Despite the consensus view heading into 2018 that the Treasury yield curve would finally steepen as the Federal Reserve raised interest rates 4 times in 2018 (and possibly again in 2019), driving US stocks lower as higher interest rates brought the post-crisis epoch of "accommodative" monetary policy to a decisive conclusion, the yield curve continues to flatten. But as US markets have mostly shrugged off this vanishing term premium, some of the country's most respected hedge fund managers have been making the rounds in the financial press, warning that the next recession - if not a devastating debt crisis - is just around the corner.
First it was Jeffrey Gundlach, then Ray Dalio (who even devoted a free e-book to the subject comparing the modern economy to that of the late 1930s) and Ken Griffin. Now Stanley Druckenmiller has joined the party with an interview with Kiril Sokoloff, chairman of 13D Global Strategy & Research, published by RealVision. During the interview, which was taped earlier this month, Druckenmiller warned that the US's "massive debt problem" would eventually lead to another financial crisis. "We tripled down on what caused the crisis. And we tripled down on it globally."
But while President Trump's decision to blow out the federal budget deficit at a time of 4.2% US GDP growth certainly won't help, Druck blames the Federal Reserve for waiting so long to raise interest rates, allowing cheap debt to proliferate and encouraging the formation of asset bubbles in both the US and emerging markets, where the strengthening dollar has allowed fears of a possible contagion to fester.
"I would raise rates every meeting as long as I could. And the minute you got substantial disruption, I would back off. And the sad thing is, since I made that statement, oh, my god, we've had these just rip roaring markets. And what I was saying is, just sneak one in every time you can. Just sneak one in. And they've passed up on so many golden opportunities. But the problem now - and you articulated it beautifully - is, now, the debt is so much higher, particularly in emerging markets, than it was five years ago. You're not going to be able to raise that much more, and we're already starting to see the consequences."
And the longer it takes the Fed to normalize interest rates, the more devastating the eventual crash will be.
The reason the debt has exploded - again, there's no hurdle rate for investment. And when you can borrow money at zero, of course, debt is going to explode.
So you're exactly right. We have this massive debt problem. If we don't normalize, it's going to accelerate and cause a bigger problem down the road.
That doesn't mean US markets won't see further upside in the coming months. Indeed, as US rates rise, Druckenmiller believes it's entirely possible that money invested in emerging markets will flow back into the US, driving US equities even higher. At the same time, this will add unneeded stress to the already precarious situation in emerging markets, increasing the risk of another debt crisis. And once these "bombs start to go off" in the EM world, contagion could quickly spread to the US. Oblivious to these risks, the Fed will continue to tighten, heaping more suffering in the EM world, until the pressure spreads to the US - at which point policymakers will scramble to slash rates and move back to an "accommodative" stance.
On a practitioner's basis, we have a lottery ticket in Brazil and in South Africa, because, as we've seen, back in the '90s and again now, these things can move 50%, 60%, and your risk is probably not much more than the carry. I don't know whether I'm going to get paid, but with the monetary tightening, we're kind of at that stage of the cycle where bombs are going off. And until the bombs go off in the developed markets, you would think the tightening will continue.
And if the tightening continues, the bombs will keep going off..."
Moving on from the subject of monetary policy, Druckenmiller shared his thoughts about the future of Alphabet stock, which, like Facebook, Twitter and a handful of other massive tech firms, has been embroiled in controversies over how it collects and monetizes personal user data, as well as whether Alphabet constitutes a monopoly. To the latter point, Druckenmiller brushed off the concerns of Margrethe Vestager, the EU's competition commissioner, who levied billions of dollars in fines against Google and Alphabet over alleged anti-trust violations. If Vestager - whom Druckenmiller derisively refers to as "that woman from Denmark" - is so concerned about a Google being a monopoly, she should try using another search engine for a year. As Druckenmiller argues, "they're only a click away."
And to hear the woman from Denmark say that the proof that Google is a monopoly and that iPhones don't compete with Android is that everyone uses the Google search engine is just nonsense. You're one click away from any other search engine. I just I wish that woman would have to use a non-Google search engine for a year-- just, OK, fine, you hate Google? Don't use their product, because it's a wonderful product.
That doesn't mean there shouldn't be some regulation, of course, Druckenmiller concedes. Still, he believes his Alphabet shares are worth holding on to.
But clearly, they are monopolies. Clearly, there should be some regulation. But at 20 times earnings and a lot of bright prospects, I can't make myself sell them yet.
Asked to comment on the theory that most big-name investors earn the bulk of their returns off two or three trading ideas, Druckenmiller said that, during his career, he preferred to place big bets in bond and currency markets that trade 24 hours...that way he can close out some or all his position at any time, thus making it easier to "change his mind."
If an investor is going to make a play like this in the equity markets, they "have to be right."
As the disclaimer, if you're going to make a bet like that, it has to be in a very liquid market, even better if it's a liquid market that trades 24 hours a day. So most of those bets, for me, invariably would end up being in the bond and currency markets because I could change my mind. But I've seen guys like Buffett and Carl Icahn do it in the equity markets. I've just never had the trust in my own analytical ability to go in an illiquid instrument, which in equity is if you're going to bet that kind of size on-- you just have to be right.
Watch a snapshot of the full interview below: