Stanley Druckenmiller (Trades, Portfolio) is among the best investors of all time. He’s now managing mostly his own money, but used to be the lead portfolio manager for George Soros (Trades, Portfolio)' Quantum Fund. He shared his view of the market with Bloomberg on Dec. 18 in an hour-long interview. It’s worth watching the whole thing, but I took notes in order to study his current thoughts as well as share them below. His key points are:
- The Federal Reserve should stop raising interest rates (this is a complete turn from his prior thinking).
- He doesn’t necessarily see a recession coming, but we could accelerate into one quickly.
- The stock market is giving off signals of where we are heading if we continue like this.
I will aslo discuss the positions he likes in this environment.
Signals
The best economist Druckenmiller knows is the inside of the stock market. Front-end cyclicals show a completely different picture from the general market. Auto stocks are down 30%, home building stocks are down 35%, banks are 25% down, retail equities are 20% down, the Russell 2000 is down 20%. How in the world can the S&P 500 only be down 11%?
Because pharma, utilities and staples, which are economically defensive, are actually up.
Druckenmiller used these indicators cycle after cycle. They haven’t always worked in recent years, but they seem to give a more convincing signal right now.
Recession
Most people argue there are no signs of a recession. Druckenmiller agrees in part. Gross domestic product growth is still very good, for example. But indicators he’s historically used in his business are definitely amber. One of these are the cyclical subsectors mentioned above. Others are the yield curve inverting. Although this hasn’t happened for the two-year and 10-year Treasuries yet, it did happen for the two-year and five-year. Druckenmiller calls it a very confusing bull flattening. The Fed has basically told the market there will be three or four more hikes and the market is saying, no there won’t be.
Credit is drying up, but Druckenmiller believes it has been spared worse because banks are considered safe. But the economy doesn’t care where the credit is. If the credit is drying up, that ultimately slows down the economy. Businesses would probably prefer to owe their debts to banks (that tend to seek cooperative solutions) instead of owing it to hedge funds and or business development companies).
The high-yield market is also moving. Leveraged loans are down.
There are no red, flashing warning signals, but Druckenmiller gets a lot of amber alerts.
Fed should stop raising interest rates
Previously, Druckenmiller has argued for hawkish policy. Why the turnaround?
Since 2010, corporate nonfinancial debt grew 60% and corporate earnings increased 27%. How did the S&P 500 earnings grow by 60%? Because of all this debt, added on because of Fed policy. The debt was used to leverage up balance sheets, through buybacks, etc., which explains a lot of the earnings growth.
We want this bubble to deflate slowly. If it doesn't, eventually we will have to do a lot more monetary stuff.
Essentially, Druckenmiller is saying we are beyond the point where we could have tried to normalize interest rates and are too late. We have to stop raising rates early because we didn’t start sooner.
He adds the Fed never hiked rates into a market like this since Volcker.
At the same time, monetary policy is tightening anyway because of the roll-off of the balance sheet.
Trades
The million-dollar question is where Druckenmiller is investing right now. He says he doesn’t like shorting stocks very much during bear markets. Instead, he goes long Treasuries. I assume he does so in a leveraged fashion, perhaps through futures markets. It seems counterintuitive to dislike shorting stocks, but he doesn’t like how they whipsaw against him.
Another sector he likes are the secular growth stocks. They have been in an uptrend that got interrupted about six months ago, but he continues to like these as long as we don’t actually enter a recession.
He specifically mentions the cloud companies ServiceNow (NOW, Financial), WorkDay (WDAY, Financial), SalesForce (CRM, Financial) and Microsoft (MSFT, Financial). These are in the second inning of an eight-inning game. They all show terrific growth, but ServiceNow's growth is not dependent on the economy so much as the shift in enterprise software towards the cloud. If we go into a low-growth environment, these sources of growth are extra valuable.
Disclosure: Author owns none of the stocks mentioned.Ă‚
Read more here:
