April 17, 2015
By Steve Blumenthal
“I’m not predicting a crash, I’m just saying the risk reward of going early (Fed raising rates) is better than going late.”
– Stan Druckenmiller
I spent 45 minutes this morning watching the Bloomberg interview with Stan Druckenmiller. I had a number of other things to share with you today, gathered over the course of the week, but they have been moved to the backseat. Put Drunkenmiller’s comments in the important category. Often gruff, I enjoy his clear and candid way.
Outperforming Warren Buffett and most everyone else, Stan’s track record is reported to be 30% per year for 30 years (with never a down year). Let’s just say we should be interested in what he has to say.
I share my notes from the interview below but I encourage you to find some down time, grab a coffee, and watch the first 40 minutes of the interview. Additionally, you’ll see that the interview references a private presentation Stan made in January 2015 at a Ken Langone (Home Depot founder and frequent CNBC guest) sponsored event. Someone recorded the presentation and titled it “The Speech at the Lost Tree Club”. It is worth the read. You’ll find the link below.
You and I are in a tough business. It is based on probabilities and involves imperfection. The mismatch between customer expectations and practical reality is challenging. Art Cashin said, “That to survive 50 years in this business, you learn that the first thing you do when you enter a room is look for the exit sign.” It is with this thinking, along with Drunkenmiller’s material, that I also share a great (short) piece on investing and risk from Ned Davis. Another grateful nod to NDR for allowing me to share it with you.
I hope you find the material helpful.
Included in this week’s On My Radar:
- Notes From the Bloomberg Druckenmiller Interview
- Speech at Lost Tree Club
- Trade Signals – Finding Uncorrelated Returns
Notes From the Bloomberg Druckenmiller Interview
He feels much like he did in 2004 and is more worried about looking down the road than the near term.
He sees no reason for zero interest rates:
- Why does the economy need extraordinary help.
- Retail sales are at an all-time high.
- Everything is booming except corporate capital reinvestment. That money is going into share buybacks and dividend payouts.
On where the Fed funds rate should be:
- In 2009, the Fed came up with a new version of the Taylor Rule. It said then that rates should be a -4%. Instead the Fed chose QE.
- Today that version of the Taylor Rule says that Fed funds rate should be 3 ½ %.
- If you use the traditional Taylor Rule, which said in 2009 rates should be -1%, today’s rates should be at 1.75%.
- We remain at 0%. Why?
- Strongly noting: The time has come to get us off the juice.
Every month that goes by we have more and more financial engineering. We are borrowing to buy stocks.
Stan’s fear is we won’t see a rise for 1.5 years. No confidence that there will be rate hikes in June, September or by year-end.
- We’ve already met the metrics they set out.
- If you wait, the risk is worse.
- It’s a pay me now or pay me later scenario.
He is not predicting a crash or predicting doom. He is saying that as someone who practices risk/reward for a living, the risk/reward of the Fed moving early is better than moving late.
He was asked about Ray Dalio’s belief that we are seeing 1937 happening all over again. Duckenmiller disagrees stating the two periods are quite different:
- In 1937, stock prices and household were 20% below where they were in 1929.
- Today we are at new highs in stock prices and household.
- From 1929 – 1937 we had a cumulative 18% deflation.
- From 2007 to now we’ve had a cumulative 16% inflation and the Fed’s favorite measure of inflation has never been below 1% since 2007.
- Unemployment was over 14% in 1937. It is currently 5.5% today.
On deleveraging he answers that there is NO deleveraging. We have re-leveraged from an already high 2008 level. World debt has grown $57 trillion – McKinsey Report. See On My Radar – Schumpeter’s Creative Destruction.
- In 2000: World Debt to GDP was 245%
- In 2007: World Debt to GDP was 269%
- Today World Debt to GDP is 290%
- We are doubling down in terms of debt.
