When Druckenmiller speaks, one should pay attention
Druckenmiller is perhaps the most astoundingly talented money manager on the planet today. For those that don’t know the name, he was a key player at Soros and now runs a family office – Duquesne Family office. He has, according to various reports, never had a down year in 30 years of money management.
Druckenmiller was recently interviewed on Real vision https://www.realvision.com. He seldom gives interviews, so this one was worth watching.
During the interview he warns the US’ ‘massive debt problem’ would eventually lead to another financial crisis. And this time, that it’s not just the US that has excessively levered but globally. Household debt in the US is now well above the levels of 2007, as is government debt.
Source: DShort.com
His cause of concern, like ours and many others that follow the market, is mal-investment. When you make the cost of borrowing money set at zero, debt is going to ramp higher and people tend to invest in non-productive assets and speculate. For a period of time all is well, but when interest rates start increasing and the investments no longer hold their value, it can spiral down very quickly. 2008 is the perfect example of this.
Of note, was his comment that he had shorted the equity market mid-2018. He is currently very exposed to US Technology equities which have had a terrific year, so was likely using futures to make the bet. He reversed his position as markets moved higher, but is very clear that we are close to some form of top, whether short or medium term.
Many notable asset managers have started to reflect on the risks in the market. That debt levels are elevated, valuations are high and that interest rates will eventually hit a pain threshold and overshoot. Ray Dalio, Howerd Marks, Druckenmiller, Ken Griffin are perhaps the most notable, but we have also noticed that many long/short equity managers have generally been reducing exposure. We have also seen this in the fund flows, with ‘smart money’ reducing exposure.
Unlike a few other notable money managers, such as Ray Dalio, Druckenmiller does not advocate the FED holding back on rate rises. In his view this would simply make the end bust that much worse. We would be in agreement and have advocated higher rates for some time.
So, what does this all mean?
Druckenmiller, and us alike, would advocate caution when investing in the equity and bond markets.
Like a number of his peers though, he has been early in his call. The reality though is that it’s near impossible to time markets. Being too cautious and not investing in US equities would have cost one significantly YTD (the same is not true though for emerging markets, which are down close to 10% and China which is down 14% YTD).
Source: Tradingview.com
Rather than try to time the market, we adjust our market exposure on the basis of valuation and various other factors. With valuations where they are, we have reduced beta or market exposure over the last year – cutting back on both equities and credit.
We do so by taking core exposure through several active asset managers, across various strategies including long/short, risk arb and macro. These managers are selected on having demonstrated an excellent track record for minimising drawdowns in uncorrelated strategies. Indeed, a few of them should make decent returns in a down market.
The bulk of our equity exposure, for example, is with managers that have 15+ years of experience and have experience of moving through cycles. The long track record is important and there are far to many managers, both long/short and long only, that have never seen a cycle. It’s going to be fun watching the ‘buy the dip’ brigade manage through the next crisis.
And crisis it will be, of one sort or another.
Such an allocation reduces the overall risk of the portfolio and allows us to then stock-pick around the edges of the core.
While markets are generally expensive, we do see some excellent opportunities at the stock level, both in the US and elsewhere.
In the US, we like several names across the Healthcare and Consumer space, but are cautious on some of the FAANG stocks. These could move higher, but we are not proponents of ‘this time it’s different’ and take the view that some of the best performers over the last few years are likely to be some of the worst when liquidity is withdrawn. This is particularly true now with passive money taking in such large amounts of capital.
Emerging markets were a huge beneficiary of cheap debt, so tighter liquidity is likely to be generally negative. While policy is still very ‘easy’ and accommodating, the relative tightening in the US has pushed the USD nicely higher. This in turn has put pressure on those countries that have USD denominated debt, such as Turkey and Argentina. The stresses may start in the emerging markets and then spread, as we have seen in prior market cycles.
As these ‘bombs’ go off (Argentina, Turkey), as Druckenmiller describes it, we are likely to see other emerging markets come under further pressure. Short-term they may rebound, but, other than a significant ramp up in liquidity conditions, I don’t see them moving above recent highs. Saying that though, we some excellent relative value in China Technology.
While some of the best money managers are getting increasingly ‘concerned’ over a market sell-off, retail money is close to fully invested. It seems no matter how hard us prudent managers yell ‘caution’ from the turrets, few are there to listen.
Source: Zerohedge.com
Having invested through the last three major bear markets – Asian Financial crisis ‘97, 2000 and 2008 – the benefits of getting out when the cracks start appearing and having dry powder at the bottom are firmly etched in my mind. We may have another 12 to 18 months of markets moving higher – it’s all dependent on the Fed and policy – but the longer debt remains cheap, the larger the downdraft from mal-investment will be.
We would be the first, however, to agree that during the early stages of the next sell off, the Fed and other CBs may step in and monetise even more assets than in the last crisis, potentially stabilising and reversing the down draft quickly. For the moment, therefore, having prudently diversified exposure, with selective equity exposure, gold and very short duration high quality bonds seem the best places to be.
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