May 25, 2018
By Steve Blumenthal
“If I were trying to create a deflationary bust, I would do exact exactly what the world’s central bankers have been doing the last six years.
I shudder to think that the malinvestment that occurred over this period.
Corporate debt has soared, but most of it has been used for financial engineering.
Bankruptcies have been minimal in the most disruptive economy since the Industrial Revolution.
– Stan Druckenmiller
Alexander Hamilton was one of the Founding Fathers of the United States. He was an influential interpreter and promoter of the U.S. Constitution and the founder of the nation’s financial system. He was a leader in seeking to replace the weak national government, and led the Annapolis Convention in 1786, which spurred Congress to call a Constitutional Convention in Philadelphia. He helped achieve ratification by writing 51 of the 85 installments of The Federalist Papers, which to this day remain the single most important reference for Constitutional interpretation.
Can you imagine the impassioned arguments in Philadelphia back then? Left this… right that… center this… Lost on much of our elected leadership, largely educated in the studies of liberal arts and law, is an understanding of how the economic machine works. Not that art, or engineering, or medicine, or science, or accounting, or liberal arts or law are less valuable pursuits, it is just that I’m not sure I should be doing electrical work or giving legal advice nor should my doctor or lawyer be creating and shaping economic policy. The great Milton Friedman said:
…The world runs on individuals pursuing their separate interests. The great achievements of civilization have not come from government bureaus. Einstein didn’t construct his theory under order from a bureaucrat. Henry Ford didn’t revolutionize the automobile industry that way. In the only cases in which the masses have escaped from the kind of grinding poverty you’re talking about, the only cases in recorded history, are where they have had capitalism and largely free trade. If you want to know where the masses are worse off, worst off, it’s exactly in the kinds of societies that depart from that. So that the record of history is absolutely crystal clear, that there is no alternative way so far discovered of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by the free-enterprise system.
Eighty-two year old Ken Langone took the stage. He was born into a family with an abundance of love, but little money. Ken co-founded Home Depot and today is both investor and philanthropist worth an estimated $2.7 billion. When I see him on CNBC, I unmute the TV and tune in. What I enjoy most is his sound business sense and the candid and the direct way he delivers it.
Earlier this month, Ken introduced his long-time friend, Stan Druckenmiller, the recipient of the 2018 Alexander Hamilton award, Ken began,
Good evening everybody. I am honored to be asked to introduce my good and close friend Stan Druckenmiller. Stanley and I go back 40 years. He is a devoted husband, father and friend. He is as fine a human being as I know, and he is one of the most successful investors in America. I have been investing with him for 40 years, we have never had a down year.
A little bit about Stanley’s beliefs in America: He believes in capitalism, he believes in free markets, free trade, limited government, and the rule of law. He almost sounds like Alexander Hamilton. And I think I can say for sure that the selection committee picked the right man to get this award, because Stanley, long before it was fashionable, even though Alexander Hamilton was devoted to the belief that much of what America became, became so because we followed the roadmap that Alexander Hamilton laid out in the early days of this country. Among other things, Stanley has an enormous heart. He is generous with his time, with his talent, and with his treasure.
Stan ran what I believe was the world’s most successful hedge fund. Never a down year and annualized returns close to 30% according to long-time investors. Most of the money he manages today is his. Stan is a global macro investor. Meaning he will invest in pretty much anything anywhere. Currencies, commodities, bonds, stocks and cash. At times, sizable allocations to cash. His bets are not limited to just U.S. assets. If he thinks an asset is over-valued, he may go short (bet it will decline in price). His goal is to invest in just a few high conviction plays. He is one of the best investment minds among us. And he has the guts to trade. When he speaks, I listen. I want to know what is on his mind.
Today, let’s do just that. “It is not the first time this country has been divided in a war of ideas and ideals, and probably not the most precarious, but it is certainly the most consequential in my lifetime, and I can’t think of better proponents of the way forward out of this mess than the people assembled in this room. This nation has emerged from turmoil before and it is critical, absolutely critical we take the right path again,” Stan said. When you click through below, you’ll find his outstanding 2018 Alexander Hamilton award speech.
As a fun aside, our summer intern just finished his freshman year at Hamilton College. Embarrassingly, I had little recall as to the impact of Alexander Hamilton on our lives until I saw the Broadway musical a few months ago. Do go see the show if you can. You may not like hip-hop music, and I struggle with most of it, but the show amazed me and the music was brilliant. I’m sure our intern is up to speed on Alexander Hamilton, but I’m not sure he knows he’s being tested. One of his job requirements is to read each week’s OMR. We’ll see if he passes the test next Tuesday.
