Stanley Druckenmiller on the current markets and investing in general
If you feel overwhelmed by the current markets (I certainly do), there is likely a good reason to feel this way. One of investing titans Stanley Druckenmiller says that we are in an unprecedented set up, probably the most difficult for predictions in his entire career which spans 45+ years. At the moment he has more humility about his view of the world than ever, so I guess we should stay humble too.
Druckenmiller is normally not very active in public, but all of his interviews that I have seen so far are full of wisdom. The latest one was conducted earlier this month by John Collison who is a co-founder of Stripe, i.e. not a full-time investor but John asked a lot of good questions. Here are my takeaways.
Macro
Inflation is a little higher than he thought it would be last year (was predicting 6%+). The asset bubble has burst with vengeance, lots of very good companies are down 60-70% without significant changes in fundamentals
Despite having ~$30tn poured into QE globally, the Fed has been very slow to recognize the inflation/asset bubble problem and this indecisiveness is becoming very costly. Specifically, during the last few years a lot of people bought assets that they will lose money on
The Fed is still way behind the inflation, thus they need to raise rates aggressively
Soft landing probability is pretty remote as there were just 2-3 soft landing in history and zero soft landings when inflation was above 5%
Historically, once inflation got above 5% it has never come down unless the Fed funds exceeded CPI; it also hasn’t happened without a recession. With the current CPI at 8%, the rates need to exceed 8% which is unlikely but possible (in this case the destruction will be huge)
A by-product of QE is a very low number of bankruptcies. When rates rise, this may change
Doesn’t use metrics popular among traditional economists (e.g. employment) to predict the economy, just observes the market. Stocks tend to lead fundamentals by 6-12 months. Some industries lead and some lag, e.g. housing is a leading indicator, retail is a lagging indicator. Collect data from companies and make conclusions about macro. Some notable observations:
Homebuilders: down 50% from highs despite good fundamentals
Trucking: down 40% from highs despite record earnings
Retail: appears to be much weaker than it should be based on GDP.
Bonds normally send strong signals, but they have been distorted by the Fed, so now their signals are pretty meaningless
There are still $1.5-2tn of excess savings and it will take some time to work through them. We will probably have a recession some time in 2023
Inflation/deflation have 70/30% probabilities. Deflation normally follows asset bubbles, so we may well see something similar to Japan in the 1990s, but it’s hard to predict
Market forecast
We are just 6 months into a bear market and it’s highly probable that the bear market will continue
The next 5 years are likely to be messy, investors should better learn how to navigate different asset classes. If he was a tech investor, he would look into blockchain
If you believe that we continue to see irresponsible monetary policy and high inflation, hold bitcoin in bull phase of the markets and gold in bear phase. There is no straightforward logical explanation, it’s just based on market observations.
Current positions
A lot of new investors came to markets in the last few years and were rewarded immediately by buying Covid beneficiaries and the likes. This contributed to the best period for short selling as there were lots of clearly overearning highly valued companies, e.g. brick and mortar retail
Made some money in the last 6-8 months: short fixed income, short stocks, long key commodities like oil, copper, gold. Now less comfortable with short fixed income and stocks (since many have de-rated by 60-80%). If you get too aggressive shorting in a bear market you may get killed. If the market rallies 15-20% from here, would probably go short again
Currency market is very interesting. No position now, but in 6 months may be short USD
Still long energy (Ukraine prolonged the life of this idea). Energy companies still look cheap, demand destruction will probably happen but so far he doesn’t see evidence of it
No specific view on crypto. At the moment it is closely correlated with NASDAQ. Sympathetic to everything that both Charlie Munger (bear) and Bill Miller (bull) are saying. Blockchain is likely to be a major disruptor in the next 5 years or so, but he is too old to compete in this space
Investing approach
Always made even higher returns in bear markets. Usually stopped buying equities and focused on bonds and treasuries. But now with 8% CPI and 3% treasury yields the situation is unprecedented and buying bonds doesn’t make sense. You have to constantly innovate your approach as the markets evolve
Macro investors root for chaos because they often benefit largely from bear markets. Druckenmiller has a bearish bias because he made a lot of money being bearish early in his career. But any great short seller would say they made 90% of their money being long, because the math is on your side
Cyclicality is rather predictable: when companies are losing money, capacity gets destroyed and margins recover, while in good times they invest in additional capacity which leads to oversupply and so on. Druckenmiller successfully traded some cyclical companies like chemicals, but he made the biggest money in equities in growth stocks
Some people are saying that he has been working harder than most of other investors. This is partially true: he used to be lazy in college, but became passionate about the markets and eagerly put a lot of effort into it. Fascinated by the fact that every event affects the prices around the world. Trying to predict how the world looks like in 12-18 months from now is very intellectually stimulating. If you are not passionate about markets, do something different. Saw people with much higher IQs who did poorly in the markets because they were not passionate
At the moment there are a lot of bull market geniuses. They don’t like the game per se, they just like winning and they’ve been surfing with a hurricane behind their back. They may get very discouraged as investing is not fun at all when you are losing
Doesn’t believe that diversification lowers risk. If you are concentrated you pay much more attention to each of your positions and constantly reevaluate them which decreases risk
Sizing is 70-80% of success in investing: it determines how much you win when you are right and how much you lose when you are wrong. Believes in streaks: you should adjust the size of your bets based on whether you are “hot” (had a series of successes) or “cold” (had a series of failures). If you follow technicians, the key thing to observe is whether they are hot or cold at the moment. If they get too cold, you may even profit from inverting them
“Invest then investigate”. An analyst suggests something to him and he immediately opens a large position and asks the analyst to dig deeper. The reason is that there is so much information and so many smart people in the market that sometimes 60-70% of the move (at least in the short term) is gone in 2-3 weeks. If you jump in and you are wrong, you can usually exit without a loss because there is no bear thesis that would destroy the stock, but if you are right and a bull thesis unfolds as you have predicted, you profit, i.e. there is an asymmetry
Never value a business based on the past and current states, think were the world and the company goes in a few years from now
Sometimes it’s crucial to step aside and recover. A war story from Dotcom bubble time:
March 1999: shorted $200mn in 10 internet stocks which continued to go up leading to a $600mn loss, the fund was down 16% YTD. He then hired two stars in their 20s and went long tech based on their recommendations. By the end of 1999 he was up 42% net for the year
In January 2000 he concluded that they were in a bubble and sold all tech stocks. But those two young stars kept small accounts in the fund and were making something like 8% per day. This drove Druckenmiller crazy and he finally took a $6bn long position. As the bubble burst, this lead to a $2-3bn loss bringing the fund’s return to -18%. He became an emotional mess and took a sabbatical to recover. Went to Africa with kids, didn’t allow himself to watch TV or read newspapers, i.e. got totally disconnected (if you take a break, take a break)
When he came back in autumn 2000, oil, interest rates and USD were all up which historically has been terrible for corporate earnings. Druckenmiller called his clients from small businesses and they all said that the business was terrible. He then put 350% of the fund into treasuries and generated 40% returns in Q4 2000 which saved him from a down year. He would have never had that idea and conviction if he hadn’t stepped aside for those 4 months to rebuild confidence
Age is a funny thing (Druckenmiller is 69): predicting and forecasting power is at peak, but he is not generating 30% returns as he used to because he is not playing as aggressively