A Cautionary Word from Value Investor Arnold Van Den Berg

When value investor Arnold Van Den Berg (Trades, Portfolio) of Century Management speaks, we should listen. A self-proclaimed student of the Benjamin Graham investing philosophy, Arnold has, "handily beaten all of the indices."

Observe an intriguing segment of his October 25, 2014 presentation.

Below is Part I Summary of his Century Management 2014 Client Review

Part I:

• Positive things in economy
  • Hydraulic fracturing
  • 3-D printing
  • Nanotechnology
  • Robotics
  • Most competitive manufacturing in the world
  • Cheap energy, competitiveness
  • Unemployment down
  • Federal deficit from an “official standpoint” coming down…but not real
  • Residential real estate improving
  • Consumers saving more
  • All these things boost corporate profit margins to record high

• Net worth of households & non-profit organizations
  • Record high
  • Very proud of this country creating this wealth
  • Favorite because the charts shows the creativity, hard work, and resourcefulness of the American public
  • Reason why it concerns him:
    • $13T “wealth added”, but he notes:
    • “Have we really improved this much since 2007 or is it sort of an artificial thing that’s being promoted by the Federal Reserve?”
  • Wealth created because Fed has driven down interest rates
    • Pushed people into stocks, real estate, and other assets
      • This would usually be in savings, fixed income (bonds) “more secure investments” for retirements
      • “Chasing yields,” they are going into a lot of “riskier investments” than they should…
      • “Driving some assets up way beyond their true worth…”
      • “This is something we really need to be concerned about”
      • Positive thing is it has driven corporate profits to a 70 year high

”‹

• Asks, “is it only due to low interest rates?”
• Labor costs have not kept up, good for corporations
• Corporations are not using this money to advance the company e.g. new technology or CAPEX
  • What they are doing instead is… “buy back shares”
  • Concerned because they are “buying back shares at pretty high prices”
• “Never been a time in world history where the whole world got together and is printing money”
  • Individual nations have done this with “disastrous results”

”‹

• Potential for inflation if “this money gets into the economy” “something to worry about”
• Banks are keeping it in the bank, “parking it”
• This has led to a “real bubble in the junk bond market”
  • Because they can’t get a good yield [investors are] going into junk bonds…such as
  • “Covenant-lite loans” they “don’t have a lot of protections”
• Shows a December 2013 quote from Richard Fisher, Fed Reserve Bank of Dallas,
  • “I worry about the fact that we’ve painted ourselves into a corner which is going to be very hard to get out of.”
  • Created all this money, how are we going to pull it back out?
• Shows Quote from Alan Greenspan, July 2014,
  • “We just do not know how this thing is going to work out when we begin to tighten.”
• Shows Quote from Jeremy Stein, August 2014,
  • “There’s no real precedent for anything of this magnitude… I don’t think anyone has yet figured out the right answer about how to deal with this.” August 2014
• Arnold mentions it will not be a soft landing, it will either be “inflation or deflation”
• Talks about what the FED’s role really is, “create stability in the economy and the currency… like a teeter-totter”
  • Currently no sign of deflation in the US
  • Deflation is a cultural thing, why it’s so dangerous…
    • “Once people realize the price is going down they stop purchasing, when people defer their purchases the [corporations] can’t sell as much product so they have to lay off people…if you can’t stop deflation then it goes into serious deflation like we did in ’29.”
    • “Will send the economy into a tailspin”
  • Shows chart of an example of another country’s monetary base, Japan
    • Talks about the consequences of pulling the money out
    • Deflation for 12 years and still have barely pulled themselves out
  • Talks about Ben Bernanke quote in 2002 about fiat currency
    • “There was very little risk of deflation” because the resilience of the economy,” “I am confident the Fed would take whatever means necessary to prevent significant deflation…”
    • Arnold states Deflation is highly unlikely but would not rule it out
      • “It’s unlikely because the “printing press”
      • The government could reduce the value of the dollar”
        • Increasing the number of dollars, the government can reduce the value of the dollar
        • “same thing as raising prices”
    • On inflation:
      • “If you’ve ever lived through inflation, there is nothing positive about that”

”‹

• Three other reasons why we are not going to have deflation
  • Fed reserve has "cultural bias"
    • They would rather risk inflation than suffer the consequences of deflation… such as the US depression
    • Gives example of the other risk-inflation
    • Statistics on Germany’s hyperinflation
      • 1913 1 Egg = 8 pfennigs, 1923 80 billion marks
      • Shoes 1913 12 marks, 1923 32 trillion marks
      • Currency became worthless
      • Arnold states “Once the currency goes, it goes very very rapidly”
    • Germany’s cultural bias is worried about too much inflation (knowing how currency instability led first to panic, then electing an extremist politician, and ultimately war)
    • These are cultural differences that can lead to unintended consequences
  • Dual mandate
    • Balancing act between price stability and maximum employment
    • Shows chart of declining value of US dollar
    • 95% of purchasing of the US dollar since the start of the Fed, “so much for price stability”
  • Political pressure

Part II To Be Continued

The remaining parts of Arnold's presentation are accessible to the public on his website.