR:  That means Matt’s going to be a great hedge fund manager, because he walks in here every day ready to change the world.

(LAUGHTER)

But it’s an asymmetric view.  When you go to, say, UNC, you’re beloved UNC, or that evil empire down the street at Duke University, and you’re looking for someone, there’s asymmetric challenge here.  You’re looking for someone that can protect capital in challenging times much more than you are that they can make money, right?

ROBERTSON:  That’s right.

KEENE:  When you do that and you recent time, and you haven’t been actively investing, but how do you grade the young Turks given the financial crisis we’ve had, the economic contraction, that upsilon off the end of the equations, the systemic risk that is out there?  Have they done a good job?

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ROBERTSON:  They have done a superb job, particularly through the break.  We have not performed as well as I would like once the break is over.  But I think that’s one of the things you can see in the tests, is the man risk averse.  And then, almost by definition, in the bad times, he will outperform the markets.

MILLER:  It’s interesting that your leadership approach has kind of changed.  During the first Tiger Management, until 2000, you basically were the man.  You made all of the stock picks, you made all of the rules, everyone did what you said.  And now, you preside over a biweekly meeting, you give advice, you listen as well, but they can make, your managers, all their own decisions, they hire and fire on their own.  Why the change in management?

ROBERTSON:  Well, it’s not — it’s even more clear than that actually.
They own their own companies and I am an investor, but it is their company.
I mean I had a man come today, one of our funds, and one of the employees came in and said what is 9x up?  And I said, you know, that is not something that I can answer.  That is something you have to get from the man who owns your partnership.

MILLER:  But you’ve become a lot more bullish on hedge funds.  I mean, you started out with four guys in the beginning of the decade, slowly seeded them.  By 2004, you had it 10 hedge funds that you were investing in.  And this year, it has exploded.  You have added 10 funds, eight in one month.  Why are you so contrarian here and investing so heavily in hedge funds?

ROBERTSON:  Well, in the past, if you work for Soros and Stan Druckenmiller, you could send up a shingle and it said, worked for 10 years for George Soros thorough, waiting for $2 billion and then I’m closing.
You can’t do that now.  You need some sponsorship.  And we have given that.
We are finding tremendous talent right now and that’s why we have been so expansive this year.

MILLER:  All right, hang on one second, Julian.  We are going to take a quick break.  We’ll come back and talk more with you about Tiger, more about the kind of investors you choose and the kind of investments you’re looking at.

Stay with us, more with Julian Robertson and Tom Keene in two minutes.

15:12

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15:14

MILLER:  All right, we are back with Julian Robertson, chairman and CEO of Tiger Management.

Julian, I want to ask you, you know, a year ago, a lot of people, including Jeremy Grantham, we’re saying maybe half of hedge funds would shut down.  We look back now and the industry contracted by only about 10 percent.  What do you think hedge funds have done?  Have they evolved?
Have they adapted better ways to succeed, to survive through this crisis?

ROBERTSON:  I think hedge funds have always had the huge advantage that they are the best way of paying the best money managers.  And so the best money managers have matriculated to hedge funds.  And I think that’s why they are doing better than the rest of the crowd and I think that’s why they’ll continue to.

KEENE:  Well, Bill Donaldson said this once, I believe when he was at the SEC.  I remember, I was at the meeting and he said, look, it’s a brain drain on Wall Street.  Are hedge funds still a brain drain on Wall Street?
It pulls the elite talent away from the rest of institutional investment?
Essentially, is the institutional Street dumber than it was 20 years ago cause you took all of the talent?

ROBERTSON:  Well, I did not take it all, but a lot has left.  And I think that has happened to great extent.  I know that we would far rather compete with a investment bank or a commercial bank than another hedge fund.

KEENE:  Let’s talk about that, your days with Kidder years ago.  You see this discussion of a utility bank versus non-bank, et cetera.  Can we really make a bifurcation between some form of dream from the 1960s, a conservative institutions versus shadow banking?  Are you optimistic that the government can get it right?

ROBERTSON:  No, I’m not optimistic about the government getting anything right.  And I think that they are very much responsible for the situation which we are in and which, to me, the most damning part of it is the dependence on the Chinese and Japanese lenders for our very existence.
And I think it is a tragedy that that is happened to the United States.
And I think that has been done by a group of politicians over long period of time, you know, 30 years.  And they’ve encouraged leverage.  They thought it was a good idea for everybody to own a great home.

KEENE:  How do you manage leverage within a hedge fund complex?  We see so often it gets people into trouble.  Is it a day-to-day management?
Is it a contractual management?  Or is it just about leadership?

ROBERTSON:  I think it is a great deal about leadership.  And I think that exposure is so much more important to monitor than leverage.  For instance, I think I could make a very good argument that a portfolio that was 150 percent invested, where it was 100 percent long and 50 percent short, is far more conservative than another portfolio which would be 90 percent long and 10 percent invested.