You’ll also find two charts that look at the 10-year and 30-year Treasury Note yields. Keeping an eye on the “Line in the Sand.” The equity market models remain modestly bullish, while fixed income remains in “sell” as you see in the Trade Signals section.
So grab that coffee and find your favorite chair. Or sit outside under your patio umbrella with a cold beer in hand, relax and enjoy what Stan has to share. This week’s piece is a quick read. Have a fun holiday weekend and I sure hope you get to celebrate it with those you love the most.
♦ If you are not signed up to receive my weekly On My Radar e-newsletter, you can subscribe here. ♦
Included in this week’s On My Radar:
- Stan Druckenmiller’s 2018 Alexander Hamilton Award Speech
- The 10-Year and the 30-Year “Lines in the Sand”
- Trade Signals — Mixed Market Signals Persist; Don’t Fight the Tape Slips to -1
- Personal Note — Hip-Hop
Stan Druckenmiller’s 2018 Alexander Hamilton Award Speech
Ken Langone continued his introduction of Stan:
“Geoff Canada is here tonight, and I know he would agree with me, that Geoff had this wonderful dream called the Harlem Children’s Zone, and when he matched up with Stan, it was absolutely certain that HCZ would go far beyond Geoff’s wildest dreams. HCZ today is one of the great examples of the ability to help people help themselves in depressed areas of America, in this case, Harlem. Geoff’s vision and Geoff’s dream was made possible, and I know he would agree with me, in part not only through Stanley’s generosity, but through Stanley’s time and talent. Our board meetings are at 7:00 in the morning and Stanley never misses one. He was chairman, and he still is chairman, of HCZ. His commitment is total. He is also chairman and a founder of Blue Meridian, an organization committed to moving the needle in social problems in America. And he has made a major, major financial commitment to that cause.
So, here we are tonight honoring a man who understands the importance of giving back, but who also understands the importance of initiative, and capitalism, and free markets, and indeed democracy. The selection committee has made a very wise choice in selecting Stan for this honor and I am humbled to have the honor to introduce him. Thank you very much.
Stanley Druckenmiller: Thank you, Ken. That was very, very nice. I have had so much good fortune in my life, but can you imagine having known that man and having him as a mentor for 42 years? Pretty cool. And then on top of that I met and married Fiona Biggs 30 years ago. To have a partner and the love of my life like Fiona and friends like Ken and Geoff Canada, I really count my blessings.
I am humbled to stand before you tonight and accept an award named after Hamilton, Alexander Hamilton. I am a bit of a Hamilton nut. I am also a bit odd to be in line with the past recipients. I was in awe enough and then I saw the co-honoree was Nikki Haley, wow. When I saw the line, the past recipients, I was thinking maybe Paul had perhaps called me bleary-eyed after a sleepless night, taking on another foreign government for their failed financial practices. But seriously, amid all the vitriol and divisions in our countries, there can be no debate about one thing: Alexander Hamilton is the most important non-president to shape the contours and the character of what would become the greatest nation in the history of civilization. And, frankly, he is actually a lot more important than most who ascended to the highest office in the land in terms of the success of our republic.
I actually grew up in a small town in South Jersey and at the age of 9 in the early ‘60s I moved to Richmond, Virginia. Now, Virginia had their own sense of their history and ours, at least back then. I took three years of American history when I was in the land of Jefferson and what I learned about Alexander Hamilton is he was shot by Aaron Burr. That was about it. I mean, who knew that a rap musical was going to be more informative about our founding father than the curriculum of the Virginia school system? Then I went to Bowdoin College in Southern Maine and I was lucky enough to take American history there, and it is there that I learned about this amazing man and his great and good contributions to our republic. I take particular pleasure in receiving this award because it is bestowed by the Manhattan Institute. Its positive impact on this city over the years has been literally immeasurable, and specifically the institute’s contributions to the cause of real reform and education in this city and beyond.
These contributions have given me one of the greatest joys of my life, watching Geoffrey Canada create and build the Harlem Children’s Zone. Geoff, you out there? And let me say this: The institute’s promotion of free markets, free trade, limited government, and the rule of law have never been more important than today, never. It is not the first time this country has been divided in a war of ideas and ideals, and probably not the most precarious, but it is certainly the most consequential in my lifetime, and I can’t think of better proponents of the way forward out of this mess than the people assembled in this room. This nation has emerged from turmoil before and it is critical, absolutely critical we take the right path again. And now a few comments of my own on the way forward.
