Stanley Druckenmiller's Pessimism Was Priced Long Ago
The source of Stanley Druckenmiller's immense wealth is his amazing investment track record over several decades. Druckenmiller's billions signal a keen understanding of markets, so when he speaks his words carry a great deal of weight.
At an investor conference last week Druckenmiller's expression of extreme bearishness of the "buy gold" variety naturally attracted attention around the world. Deservedly so. Druckenmiller is once again one of the greats.
Yet despite Druckenmiller's investing genius, investors would be wise to not join Druckenmiller in his intense worry. The previous statement isn't a suggestion that all is perfectly rosy in the economy and markets, but it is to say that what has Druckenmiller worried is already priced. That's what markets do day after day, minute by minute, and second by second. They're constantly processing information.
So while equity markets could correct in a savagely brutal way today, tomorrow, next Tuesday, or next month, they won't based on the information provided by Druckenmiller at the Ira Sohn conference. What drives large and sudden market swings is surprise, yet Druckenmiller was presenting information that was and is already known. If Druckenmiller actually did offer something new last week, markets have by now digested it.
As for what has Druckenmiller concerned, he mentioned a few key things. First, he noted that when Duquesne Capital opened its doors in 1981, "financial leverage was less than half what is today." Scary stuff at first glance, but it's worth pointing out that the U.S. economy is exponentially larger today than it was in 1981. With it much larger, it's no surprise that leverage has increased in concert with stupdendous economic growth.
Put simply, individuals and companies of means can borrow a great deal. Druckenmiller himself could likely borrow billions today without much effort at all, but in 1981 his wealth probably would have placed his borrowing ability in the low millions, at best. Bill Gates can borrow a lot too, as can Paul Tudor Jones. They can because they're rich. Apple and Google can borrow billions at very low rates of interest because they're among the most valuable companies on earth. The only thing surprising about financial leverage today vs. 1981 is that it's not greater.
Federal debt also worries Druckenmiller. He noted that the "impeding of market signals has allowed politicians to continue to ignore badly needed entitlement and tax reform." But without defending the various wasteful and harmful government programs for even a second, the reality is that investors around the world line up to buy the debt issued by Treasury. Leaving aside the pointlessness of U.S. entitlement programs, the desire among investors to own Treasury debt is a fairly powerful market signal that reform of what makes no sense isn't much of a priority. Investors in what is a very deep market are evidently quite comfortable.
Druckenmiller went on to lament that "We are deep into the longest period ever of excessively easy monetary policies." There Druckenmiller is talking about credit, and specifically the Federal Reserve. Ok, but credit is not money. If it were, a central bank formed in Honduras could conduct "excessively easy monetary" policy too. And counterfeiting would be encouraged.
But as Druckenmiller surely knows, credit is real economic resources. When individuals borrow dollars, yen, euros and yuan, they're not borrowing money as much as they're borrowing the resources that money can procure. What this hopefully reminds us is that the Fed has no private stash of economic resources, and by extension it has no credit to be easy with that it hasn't extracted from the real economy (meaning we) first.
What this tells us is that unless investors believe Ben Bernanke and Janet Yellen are better allocators of precious economic resources than are people like Druckenmiller, "excessively easy monetary policies" from the Fed haven't boosted the economy; rather they've been a barrier to much greater economic growth and even better stock-market returns. Druckenmiller seems to admit as much; albeit in oblique fashion. As he put it about the Fed's frenzied activity that has coincided with fairly limp economic growth, Yellen et al's objective seems to be "avoiding a recession over the near term." The problem with all this is that recessions left alone are the surest signal of a raging economic boom on the way.
Lest we forget, recessions are an economy's way of cleansing itself of what's not working; all the misuses of labor, bad investments, and lousy companies that are holding back growth. So if what Druckenmiller asserts is true, that the Fed has been tinkering on the edges to stave off recession, what he's really saying is that the economy isn't exhausted as much as it's presently being lightly suffocated by our central bank. Imagine how much better the economy would be at present if the Fed were neither mis-allocating trillions in credit nor blocking the corrections necessary for abundant economic health.
Of course what had tongues wagging the most was Druckenmiller's assertion that "the bull market is exhausting itself" and that Fed policy has been a factor. As Druckenmiller put it, Fed machinations have "propelled financial assets higher." Ok, but if he believes that the Fed's borrowing of $4 trillion in order to mis-allocate it actually authored a stock market boom, he's also implicitly admitting that the Fed's actions have in fact robbed investors of an even greater bull market.
Indeed, while it's fairly easy to pick apart the popular assertion that the Federal Reserve created an artificial bull, even if readers lack skepticism they can't argue with a basic truth about both recessions and market corrections: both, if left alone, set the stage for future booms and bull markets. They do simply because both ensure that lousy companies are starved of capital so that good ones receive more of it. If it's true that fine tuning from the Fed "propelled financial assets higher," then it's also true that the Fed propped up what markets wouldn't have on their own; all at the expense of more deserving companies that either got by with less capital, or none at all.
Just as recessions that are meddled with result in limp rebounds (see 2008-present, see the 1930s), so do bear markets that governmental bodies try to suppress logically result in softer rallies. Assuming what logic says is unlikely, that the Fed's QE authored an artificial stock-market boom, it only occurred at the expense of something much greater. This tells us markets perhaps aren't exhausted as much as central bank interference has deprived investors of something much more substantial.
So while Stanley Druckenmiller's brilliant track record means that what he says matters, readers need to think about how they'd respond if it had been someone not Druckenmiller expressing the same pessimism last week about the Fed, corporate leverage, Treasury debt, and quantitative easing. Their response, whether in agreement or not, would be to yawn. Nothing new was presented.
And that's the point. While Druckenmiller can't be ignored, what has him worried isn't new information. Because it isn't, it's once again priced. Markets could surely implode tomorrow or next week, but they won't correct based on what has Druckenmiller so downcast.
