Introduction: Thomas D. Conrad, Ph.D. is currently a hedge fund manager and president of Financial Management Corporation. He received his Masters Degree in Accounting, Statistics, and Financial Management from The University of Maryland in 1961 and his Ph.D. in Business Administration from The American University in 1965, with emphasis on Securities Analysis and Managerial Economics. His Doctoral Dissertation, "A Statistical Analysis of The Results of Integrating The Use of Mutual Funds and Life Insurance in Financial Planning" was later published. Dr. Conrad has taught and lectured at seven universities, including The American Institute of Banking and The American Savings and Loan Institute. Dr. Conrad has held a seat on the Philadelphia-Baltimore-Washington Stock Exchange, and served in the Reagan Administration as Deputy Assistant Secretary of the United States Air Force (Financial Management). His website is www.worldfund.net.
Anthony Wile: Hi, Tom. Nice speaking with you again. You're in the market every day from morning to evening, watching the numbers and also tracking the performance of your managers since you're a fund of funds. What do you think of this market? What's your sense?
Tom Conrad: Well, I'm early in the bearish game, maybe too early – but I'm certainly a bear. The market is over-extended in that equity prices are not justified by earnings, and we haven't had a correction of any significance for over five years.
We've been buying farmland and expanding our silver holdings. We just purchased shares in a farm in Eastern Europe and I long ago determined that Uruguay would be a place where we'd want to have exposure. So we've purchased several farms there. We're gradually migrating from securities assets to commodities holdings.
Anthony Wile: That makes sense given the age of this "paper bull" – as opposed to a "golden bull" – but given the way this market is appreciating, you probably can't afford to sit out.
Tom Conrad: Our exposure is significant, but I'm also taking a contrarian approach. That's what a hedge fund does, after all. It hedges its positions. So we're always looking to balance our investments with alternative approaches.
We manage to do pretty well, though. At the time of this interview, we're up 5 percent while the market is even. Overall, I guess you'd call our stance "defensive," though if you annualized our returns, we'd be up something like 11 percent.
Anthony Wile: Can you give us a sense of what defensive means?
Tom Conrad: We're expanding our positions in precious metals – not just gold but silver, too.
Anthony Wile: Where is gold headed these days?
Tom Conrad: I think gold will rise. When and how, I'm not prepared to say. I don't know if we'll see a run-up similar to the great expansion that began in 2001, but it's an indispensable part of our portfolio at some level, with some weighting.
Anyway, I'm not so interested in the price at any given time as I am with gold's prevailing tendency, which is to run counter-cyclically. Running a hedge fund as a fund-of-funds, I have a responsibility to position the fund on both sides of market trends. One thing certain about markets is that trends change.
Anthony Wile: You've certainly seen trends rotating in the past decade-and-a-half. First equities moved up hard and then they moved down … and then back up. Gold and silver moved up significantly and then down as well.
Tom Conrad: When it comes to the current bull market, I turned contrarian about two years ago. That was when the price-earnings ratio began to widen. We've all known the market is in for a correction but as always the timing becomes the question.
Anthony Wile: You have to have a feel for it.
Tom Conrad: I've been following markets for 50 years. Within the next five months there will probably be a market correction. I think I am looking for 15 percent correction. But not, overall, a bear market.
Anthony Wile: Isn't the market considerably overvalued, as you've pointed out? Why not a bear market?
Tom Conrad: Unlike other markets in my lifetime, this market is being driven overwhelmingly and in a concentrated way by a monetary policy orchestrated by the Fed. Also, it's obviously directed out of Switzerland by the BIS. It's not just the Fed which is printing a lot of money but also Japan, China and now Europe. You have to step back to see how coordinated the printing really is.
Anthony Wile: In other words, ordinary rules don't apply this time around.
Tom Conrad: This is a situation where the Fed wants to prolong the economy's upward swing by tremendous activism. Interest rates are certainly lower than the natural rate would be. Easy money is the goal and has been since 2008. And markets have been responding since 2009. That's some six years of constant stimulation, a loose money policy that has helped drive the market back up to new heights. I don't know if they have the guts to let the market be a free one. But that's not a realistic goal anyway. It's nothing near a free market.
Anthony Wile: It's also a narrow market.
