On January 29, Tony Pasquariello, global head of Goldman Hedge Fund Coverage (whose observations we have frequently profiled on these pages) spoke to investing legend Stanley Druckenmiller, head of the Duquesne Family Office, about his current outlook on the market, his approach to risk management throughout his career, and his perspective on the conversation surrounding the role of capitalism in American society. The result was a fascinating conversation that was anything but the canned talking points one would expect from such a high level interview (h/t to @JohnStCapital for bring it to our attention).
Without missing a beat, Druck admitted that this "is the wildest cocktail I've ever seen in trying to figure out a roadmap." Below we summarize some of his key observations.
“The recession we had was 5x the average since WWII but it occurred in 25% of the time,” Druckenmiller said adding that “more bizarrely in a year when 11 million more people were unemployed, we had the largest increase in personal income in 20yrs during an economic downturn, due to massive policy support. The CARES Act added trillions in fiscal stimulus. How big was it? In three months in 2020 we increased the deficit more than the past 5 recessions combined (1973, 1975, 1982, the early 90s', the dot com bust and the GFC). The Fed in 6 weeks bought more treasuries than in 10yrs under Bernanke/Yellen. Corporate borrowing, which almost always goes down in a recession, which had already increased from $6trln to $10trln going into the crisis due to the Fed’s free-money policies, went up $400bln. Putting that in perspective, it went down by $500bn during the GFC.”
"So we had this massive increase in liquidity and stimulus which is the background and all of this stimulus has flown into financial markets, into commodities, into financial interests so it's a bizarre background."
"The juxtaposition of the various policy responses is somewhat breathtaking. Since 2018, M2 in the US has grown 25% more than nominal GDP; a 25% increase in liquidity. In China M2 to nominal GDP is where it was 3 years ago. So China hasn't borrowed anything from their future and we've had a massive liquidity input and frankly very little investment. It's primarily been transfer payments and Fed Stimulus. We've done a horrific job with the virus. The Chinese and Asia in general they've pretty much defeat the virus."
"So the background could not be more different, but could not be more exciting if you are a macro investor, because on top of all this there is the other big force in the equation which is vaccines. And it's possible in fact probable that all this stimulus will be in place just when we unleash the biggest increase in pent up demand globally since the 1920s which could make the world extremely different than it looks today."
In response to a question from Pasquariello what is Druck's favorite asset with the best opportunity, Druckenmiller refuses to answer, saying "that's not how I play the game" and instead he says that the "overriding theme is inflation relative to what policymakers think. But because of the policymaker response which could be very varied based on the vaccine, I've found it's better to have a matrix. So basically to play reflation I have a short treasury position primarily at the long end."
Take home #1: Druckenmiller is short long-end Treasuries.
He also has a large position in commodities: "the longer the Fed tries to keep rates suppressed the more I win on commodities; the quicker they respond the quicker I might have a bigger problem with commodities."
Take home #2: He is very long commodities.
And then there was currencies: "because of the juxtaposition of the US policy response versus Asia, I have a very, very short dollar position."
Take home #3: He is also "very very" short the dollar.
Pasquariello then asks Druckenmiller about his view on stocks, and specifically the tech space (both mega cap, cloud and smaller cap names). Here, Druckenmiller is more reserved and says that "if we get 4-5% inflation in the US a few years out and bond yields rise precipitously that's very negative historically for growth stocks relative to other stocks. On the other hand the comparisons with 2000 are ridiculous. The reason they are ridiculous is we had a double whammy back then of not only the raging mania of overvaluation but also earnings were about to end, because those companies that were growing rapidly then were all about building the Internet itself", and that was done so there was no way to generate earnings.
Looking to today, Druckenmiller says that "the combination of valuation and challenged bond markets could certainly make growth stocks in a very, very challenged environment the next 5 years relative to what they've been."
"Having said that, on the cloud we are in the 3rd-4th inning. COVID-19 had us jump from the 1st to 3rd-4th inning but we're not in the 9th inning and if anything every company that I talk to is speeding up their transition because they are going to competitively die if they stay behind within digital transformation."
"Within tech itself AMZN and MSFT have been big underperformers in the last 2-3 months. It's like that market has rotated into 40x sales tech companies or into radioactive reopening stocks. And if you look at Amazons, Microsofts and Googles of the world, they are not overvalued, they are GARP names that are currently out of favor. And if the Fed continues to push the envelope in terms of friendliness I'm not worried about those stocks in fact they could keep going."
The interview then shifts to geographical preference and the Asian region in particular, to which Druckenmiller says that he owns China, Japan and Korea, "They've had a very good start to the year" and considering how much the US borrowed from the future, he thinks "Asia is the big, big winner coming out of COVID-19."
The same is true within tech itself, where Intel has thrown in the towel "so Asia owns foundry, memory, they are ahead in robotics.I think the next 5 years Asia looks a lot better than the US because at some point we have to pay back in terms of productivity, in terms of higher wages, in terms of lower dollar for all these transfer payments we've made the last nine months and we will continue to make."
"So I'm quite constructive on a number of names in Taiwan, in Korea, in China, in Singapore. Long-term Asia is going to be an outperformer vs the US, and especially the currency market. Net investment into China just passed the US ever this year, and it's the beginning rather than the end of a trend."
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The conversation then turns to the topic of money and risk management to which Druck, who has never recorded a down year since 1981, said it was "a lot of it is luck. I've been deep in the hole 3-4 years and in every case something came along and it was just a coincidence of the calendar that at Dec 31 I was up. If you looked at May 31-May 31 there would have been some down years."
Druck then says that "the fact that he can trade 5-6 asset classes does a few things.
- Number one, it can point you in the right direction and if you believe something you can make big, big gains.
- Number two, as a macro investor currencies and bonds trade 24 hours a day and are very liquid and you can change your mind, which I've had to do a lot in my career cause I've been wrong a lot.
- Number three, it also gives you discipline not to playing around in an area that is dangerous. Equity only investors need to be in equities. But if you're a macro investor you don't need to be in equities at any given point in time.
As an example of the last point, Druck said he has never lost money big in credit because the only time he bets in credit is every 8 years after there's a big debacle in credit and that's when he buys a bunch of credit. But if he was a purely credit investor he would've had 3 or 4 down 30% years.
Druckenmiller also said the he is "very much of philosophy to put all your eggs in one basket and watch it very carefully." He has found that every investor has 3-4 big winners per year and usually you know what they are. But when you get in trouble is with something you're not focused on. But if you put 50-70% of your assets in one asset class, "trust me you're focused and you're more risk averse" then with something you might have 5% or 6%.
The investor also admitted that he has never used VaR: "I'm very unsophisticated I watch my PnL everyday and if it starts acting in a strange manner relative to what I'd expect in a matrix, my antenna would go up."
The reason why Drucknemiller simply uses his PnL for risk management is that "I've found all risk models are great until complete chaos happens and then all the correlations break down and they can suck you in into a false security. If you watch your PnL, it's a much better warning system than some of these mathematical models out there. They're useful, just not useful when you actually need them."
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Naturally, no conversation could take place without a discussion of bitcoin, and when asked if bitcoin may be the "mother of all asset bubbles or something genuine" Druckenmiller said "maybe both." And while he admits he does not know the future, he knows how we got here, and his take is one we completely agree with (and one which Neel Kashkari should read very closely): Bitcoin "wouldn't do what it's doing without Central Bank behavior."
While Druck was skeptical of XBT 3-4 years ago when the crypto first broke out out - "why would anybody buy this thing" - he now admits that bulls have done an unbelievable marketing job. Bitcoin has been around 13 years and younger millennials look at bitcoin the way he looks at Gold. That said, Druck has doubts whether Bitcoin will ever be anything other than a store of value, as Bitcoin has problems as a currency because it uses a lot of energy, it's volatile and it's got other problems. But that doesn't matter because right now it's an asset class, "my view of it has been way overblown in the press; I do own some of it, it's gone up a lot since I bought it." In the end he doesn't believe in it. He doesn't not believe in it. He simply admits honestly that he "doesn't know."
The conversation then shifts to more philosophical topics, and in response to a question how he would characterize "the state of American capitalism", Druck says that he's worried because "we have not engaged in capitalism for some time."
"The Central Bank has bastardized the most important price in the world which is the cost of money. We have crony capitalism as you know."
"But even in the best days of capitalism there's always been a stain in the US, which is I grew up believing that we are a meritocracy by and large but there is a subsector of out society where we are in a caste system. We have a lot of neighborhoods in our country where millions of kids just don't have opportunity to pull up their bootstraps and work hard."
"That's always been there and is something we need to address. Which is why I am not sure events of last summer were a bad thing. It's my own view that they were a good thing because people need to be woken up to fact that American Dream is a great thing but there are a significant amount of kids without access to the American dream the way I had."
Watch the full interview below.