Billionaire Stan Druckenmiller - Risk-reward Does Not Make Sense
Transcript
Narrator: Stan Druckenmiller has one of the best track records in the history of investing. Now he’s going on the record with me in an exclusive interview — what he’s worried about, what he’s betting on, and where in the world does he see the markets heading. Find out straight ahead on this special edition of Encore.
Stan Druckenmiller: Why does the economy need holding up now?
Stan Druckenmiller: It would be remarkable to me if the run in the euro is over.
Stan Druckenmiller: There’s good debt growth and there’s bad debt growth.
Stephanie Ruhle: Well, welcome to Bloomberg Encore. I’m Stephanie Ruhle. It’s hard to find anyone who’s amassed more insight on investing than Stan Druckenmiller. He spent years working under George Soros and ran Duquesne Capital Management for three decades before converting it to a family office in 2010. We sat down recently for an exclusive conversation covering many aspects of the global economy. Lately, Stan has been sounding the alarm on the Fed, so I began by asking him why he’s so concerned and why today specifically reminds him of the pre-crisis days of 2004.
Stan Druckenmiller: Not just like 2004, but it certainly rhymes. Back in late 2003, I remember we had 9% nominal growth, 7% real growth. The economy was very, very strong, but we had 1% interest rates, and we also had a tag on them that they were going to remain there for a considerable period. I just felt at the time that Fed policy was unnecessarily easy. They wanted to ensure that the economic recovery got enough momentum. I was more fearful, because historically I’ve done a lot of work analyzing central banks and subsequent activity, and we’ve had problems in the past when monetary policy was too easy. I just thought it was unnecessary. I was worried that some trouble might be brewing, but I couldn’t put my finger on what it was. I just knew that we were running an unnecessarily loose monetary policy and it may have consequences down the road.
And that’s kind of how I feel now. I think we’re taking a terrible risk/reward in terms of zero rates. Everyone keeps asking me, “Well, how is this going to manifest itself?” I don’t even know whether it is going to manifest itself. I just know that the rates are unnecessary, and again it’s sort of the same language: “Oh, the risk of going too early is greater than going too late. We need to ensure the recovery.” I’m more worried about things down the road than looking in the near term, and I think a lot of the dialogue about this is far too myopic, rather than trying to look at things with a longer-term perspective.
Stephanie Ruhle: So are you saying whether they raise in June or September isn’t the issue — it’s the fact that rates have been so low for so long, that’s the real problem?
Stan Druckenmiller: I don’t want to describe this as a real problem. What I’d like to describe is a situation where we went through a financial crisis. Immediately as that financial crisis unfolded, the Fed took dramatic and aggressive steps which, in hindsight, were about as close to perfection as you could achieve. I say that because we were in the initial stages of a balance sheet recession — we had one in the ’30s that turned into a depression — so the Fed took aggressive measures to rebuild the consumer’s, and frankly the whole country’s, balance sheet. The reward was tremendous: if you could get asset prices back up and not have the meltdown in economic activity you had in the ’30s, there was very little risk. So it was sort of a no-brainer.
Today, if you look at the situation, stock prices and household net worth per capita are at record highs. By the way, they went to record highs in 2013 and they’ve been going up for two straight years. So I’m not sure exactly what the Fed is trying to achieve in terms of the reward here, particularly since, if you look at what is going on, we’ve had a tremendous amount of debt growth — particularly in the corporate sector — and unfortunately the productivity of that debt, if it were measurable, I would say is at an all-time low.
Why do I say that? Because there’s good debt growth and there’s bad debt growth. Good debt growth is when you borrow money and it goes into the real economy — you do capital spending, you build businesses. But by most calculations, almost 98% of the current debt growth has gone into M&A, corporate buybacks at record prices, and leveraged buyouts. So where it’s going is into financial engineering. I can’t prove it, but I would feel very confident that a trillion dollars in buybacks and dividends in the last year, and four trillion forecast this year for M&A, is a job reducer and an economic reducer. So I don’t know exactly what they think they’re getting out of 0% rates.
Stephanie Ruhle: Well, these are CEOs who are worried — who know they have to answer to demanding shareholders, possibly activist investors. Larry Fink has come out and said these companies need to reinvest, need to grow, and it’s not what they’re doing.
Stan Druckenmiller: Yeah, well, we live in a culture where you go through various periods of something being in fashion and something being out of fashion. Activism is in fashion, and right now listening to activists is in fashion. But I would say if you’re the Fed, you have to take that into account. If what you’re getting for zero rates is just a bunch of financial engineering rather than demand — and by the way, you’re getting a re-leveraging of an economy that never really deleveraged the last time — you’re setting up the possibility of another asset bubble and investment bust.
Now, I want to be very clear: I’m not forecasting an asset bubble and investment bust two or three years down the road. What I’m saying is, if you’re a policy maker, the risk/reward is so skewed right now, because the zero rates aren’t getting you anything substantial in my opinion in terms of economic growth, as opposed to the reward when they went into this five or six years ago. But the debt growth is accelerating. So to me, it’s not so much that I’m predicting some catastrophe in three or four years — I’m not. I’m just saying, as someone who lives risk/reward every day, the risk/reward of going too early is much more favorable than going too late, and I don’t hear anybody saying that. All I hear is the opposite: “The risk of going too early is much greater than going too late.”
Well, if the risk of going too early is, “Oh my God, another taper tantrum,” or “God forbid a 10% correction in stock prices,” or maybe a slowdown in GDP growth — and you have the potential, and I only say the potential, for deflation and then something even more serious down the road — it seems to me a no-brainer. By the way, 25 basis points — really, 25 basis points? We still have negative real rates. Do they actually think 25 basis points is going to bring on the next depression?
Stephanie Ruhle: Well, in Ben Bernanke’s recent blog posts he’s basically saying it’s not the Fed who created the situation — the Fed responded to slack in the economy, to overall conditions. So he’s not saying it’s the Fed; he’s saying they’re just trying to help hold up the economy.
Stan Druckenmiller: Well, why does the economy need holding up now? I mean, retail sales are at an all-time high. Everything is booming except for capital investment — I just told you why I think that is. I don’t know why it needs extraordinary help here. Should we maybe have negative real rates? Yeah, but by the way, 1% fed funds would be negative real rates.
These guys in 2009 came up with a new version of the Taylor Rule. Who are “these guys”? The Fed, the academics — I believe Chairman Bernanke actually cited it — that said if they could, they’d like rates at minus 4%, and because they couldn’t do that, they did QE. Do you know where that version of the Taylor Rule they were using says fed funds should be today? Three and a half percent. Now if you use the traditional Taylor Rule, which at the time said rates should be minus 1%, that says we should be at 1.75%. There is no traditional theory that says rates should be at zero at this stage of a cycle.
Stephanie Ruhle: Then are you puzzled by the academics right now? When I read Alan Blinder, who’s saying he likes a patient Fed — are you saying, “What are these guys thinking?”
Stan Druckenmiller: No, I think I know the article you’re referring to. I just think they’re very myopic. And by the way, it’s hard — we haven’t pulled the trigger in many, many years, and I’m not saying it’s easy to be the one who stands up there and gets us off the juice we’ve been on for six to eight years. I’m just saying the time has come. I thought the time came six months ago. The risk/reward is skewed toward early.
Watch what’s developed: when you ask about June or September, every month that goes by we have more and more financial engineering. And easy monetary policy — I think every academic would agree — borrows from the future. It’s a temporary demand stimulus, borrowing from the future. It makes sense to borrow from future generations when unemployment was 10%. Why does it make sense to borrow from future generations when unemployment is 5.5%? I don’t get that.
Stephanie Ruhle: So is Janet Yellen in a no-win situation, given what rates have been for so long? It sounds like you’re saying June or September isn’t even relevant — what can she do?
Stan Druckenmiller: I think it’s relevant. I’d much rather see June. My fear is we’re not going to see anything for a year and a half, because they set up metrics eight or nine months ago that were met three or four months ago — so then they changed the metrics. And I have no confidence whatsoever that you’re going to see rate hikes in September or December or whenever, because when they lay out metrics and then change them, and then change again, and then change again — who knows when they’re going to go? And by then, how far will the financial engineering have gone, and how far will the debt go? This is all “pay me now or pay me later.” I agree — if you go a quarter point, it might do a few things to markets and so forth. But if you wait and you go a year later or two years later, it’s going to do much, much more.
Narrator: Coming up on this edition of Encore, Stan Druckenmiller tells me about some big surprises he’s predicting in the markets that might make big bets pay off.
Stan Druckenmiller: I’m pretty optimistic on crude prices. I think they’re going to do better than the forward curve.
Narrator: Welcome back to Encore and my exclusive interview with Stan Druckenmiller. Hedge fund titan Ray Dalio recently warned that aggressive tightening by the Fed in 2015 could lead to a disastrous repeat of 1937. I asked Stan if he agrees.
Stan Druckenmiller: I have trouble with the 1937 analogy. He is up 14% this year, so all right…
Stephanie Ruhle: So why do you have trouble with 1937?
Stan Druckenmiller: I just think the two periods are quite different. Number one, I already talked to you about the effects of a balance sheet recession. In 1937, the stock market and household net worth were still 20% below where they were in 1929 — eight years later. As I’ve already stated, our stock prices and household net worth are at new highs, so the balance sheet is not in the state it was back in 1937. Number two, from 1929 to 1937, we had cumulative 18% deflation in this country. From 2007 until now, we’ve had cumulative 16% inflation, and the Fed’s favorite measure of inflation has never been below 1% in any of those years. And finally, in 1937, unemployment was still over 14%. It’s currently 5.1–5.2%.
So I have a lot of respect for Mr. Dalio, but you know, I guess that’s what makes markets — I see things differently.
Stephanie Ruhle: You said the most significant thing you learned from George Soros: “When you see it, bet big.” Is there something clear that you see right now that would make sense to make a big bet on?
Stan Druckenmiller: Well, there was a while ago, and I’m still there. The divergence and flipping of monetary policies between the United States and Europe in May of 2014 presented a textbook opportunity in currencies: where we were tapering, ending QE, they were going to start QE, they went to a negative deposit rate, and we are frankly at least flirting with someday getting off the zero bound. And the euro was overvalued for a long, long time because they were shrinking their balance sheet while we were increasing ours. I’ve never seen a major currency trend last less than two years, and it’s only been 10 months. So it would be remarkable to me if the run in the euro is over. It wouldn’t be remarkable if we paused for a while — the way the yen did in 2013 and went sideways. So that’s one big bet that hasn’t changed for quite a while.
Another big bet is Japanese equities and European equities. Those are the only big bets, but I have some new ideas I’m flirting with.
Stephanie Ruhle: What?
Stan Druckenmiller: Well, I’m pretty optimistic on crude prices. I think they’re going to do better than the forward curve. Because, as my protégé said a year ago, “The cure for high prices is high prices.” Well, he would also say now, “The cure for lower prices is lower prices.” What does that mean? It means prices at $50 have caused a lot of behavior in terms of future production and exploration budgets that should pretty much clear up the supply/demand outlook by early 2016. I think that’s very different from what the world is thinking.
Stephanie Ruhle: Do you think Greece is leaving the Euro Zone?
Stan Druckenmiller: Probably.
Stephanie Ruhle: Do you care?
Stan Druckenmiller: I care a lot more if I were Greek. If you mean do I care as an investor — yes, but not as a vacationer. The banks don’t own Greek debt anymore. Draghi has QE at his disposal. My guess is there won’t be contagion, but even if there is, he can contain it. And as soon as market participants see that, you won’t get contagion. I don’t get this theory about how Greece flushes itself down a toilet and puts itself through misery, and all the Spanish and Italians go, “Oh, gee, let’s do that too.” I think a more rational response is for them to reform and become more embedded in Europe, not less. So I prefer to see Greece stay in the Euro Zone for a lot of economic and market reasons — and maybe humanitarian reasons. But as a market participant, I think it’s way overanalyzed and way overrated.
Stephanie Ruhle: Is the ECB falling into the same trap the Fed did in loosening monetary policy?
Stan Druckenmiller: I don’t know, because it’s more like 2009 and 2010 here. Since I was an advocate of it there, I can’t certainly advocate against it there. Having said that, minus 28 basis points on a two-year — and then there’s an article in the Journal this morning about some woman borrowing money and the bank has to pay her to borrow. I mean, it gets a little strange.
