Druckenmiller: "The Best Economist I Know Is Saying Something Is Not Right"

Stanley Druckenmiller established himself as one of the most successful hedge fund managers of his generation thanks to an uncanny ability for recognizing signals in asset prices that portended an coming recession. So when he warns about rough times ahead, it's probably worth listening.

Though he's kept a relatively low profile since closing Duquesne Capital in 2010 and opening a family office based in midtown, Druckenmiller's name has been popping up in the headlines of the financial press more frequently lately where his criticisms of the Fed were ridiculed (back in September he warned that we we are at the point in the tightening cycle where "bombs are going off")  before they were echoed by no less a figure than the president himself. Over the weekend, Druckenmiller offered his latest contrarian screed against Wall Street pearl clutchers by arguing in an op-ed published with former Fed Gov. Kevin Warsh that Trump has a point, and that the Fed already missed its opportunity to safely tighten monetary policy. Now, the Fed has two choices: either reconsider its plans to raise rates to 3% and beyond over the next year, or risk destabilizing asset markets and the broader economy.

Druck

And in an interview that bears similarities to Jeff Gundlachs' "truth bomb"-strewn chat with CNBC, Druckenmiller sat down with Bloomberg for an hour-long interview where he warned that market conditions are about to get a lot worse.

The only question, in Druckenmiller's mind, is not whether the selloff will worsen, but by how much? Because the indicators that Druckenmiller used to anticipate the last four downturns are once again turning red, suggesting the "highest probability is that we struggle going forward."

After a wild three months in the financial markets, the billionaire investor is warning that trading conditions may become even more challenging as central banks withdraw stimulus from a global economy that’s already slowing. He anticipates lousy returns on stocks for years to come and has been buying U.S. Treasuries on the expectation that yields will keep dropping.

"If you look at the indicators I have historically used in my business, they’re not red yet, but they are definitely amber and they are setting off warning signs," Druckenmiller said in an interview with Bloomberg Television. "The highest probability is we struggle going forward."

Druckenmiller acknowledged that markets and economic data are sending conflicting signals. But if he had to chose between the data and markets, Druckenmiller said he puts more stock in the signals being sent by growth-sensitive cyclical stocks and the short end of the Treasury curve.

"The best economist I know out there is the inside of the stock markets" he said. It's telling us that "there's something not right."

To Druckenmiller, two warning signs stand out: The 20% drop in cyclicals since September...

Cyclicals

...and the recent inversion along the short end of the yield curve.

Yield

To be clear, Druckenmiller insisted that he wasn't predicting a recession "yet" (though the bearishness that permeated his interview would suggest otherwise). He just wants to see the Fed avoid making a major policy mistake - because the more mistakes the central bank makes now, the more "crazy monetary stuff" it will need to do later to undo those mistakes.

"It’s just a time for caution," he said in the interview. "You want this bubble to unwind slowly now, because if you don’t, and let’s say these indicators turn red, you may have to do a lot more crazy monetary stuff and actually it’ll be more of a problem."

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"The air can be let out of this balloon without causing another financial crisis," he said. "I think it’s possible, but it’s hard to believe markets will not have struggling returns the next three to five years."

As Wall Street fixates on the number of rate hikes in 2019, Druckenmiller is building his portfolio with an eye on the futures-curve horizon (while talk of tightening dominates the financial press, traders have already priced in a rate cut in 2020). He believes owning the front end of the Treasury curve will pay off if the Fed is forced to reverse course (a bet that has already proven lucrative as the yield curve has flattened since October).

Druckenmiller, who now manages his own family office in midtown Manhattan, said he typically avoids betting against the stock market in times of economic uncertainty because "you get these vicious rallies, you get squeezed out of shorts." Instead, he often prefers owning Treasuries, since they tend to appreciate when the Fed has to slash borrowing costs to stoke growth. He said one of his best trades ever was buying two-year notes in late 2000, after the dot-com bubble burst but before the central bank cut rates 11 times over the following year.

Another of Druckenmiller's rate-cut plays is staying short financial names (another lucrative bet in recent weeks).

This time, Druckenmiller said he owns two-, five- and 10-year Treasuries. If the Fed tightens policy too much and is forced to reverse course, "it’s not inconceivable to me at all that the 2-years are back to 50 to 60 basis points in a couple of years," from about 2.70 percent today, he said.

For similar reasons, Druckenmiller said he has been short "all the financials," including banks, because they generally benefit as interest rates rise and suffer as rates fall.

After leading the market to record highs, tech stocks have borne the brunt of the selling during the explosion of volatility during the second half of 2018. But Druckenmiller still believes that certain tech companies like Microsoft and Salesforce (note: he doesn't mention a single FAANG stock) are on track for strong "secular" growth, thanks to their dominance in the cloud-computing space.

At the same time, Druckenmiller is long "secular growth" stocks and he cited Microsoft Corp., Salesforce.com Inc., ServiceNow Inc. and Workday Inc. because they’re active in cloud computing. He said he expects them to outperform the market in both a growing and shrinking economy.

"Everything has to convert to the cloud," he said. "If we get in a mild recession, demand goes up because it’s a way to cut costs."

Touching on the subject of Trump's trade war, Druckenmiller said that while he believes Trump will eventually strike a deal with China, the fact that politics now has such outsize influence on markets has complicated his forecasts.

"It’s tough because economic signals and economic puzzle-solving is something I’ve done for a long time," he said. "How all this politics is going to play out, I’m not so sure."

And while Druckenmiller made his name betting against the pound in the early 1990s alongside George Soros, today, he's avoiding UK markets because Brexit is such a "binary outcome."

"Either it happens, or it doesn't".

We couldn't have put it better ourselves.

Watch the full hour-long interview: