When Stanley Druckenmiller Talks It Pays To Listen
When Stanley Druckenmiller is talking, it usually pays to listen. Not that Druckenmiller is right every single time — he usually admits that he made several mistakes and wrong calls in his investment career. However, Druckenmiller has not only been right a lot, which is reflected by the great performance, admitting mistakes makes him humble and shows how reflective he is. And both are important qualities for a great investor — being humble about the market and constantly questioning everything.
A few weeks ago, Stanley Druckenmiller gave one of his rare interviews/speeches again. In the following article I will present the main points of Druckenmiller’s current view of the market.
The FED Gambled
Stanley Druckenmiller is quite famous for blaming and criticizing the FED during the last decade. In his opinion, the FED gambled in an irresponsible way and made a bet with a terrible risk-reward-ratio. When inflation was slightly below 2%, the FED tried almost everything to get inflation to the target. While the reward was getting inflation in line with the target, the risk was a massive asset bubble and inflation exploding. The FED kept interest rates close to zero for too long and today we know, the FED lost its bet and created an insane asset bubble. And while we can argue that it is not the FED’s mandate to watch out for asset bubbles, they could have done a little more than completely closing their eyes and ignoring the situation. Druckenmiller is comparing this extreme asset bubble to the year 1929 in the United States or 1989 in Japan. Or to put it differently: We are now in one of the most extreme asset bubbles ever and the bubble is about to pop.
And the second big mistake of the FED was its theory of inflation being transitory, which made them watch it for too long before they took action. Inflation was already in the mid-to-high single digits when the FED was still talking about it being transitory. In 2020 and especially in 2021 it was clearly visible that inflation was picking up steam — but the FED did not react before 2022.
Crisis Is Spiraling
And although the FED is now fighting hard by raising interest rates (interest rates are increased with the highest pace in the last few decades), it seems too late to get the situation under control.
At this point, we must expect the situation to spiral. Companies will increase prices due to the increased expenses for energy and raw materials. Customers must pay more for energy and products they are buying and will probably demand higher wages (as purchasing power is going down and nobody will accept that). And the companies having to pay higher wages for the workers will result in higher costs, and this will lead to higher expenses for companies that have to be compensated with higher prices for products.
But not only the price-wage spiral is a problem. The loose monetary policy created many other problems — it changed the behavior of people and investors. Behavior always was different during asset bubbles. For example, the level of fraud is going up or we see so-called zombie companies that manage to stay alive although they should already have been forced to declare bankruptcy. And when looking around we are already seeing the blow-ups and explosions — UK pension crisis, speculative assets faltering or FTX imploding to just name a few. But is seems like most people are not able to connect the dots and are still seeing this as isolated incidents completely ignoring the ripple-effect these events can have.
Long-lasting Crisis
As consequence, Stanley Druckenmiller is not only expecting extreme difficulties to get the situation under control again. He is expecting a hard landing for the U.S. economy (not later than end 2023) and would be stunned if the United States are not in a recession by 2023.
And when Stanley Druckenmiller is talking about other times in history in which it took decades for the stock market to reach previous levels again, we can interpret what the investors is expecting for the next decade. It took until 1954 before the Dow Jones Industrial Average could reach the same level as in 1929 again (25 years) and in 1982 the Dow Jones Industrial Average was at the same level as in 1966 again (16 years). Stanley Druckenmiller is quite diplomatic, but in my opinion, he is expecting a horrible recession and sees it as rather unlikely that the Dow Jones Industrial will be higher in 10 years than it is today. And Stanley Druckenmiller is not the only investor talking about the next lost decade — Warren Buffett, Charlie Munger, Ray Dalio and Druckenmiller’s former partner George Soros make similar predictions.
This Is Not 1982!
When going back in history to find another time with a similar high inflation rate as right now (and many perceive inflation probably to be the major problem), we land in the early 1980s. But Druckenmiller is also pointing out how radically different the year 2022 is from 1982. Druckenmiller not only assumes the situation to be different — Druckenmiller assumes that the situation is completely reversed right now.
When comparing the situation, we can start with two fundamental differences:
- Earnings: In 1982 company’s earnings were depressed as the economy was struggling and still in a recession while earnings today are extremely inflated after a 13-year bull run for many companies (just briefly interrupted by the COVID-19 recession).
- Valuation Multiples: In 1982, valuation multiples were extremely low and at very depressed levels while stocks today are trading for very high valuation multiples (and have been trading at even higher valuation multiples a few months ago). In the early 1980s, corporate equites to GDP ratio was only at 32% while it is at 150% right now and was above 200% a few months ago.
Additionally, there are two (secular) forces Druckenmiller also mentions:
- Globalization: In the early 1980s, we were at the beginning of globalization, which was a huge tailwind for the U.S. economy as well as most corporations. Today, on the other hand, globalization seems to reverse turning into a headwind.
- FED: And the last 10–15 years of quantitative easing by the FED certainly added fuel to the fire and makes the situation today so radically different from 1982.
And many of these positive forces — globalization, quantitative easing, valuation multiples expanding — are not just stopping, but actually reversing. We are going from globalization to many countries adding trade restrictions, we are going from quantitative easing to quantitative tightening and valuation multiples contracting will crash the stock market.
Conclusion
Druckenmiller is one of many great investors that is quite bearish about the coming years and sees a storm coming on the horizon. Druckenmiller as an extremely reflected investors, is often making cautious predictions and always pointing out he could be wrong. But I assume he is expecting a brutal recession and bear market in the coming years — and I am afraid he is not wrong this time.
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