Stephanie Ruhle: So when you say, for example, you like European equities or there are buying opportunities there — do you actually see economic recovery, or do you just see from an investor standpoint some bargains you can make money on? Because those are two very different things.
Stan Druckenmiller: No, I see economic recovery, and I see a lot of great companies. Analysts have been downgrading BMW and Volkswagen because of their Chinese exposure. What do you think happens with a weak euro giving you an earnings tailwind if China recovers? You’ve got great companies like Airbus that are now much more competitive than they were against Boeing. But all our anecdotal evidence is that Europe has actually turned and looks pretty good.
Narrator: More with Stan Druckenmiller when we return. We’ll discuss the effects of a strong dollar on the US economy as Encore continues.
Stephanie Ruhle: Stan, there’s been a lot of commentary in the financial press, even comments from the Fed, on the effects a strong dollar could have on the US economy. What’s your take?
Stan Druckenmiller: Stephanie, as you know, I’ve been analyzing currencies and their effect on the economy for the better part of 40 years — it’s a big piece of what I do for a living. And honestly, I can find no correlation between the level and direction of the dollar and the economy. Intuitively, it doesn’t make a lot of sense, because what happens is — it’s definitely negative for corporate profits, that’s unequivocally true — but that’s a very small part of the economy relative to who it benefits, which is the consumer. The consumer, who is 70% of the economy, gets a big increase in purchasing power when the dollar goes up. So I’m kind of befuddled by it.
Just looking back at the evidence: the dollar went from 80 to 160 by June of 2008. Under the strong dollar theory, shouldn’t we be going into an economic boom and great inflation in 2008? My recollection is that’s not what happened subsequently. Or I remember when I was at Soros — the yen went from 78 to 147 in a very rapid period, about a year, in 1995–1996. Did Japan experience great economic growth because their currency went down 50 or 60%? In fact, when I look back, a strong dollar has been associated with a strong economy. I’m not saying it causes it — it’s kind of like saying ice cream causes hot weather. I don’t know the cause and effect. But I will say I’ve been looking at this for a long, long time, and while there is evidence that the dollar affects corporate profits, I can’t find evidence that a currency has that big an impact on economic activity.
Stephanie Ruhle: Bill Ackman says the biggest risk he sees is the student loan market — he sees billions in student loans that are simply not going to get paid back. Do you agree?
Stan Druckenmiller: Yeah, I don’t know whether it’s systemic, but of course they’re not going to get paid back. It’s very, very reminiscent of the housing situation — with great, good intentions, you had a subsidized market which increased demand, and when you mess around with markets, this is what you end up with. But I saw your piece with Bill, and yeah, it’s accurate.
Stephanie Ruhle: Do you think student loans could be the next subprime?
Stan Druckenmiller: No, but I think they can be one piece of a potentially dangerous puzzle.
Stephanie Ruhle: When you first took a look at subprime — the first time you were presented with it — how scared were you? How concerned? When you’re saying now, “I’m somewhat concerned about student loans,” is that how you felt when you first looked at subprime? Or from the get-go did you say, “Man, this is a flaming pile of garbage”?
Stan Druckenmiller: What happened was, I got concerned that Fed policy was out of whack in 2003 and 2004. And I had this gentleman come in from Bear Stearns in 2005 — it’s incredible, because Bear Stearns, as you know, went under because of subprime — and he worked there, and he laid out for me on a monthly schedule and convinced me in half an hour that the economy couldn’t make it past the third quarter of ‘07 because of subprime, that this was going to be a monumental bust. The hair was standing on the back of my neck by the time he was finished. And as you probably know, I think a month later I gave a speech at Ira Sohn in 2005 — I was just plagiarizing everything this guy gave me.
Stephanie Ruhle: What happened to that guy?
Stan Druckenmiller: I hired him at Duquesne.
Narrator: That’s it for Bloomberg Encore and my exclusive interview with Stan Druckenmiller. Keep watching Bloomberg Television for more insights from the world’s most respected financial experts, and visit Bloomberg.com and our mobile platforms for coverage of the markets anytime, anywhere. I’m Stephanie Ruhle — thanks for watching.