MILLER:  Let me ask you about leadership.  I mean, you’ve always stressed, according to Lee Ainslie, the importance of integrity in your personal conduct and how you represent the firm in evaluating management teams — that’s a direct quote from him there.  How can you reconcile that with that with the sort of gun-slinging, entrepreneurial, hedge-fund culture that we have today?

ROBERTSON:  I think that that gun-slinging approach.

MILLER:  The competitiveness that even you have.

ROBERTSON:  Well, that’s right, but I do not think that necessarily leads to a gun-slinging approach.  I think that if you really look at how to do a good record over the years, it’s not to make the huge amounts of money.  It’s to avoid big losses.  That’s the way to really make money over the years.  And I think that’s really what hedge funds do.  I think that, for instance, our funds far outperform the markets in bad times.  And we’ve had trouble.  We haven’t kept up since the market changed.

MILLER:  What are doing now to protect yourself?  I mean I know you’re fairly concerned about the economy as it is, especially considering the fact that you’re concerned about the Chinese stop buying our debt.  What are you doing to protect yourself against the repercussions of that?

ROBERTSON:  Well, if they do, all these people who are worried about inflation or not, they can just not worry about it anymore because it’s a matter of supply and demand.  I mean, who will buy those bonds and what will the bonds have to yield in order to attract people to buy them?  And I think they’re going to have to — if those buyers are gone, I think they’re going to really have to pump the rates up to get them sold.

MILLER:  All right, hang on a second.  We’re going to take a quick break.  I want to come back, though, and ask you what you’re actually doing to protect your money in the case that Armageddon actually happens, as you said could possibly happen.

More on where to invest your money when we continue our conversation with Tiger Management’s Julian Robertson.

15:20

(COMMERCIAL BREAK)

15:23

MILLER:  All right  we are back with Julian Robertson, the legendary founder of Tiger Management, and Tom Keene, Bloomberg editor at large.

Julian, let me ask you, we were talking about what happens if the Chinese and Japanese stop buying U.S. debt; we see interest rates soar, we see inflation soar, it’s complete Armageddon.  What are you in financially to protect yourself against that?

ROBERTSON:  Well we have bought some very long options called curve caps.  And essentially, they are puts on long-term bonds and the leverage is probably more than what you can get in a put on this thing.

Now, you buy them as an insurance policy.  One, you know what you can lose.  If you go short, the bonds, as you know, the risk is unlimited.  But if you buy puts, the risk is limited to the price of the puts.  But we have bought a lot of those and I think that would insure us in the event of a massive rate increase

KEENE:  I want to get in one question here on your beloved New Zealand.  We’ve got a lot of first-order effects we could sort of sort through.  What dollar dynamics would be, or interest dynamics would be.
Too often, we in the media, we are in a cocoon here.  We don’t worry about what the rest of the world’s second-order effects will be.

How is New Zealand for that matter or China going to respond to the deficit we have, to the dynamics of slow growth, to the job report that we saw this morning?  How do you perceive a nation like New Zealand or a larger player is going to respond to all this?

ROBERTSON:  Well, let me say first, New Zealand they’re even more profligate than we are.  They really spend more than they earn.

KEENE:  Well, when you move down there, you moved to the GDP, didn’t you?

(LAUGHTER)

I mean, you tilted the needle on the GDP, right?

ROBERTSON:  We just brought love, that was all.

But it’s amazing to have picked the two most profligate countries in the world to live in.

KEENE:  How’s a guy from North Carolina do that?  I don’t know how that happens.

ROBERTSON:  I don’t know how it happened either.

MILLER:  How do you take your message down there?  How do you present your message here  in the U.S.?  I mean, you are concerned about the trade deficits that Tom was talking about.  You are concerned about the economic implications of what we’re going through here.  How do we work off this debt?  What should we do?  What should the administration do?

ROBERTSON:  Well I think we really have to almost be Margaret Thatcheresque about it.  When she took over Great Britain, she told the press they would have a long time before things got good again.  And our government is trying to do quick fixes, stimulus packages, this, that and the other.  And basically, what we’re going to have to do, we’ve spent too much as a nation.  We’ve spent too much as a people.  And like anybody else who gets over indebted, we’ve got to cut back until we get back in shape again.

MILLER:  All right, Julian.  Thanks so much for spending time with us.

KEENE:  He’s got to get that voice better.  He’s sounds way too much like me.

MILLER:  I’m going to give him some of my special herbal tea here.

Julian, thanks.  Julian Robertson.

ROBERTSON:  Sure.

MILLER:  Tom Keene, appreciate you joining us as well.

15:27

***END OF TRANSCRIPT***

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