He was asked about corporate credit – the host speaking favorably about corporate balance sheets. Druckenmiller responds with a firm NO and adds:
- Corporate credit in 2007 was $3.5 trillion and is now $7 trillion
- We are not talking about good quality debt
- High yield loans in 2007 were $800 billion and are $1.4 trillion now
- Covenant lite loans which were $100 billion then are $500 billion now at a $300 billion run rate
- 28% of debt back then was B rated. Now 71% is B rated
- The risk of a credit event is extremely high
His style of investing is he can change his portfolio within 24 hours.
Something he learned from George Soros: When you see it, bet big.
Big bets he sees today:
- Flipping of monetary policy created a textbook opportunity in currencies: The negative deposit rate in the EU, the EU going into QE and the US ending QE. He has never seen a major currency trend last less than two years. We are ten months into it. Dollar higher. Euro lower.
- Another big bet is long Japanese and European equities.
- Has new ideas he’s flirting with – is pretty optimistic on crude prices.
- Also sees one other wild card. China’s stock market is up 140% in six months on record volume and record breadth. As day follows night six months down the road, China will be in a full-blown strong economy. He is opining on the transmission mechanism of the market to the economy – market goes up, wealth goes up, the economy goes up.
He believes Europe’s economy has actually turned and is looking better.
He believes the Euro could get into the 80s. Stating, that would be about the average move for a currency when they get into a big trend. The big currency moves when in motion generally see something like a 50% to 55% move which would target an 80 handle on the Euro. Don’t forget it was at 82 in 2000.
I really enjoyed his comments around the dollar and the economy:
- Effects the strong dollar could have on the US economy. He finds no correlation between the level of the dollar and the direction of the dollar on the effect on the economy – after a personal study for a better part of 40 years. He can find no correlation to the level and direction of the dollar to the economy.
- It is true that a strong dollar has a negative effect on corporate earnings; however, that is very small compared to the impact a strong dollar has on the consumer who is 70% of the economy. The consumer gets a big purchasing boost in a stronger dollar.
- He does see correlation in a strong dollar to a strong economy but can’t say if it is because a strong economy causes a strong dollar or a strong dollar causes a strong economy. No evidence.
He cited the following supporting the above:
- The dollar went from 80 to 160 by June 2008. Under a dollar theory, shouldn’t we have been going into an economic boom? He recalls the economy sunk sharply shortly after.
- When he was at Soros, the yen declined from 78 to 147 vs. the dollar between 1995 and 1996. Japan did not experience great economic growth because their currency went down 50% to 60%.
- He has been looking at this for a long, long time; he can’t find the evidence that a currency has that big of an effect on economic activity.
He touched on the student loan problem: stating it is very reminiscent of the housing boom. Bill Ackman thinks it is the biggest risk we face. Druckenmiller doesn’t see the debt getting paid back. He is somewhat concerned about the student loan problem and generally agrees with Bill.
One mistake he made in the past was getting emotional about investing. Nice to hear that from one of the great traders.
I tried to hit all the important points but click here for the full piece.
Speech at Lost Tree Club
When clients and friends ask me for investing advice, I ask them if they are an investor or a speculator. What I’m trying to do is see what process best suites who they are inside. Put an investor (let’s call this category broad based asset allocation) “all in” on a few speculative bets and failure is sure to occur. Broadly diversify the speculator and a similar personality/expectation mismatch is sure to occur.
Great speculators have the conviction to stick with a bet when it is not working. Most also have a risk management process to limit loss. No one hits 100%. I have heard it said that broad diversification is the only free lunch in the investment business. To that I agree. Sure wish I had a 10% allocation to Druckenmiller’s hedge fund over the last 30 years.
The Druckenmiller speech at Lost Tree Club is readable and enjoyable. You get a chance to get into the mind of one of history’s greatest investment speculators. All I can say is read it, file it and reread it again another day. It is both enlightening and enjoyable. Link to the full piece here.
Link to piece here http://www.cmgwealth.com/ri/on-my-radar-the-speech-at-lost-tree-club/