Tom Conrad: The upward movement is confined and concentrated and has been throughout this expansion. A lot of what moves the averages has to do with technical trading, the computerized trading that happens on an almost instantaneous basis.
Anthony Wile: How do you play a market like this? Do you anticipate the correction?
Tom Conrad: Obviously, you hedge. I've bought gold, though gold is not going to do much until people get pessimistic about current market movements. But in a market like this everyone should own some gold if they have sense. Also, I look for investments outside the mainstream. I've taken advantage of opportunities in Turkey, Taiwan and even South Africa. Chile is booming.
Anthony Wlle: Aren't you taking on more risk that way?
Tom Conrad: The risk is generalized and unprecedented, so you´re going to have risk no matter what. The market distortions are worldwide. Trans-national organizations are trying to direct where the world economy is going.
Anthony Wile: So it's a dangerous time for markets.
Tom Conrad: Is it dangerous? Yes. But I am optimistic that we will continue to make money despite these outside forces at work. At the same time, I don't want to downplay what's going on. It is a lot tougher to make money because all the traditional criteria don't apply. Politics and money are driving this market. For me, the best way to compete is to look for more special situations under the radar. That's what I'm doing, looking for special situations.
Anthony Wile: Do you have a timeline for a pull-back? Can this market really continue to drive forward?
Tom Conrad: I don't know the answer to that question. I'd say we'll see the current pattern persist at least to some extent – whether or not we get a pullback – until the next presidential election in another year and a half.
Anthony Wile: What could precipitate a correction?
Tom Conrad: Raising rates. That's why they're being so cautious. It's a kind of promotional approach in that they've made such a big deal about a tiny amount that people believe it's more important than it is. When they do finally raise by a quarter of a point after talking about it for a couple of years, the move becomes magnified.
It's just a quarter of a point but it seems like more because of the publicity. And thus, this takes some of the pressure off. They do it once and the attention and media scrutiny makes it appear like a far more major step than it is.
It's a token figure, a public relations gambit, but the coverage will make it appear to be a significant move even though it's not. And as a result, they'll have bought themselves more time before they have to raise again.
Anthony Wile: How does it all end?
Tom Conrad: Honestly, I don't know. I haven't been through anything like this. It can certainly end in a major depression in the world at least comparable to 1931 or even some kind of popular revolt if things get too bad.
Anthony Wile: That doesn't sound very positive.
Tom Conrad: The long-term trends are not hopeful in the context of traditional modern investing. As we've discussed, there's too much monetary and political influence in the world, too many technocrats trying to tell you what to do. And too much mob rule as well, where you have voters who are simply trying to vote in those who will open the public purse. This is a real problem: too many voters who have no property, pay no taxes and generally are only benefiting themselves.
Anthony Wile: Are you speaking specifically of Western countries or is this a worldwide phenomenon?
Tom Conrad: From a monetary standpoint, as I mentioned, it's worldwide. And the economic models – and even the political ones – are generally the same around the world. China and even Russia have adopted Western-style systems including central banking.
Anthony Wile: But there are increasingly military tensions between East and West …
Tom Conrad: Economic tensions often give rise to military ones. I see greater possibilities of war … especially as markets reach a tipping point. China in particular is becoming more aggressive and imperialistic. The statistics in China are not trustworthy and they've been stimulating hugely though the media doesn't seem to be connecting cause and effect.
They've got a housing bubble and an economy that is far over capacity. They are positioned to supply the world but the world isn't buying. The consumer demand is not there and thus the Chinese government has been trying to stimulate demand at home. But that's a questionable policy at best. The alternative is always the same – a military one.
Anthony Wile: Demographic issues are a problem, as well.
Tom Conrad: China has an oversupply of men due to its one-child policy. Families in China prefer boys and so you have an excess capacity of young men who cannot find companionship and may never marry or have children. This is a big danger for China because an oversupply of young men can be politically and economically destabilizing. It's one reason perhaps why China has been acting more aggressively in its own region of the world. At the very least, if you raise military tensions you justify a bigger army – and that's one place the excess male population can go where they are supervised and subjected to considerable discipline.
Anthony Wile: What about Japan?
Tom Conrad: Japan has demographic problems and the approach being taken by the politicians is very similar to China's and the US's – which is Keynesian and stimulative. They are printing money and attempting to boost securities prices, which doesn't translate into increased jobs or a vibrant economy. You can't build economic vitality through monetary policy. What you end up with is asset bubbles and those eventually burst, as this one will in Japan, in China and, of course, in the US.
Anthony Wile: Good points. You mentioned you are looking for alternative opportunities …
Tom Conrad: As a hedge fund, I sell the market short where I see opportunities to do so. I'm short the S&P as well as long, and I've maintained and expanded our position in gold and silver. I've purchased farmland in Uruguay and in Russia.
With farming, I'm trying to diversify as well, so in addition to cattle we're concentrating on soybeans. Also, I should point out we're buying black earth farms – virgin soil that hasn't been subject to a lot of agricultural activities, especially not intensive "green" farming with pesticides and other chemicals. This is where I am most enthusiastic.
Agriculture is a big opportunity from an investment standpoint. You have to be careful about what you buy and where. Uruguay for instance has places where the topsoil is four feet compared to places in the US where the topsoil is four inches or less. You have to look for the proper virgin locals. I intend to do more of this with the fund.
Anthony Wile: Sounds like an innovative approach.
Tom Conrad: I think so. It's sensible anyway. Diversification in this market at this time is the prudent approach. In order to counteract the risks in the marketplace, diversification is most important. We are diversifying every way possible including through asset classes, strategies and via geography itself.
We believe in having half of our investments outside of the US and we emphasize a truly strategic approach. This idea of readjusting your portfolio depending on your age has little to recommend it practically. The bond market is as oversold as the stock market if not more so. By reducing your exposure to stocks and increasing your exposure to bonds, especially Treasuries, you're doing absolutely nothing to minimize your real risks. A couple of rate hikes by central banks and you'll possibly have a major bond market implosion. All those grandparents that believed they were doing the prudent thing by expanding their exposure in the fixed income market will get a very unpleasant surprise.
Anthony Wile: So what do they do? Buy dividend stocks?
Tom Conrad: We don't believe in income-type stocks. If a person needs income we'll get it through growth, all kinds of growth. Your manager has to be good enough to deliver growth. There are no shortcuts. Growth comes from picking the right investments and diversifying prudently across asset classes.
I mentioned strategic diversification, by the way. Most people don't understand what that is. But as a hedge fund operating with a fund-of-funds approach, our diversification is a necessary part of the process. I utilize 15 money managers because that provides strategic diversification thus reducing risk. Fifteen is the magic number – no more or less according to academic and historical studies.
This is the way I substantially reduce the risk of fads and embezzlement. Over 50 years, I've seen almost everything go wrong that can go wrong. Oftentimes the best performing funds one year are the worst performing the next because the strategy they use isn't applicable to the changing circumstances. Our managers are constantly evaluated using a variety of mathematical analyses. The worst performing ones are removed on a regular basis. The best performing ones receive more funds. And since we retain an extensive database of over 200 additional funds, we are in a position to add in new funds that are performing well.
Anthony Wile: The fund-of-funds approach seems like a practical one if operated successfully.
Tom Conrad: Yes, but like anything else, you have to know what you're doing. We've given up a substantial amount of personal revenue because we don't charge very much. On the other hand, we've been ranked as high as number three among all hedge funds worldwide because of the successful way we've implemented our approach.
Anthony Wile: Is the mainstream Wall Street community beginning to emulate what you've created?
Tom Conrad: No. We function in an independent environment. I can't even tell our funds managers what to do. Buy when it comes to Wall Street it's just the opposite. The broker is there to sell the products of the firm – and does so in my estimation whether those products are appropriate for the customer or not.
Whether the broker is mainstream or independent, the chances are that he has conflicts of interest generated by the suppliers of the products he recommends. Every broker thus has relationships that he needs to accommodate – and he may do so by recommending those products to the client no matter the appropriateness.
Anthony Wile: Sounds like a fund-of-funds approach does away with most of those conflicts of interest.
Tom Conrad: I believe the fund-of-funds approach provides you with the best possibility of diversified – hedged – growth. Our fund is over 20 years old and we've seen a number of kinds of markets and variable asset classes but we've always been able to adapt and succeed.
We're in very challenging times right now because of all the uncertainty and market interference, but I have faith in this model based on our longevity and success over a significant time period. I don't expect that to change, even though markets always do.
Anthony Wile: Thanks for the insights and sitting down with us again.
Tom Conrad: My pleasure.