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Stepan Lavrouk
Stepan Lavrouk
Articles (321) 

Stanley Druckenmiller: People Have Been Doing Stupid Things

The famous hedge fund manager speaks out against loose monetary policy

June 05, 2019 | About:

Hedge fund manager Stanley Druckenmiller (Trades, Portfolio) recently gave an interview to the Economic Club of New York in which he chastised the Federal Reserve for depressing interest rates for so long. Druckenmiller, who was once the lead portfolio manager for George Soros' (Trades, Portfolio) Quantum Fund, believes that the buildup in debt in the U.S. economy poses a serious systemic risk.

“Loose monetary policy contributed to the financial crisis”

“I will go to my grave believing that really loose monetary policy greatly contributed to the financial crisis. There were obviously also problems with regulation, but we had a 1% Fed funds rate in 2003, after it was pretty obvious the economy had turned [for the better]... I’ve made some money predicting boom-bust cycles - sometimes I’m right, sometimes I’m wrong - but every bust I have ever seen was set up by an asset bubble, generally set up by too-loose policy.”

Druckenmiller believes that the initial monetary interventions carried out with the Fed in 2008 and 2009 were necessary and well executed. However, he thinks that central bankers should have turned off the spigot once it became clear that the economy was on its way to recovery. Instead what happened was two more rounds of quantitative easing, creating the conditions for “another misallocation of resources.” Druckenmiller would have preferred if the Fed had gradually raised rates over the last eight years, so that eventually they were high enough to discourage reckless behavior. That did not happen, so he thinks we are now in the middle of another asset bubble.

“I was afraid that people were going to do stupid things and indeed they have”

“Corporate debt was $6 trillion in 2010, it’s since grown to $10 trillion, up 65%. That’s not necessarily a disaster, it depends on what they borrowed. But I would point out that during that same period corporate profits grew from $1.7 trillion to $2.2 trillion - that’s cumulative over those eight years. So on a $4 trillion increase in debt, we got $500 billion in corporate profits, but it’s worse than that - the interest cost on the extra $4 trillion in debt only went up 23%, from $475 billion to $565 billion. So think about the horrendous productivity of capital here. You increase your debt 65%, but your interest costs only go up 23% - you would think your profits would explode with that formula - they went up 29%, over eight years, not in one year.”

Moreover, while total corporate profit growth has been underwhelming, that hasn’t been the case for earnings per share, which Druckenmiller considers to be another serious misallocation of capital. Over the period 2010 to 2018, buybacks rose from 20% of capital expenditures to 55%, with a much higher stock market. He believes that companies are taking advantage of easy monetary conditions to juice their own valuations, rather than investing in themselves.

Who is doing the borrowing?

“The companies that are growing and innovating, they’re not the ones who are borrowing the money. It’s not Google, or Facebook - they’re spending their brains out on innovation. It’s old, dying retail companies, companies with 24 square feet per capita in this country, and that number is 3 in Germany and 2 in China. But we have all these zombies walking around. So here we are, in probably the most innovative, economically disruptive period since the late 1800s and you hardly see any bankruptcies.”

It’s a commonly held belief that the much-touted FAANGs are excessively highly valued and are the major contributors to the distortion in the stock market. While there is substance to that belief, it also seems clear that the companies that are going to become a thorny issue for the U.S. economy are in the legacy areas that Druckenmiller describes. Financial systems, like forests, need to be allowed to cleanse themselves of dead weight. Staving off the inevitable simple leads to a worse fire down the road.

Disclosure: The author owns no stocks mentioned.

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

Rating: 5.0/5 (4 votes)

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Comments

andriumg10
Andriumg10 - 5 months ago    Report SPAM

What are these companies?

Thomas Macpherson
Thomas Macpherson premium member - 5 months ago

Great stuff Stepan. I wrote earlier aboutthe growth of debt in the Russell 2000 and the fact that most companies achieve no return on this capital infusion. It seems quite stunning to me how much cheap debt has kept many companoes afloat. Thanks again for pointing out such a great interview. Best. - Tom

Stepan Lavrouk
Stepan Lavrouk - 5 months ago    Report SPAM

Thanks - it also makes you wonder what's going to happen if the Fed ever decides to raise rates - how many of these cheap stocks are going to fold?

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