Billionaire hedge fund legend Stanley Druckenmiller, the now-retired founder of Duquesne Capital, thinks theFederal Reserve’s aggressive approach to monetary policy could “end badly.”
According to Druckenmiller, the Fed’s policies in recent years have made no sense from a risk/reward perspective.
“I know you’re frustrated about zero rates, I know that it’s so tempting to make investments and it looks good for today, but when this thing ends, because we’ve had speculation, we’ve had money building up for four to six years in terms of a risk pattern. I think it could end very badly,” he said on January 18 at the Lone Tree Club in North Palm Beach, Florida.
Druckenmiller, 61, accurately called the housing crisis. During his speech, he said that he has the same horrific feeling now as he did back then.
“…I feel more like it as in ’04 where every bone in my body said this is a bad risk/reward, but I can’t figure out how it’s going to end. I just know it’s going to end badly, and a year-and-a-half later we figure out it was housing and subprime. I feel the same way now.”
Druckenmiller pointed out that there are some “early signs,” including a huge percentage of initial public offerings (IPOs) that are unprofitable. He noted that the other time we had 80% of IPOs be unprofitable was in 1999 prior to the tech bubble burst. He also noted that there are “some really weird things” going on in the credit market.
Here’s an excerpt from his Q&A with billionaire investor Ken Langone [via Cove Street Capital]:
Ken Langone: “You mentioned in your talk that there are already early signs of excesses due to over-easy monetary policy. What are some of the signs you see?”
Stan Druckenmiller: “OK. I mentioned credit…Let’s talk about that for a minute. In 2006 and 2007, which I think most of us would agree was not a down period in terms of speculation, corporations issued $US700 billion in debt over that two-year period. In 2013 and 2014 they have already issued $US1.1 trillion in debt, 50 per cent more than they did in the ’06, ’07 period over that same time period. But more disturbing to me if you look at the debt that is being issued, Kenny, back in ’06, ’07, 28 per cent of that debt was B rated. Today 71 per cent of the debt that’s been issued in the last two years is B rated. So, not only have we issued a lot more debt, we’re doing so at much less standards. Another way to look at that is if those in the audience who know what covenant-light loans are, which are loans without a lot of stuff tied around you, back in ’06, ’07 less than 20 per cent of the debt was issued cov-light.
Now that number is over 60 per cent. So, that’s one sign. The other sign I would say is in corporate behaviour, just behaviour itself. So, let’s look at the current earnings of corporate America. Last year they earned $US1.1 trillion; 1.4 trillion in depreciation. Now, that’s about $US2.5 trillion in operating cash flow. They spent 1.7 trillion on business and capital equipment and another 700 billion on dividends. So, virtually all of their operating cash flow has gone to business spending and dividends, which is ok. I’m onboard with that.
“But then they increase their debt 600 billion. How did that happen if they didn’t have negative cash flow? Because they went out and bought $US567 billion worth of stock back with debt, by issuing debt. So, what’s happening is their book value is staying virtually the same, bu their debt is going like this. From 1987 when Greenspan took over for Volcker, our economy went from 150 per cent debt to GDP to 390 per cent as we had these easy money policies moving people more and more out the risk curve. Interestingly, in the financial crisis that went down from about 390 to 365. But now because of corporate behaviour, government behaviour, and everything else, those ratios are starting to go back up again.
“Look, if you think we can have zero interest rates forever, maybe it won’t matter, but in my view one of two things is going to happen with all that debt. A, if interest rates go up, they’re screwed and, B, if the economy is as bad as all the bears say it is, which I don’t believe, some industries will get into trouble where they can’t even cover the debt at this level.
“And just one example might be 18 per cent of the high-yield debt issued in the last year is energy. And I don’t mean to offend any Texans in the room, but if you ever met anybody from Texas, those guys know how to gamble, and if you let them stick a hole in the ground with your money, they’re going to do it. So, I don’t exactly know what’s going to happen. I don’t know when it’s going to happen. I just have the same horrific sense I had back in ’04. And by the way, it lasted another two years. So, you don’t need to run out and sell whatever tonight.”
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