Unfortunately, I am old enough to remember when the Soviets were building a strong economy with central planning and then it crumbled, and the wall came down. And then I remember when the Japanese were supposedly eclipsing the U.S. economy with their system of keiretsu and affiliate industrial companies partnering with the government and then the Japanese Lost Decade became two. And now there is China. And it is their turn, with their new leader for life, centralized decision-making on economic matters through 2025 and beyond.
In each of these cases, illiberal statists in our own country are most impressed by the top-down designs of foreign powers than our own track record of free market capitalism here at home, sort of a Wizard of Oz trumps the invisible hand narrative. But I actually believe it is an unfair comparison. Capitalism is under attack, but we have been moving further and further away from capitalism with each passing presidential administration. So, my advice is simple. Thank you, I wasn’t expecting a lot of applause tonight. So, my advice is simple. Can we try capitalism? Real capitalism. Give it a chance. Not the increasingly bastardized version we have been practicing the last two decades. And then let’s just see whether a capitalist economic system is the most effective way to bring about broad-based prosperity and the flourishing of human dignity.
[SB: For non-economic geeks: The “invisible hand” is a metaphor for how, in a free market economy, self-interested individuals operate through a system of mutual interdependence to promote the general benefit of society at large. The idea, introduced by the 18th-century Scottish philosopher and economist Adam Smith, characterizes the mechanisms through which beneficial social and economic outcomes may arise from the accumulated self-interested actions of individuals, none of whom intends to bring about such outcomes. The notion of the invisible hand has been employed in economics and other social sciences to explain the division of labor, the emergence of a medium of exchange, the growth of wealth, the patterns (such as price levels) in market competition, and the institutions and rules of society. More controversially, it has been used to argue that free markets, made up of economic agents who act in their own self-interest, deliver the best possible social and economic outcomes. (Source.) Ok, back to Stan.]
For eight years I watched the Obama administration disparage the efficacy and fairness of capitalism, the influence of government increased in every aspect of our lives, the cost of regulation doubled, corporate America was attacked in the name of social equality, and our healthcare system, hard to believe, was made even more inefficient. Now, I did not support Donald Trump. But, after he was elected, I was at least hopeful that it would represent an inflection point in the trend away from capitalism. And while there has been some relief on the regulatory front, and of course we have gotten a corporate tax cut, some of the more egregious trends away from capitalism are continuing and, frankly, new elements that violate the principles of capitalism have been added.
For starters, free trade is under assault, but I see no need to lecture the people in this room on the merits of comparative advantage. Next, Hamilton had a very deep respect for the rule of law as opposed to the rule of man. The best tech companies in the world are in the U.S. because of a mix of education, immigration, finance, and meritocracy. The central pillar that bolsters this mix and makes our economic system successful is a respect for the rule of law. Is there a better example of this than Amazon? Its founder is a Hamilton-inspired adopted son of an immigrant who is literally revolutionizing the way business is done. It is no coincidence that Amazon was built in America, no surprise that governments, foreign governments, envy its origin, and no question that legacy incumbents impugn its name but mimic its tactics.
Capitalism is intolerant of high-cost providers, rent-seekers, middlemen, and those who extract more value than is their due. Amazon’s biggest backers are not people in elevated positions of power, it’s their customers. Well, and a few investors too. The President’s personal view of Amazon should have no bearing on its future success. If intervention is enacted based on his feelings, we will be no better than other countries in the world where corruption and rent-seeking become the main reasons for stagnation and mediocrity. Regarding a continuing trend away from capitalism, Adam Smith would be distraught to know that we are expending an ever-increasing amount of our national resources on government transfer payments.
I spent two years of my life going to liberal and conservative universities to try and get young people energized about the looming explosion entitlements as well as their looming decreasing share of the economic pie. I even asked Geoff Canada to go with me so the students would show up. I got incredibly enthusiastic responses from ultra-liberal Berkeley to conservative USC. I even did a TED talk, and I was so effective in terms of the national debate that the only thing that Donald Trump and Hillary Clinton agreed on was that entitlements shouldn’t be touched. Good going, Stan.
But then we missed the golden opportunity to offset some revenue loss and address generational equity when Congress passed tax reform. Instead, government debt, which has doubled over the last decade, is set to increase to levels only reached during World War II over the next decade, so we will have sacrificed our future during a relatively peaceful economic period with no post-war reduction simply because politicians can’t say no. This does not exactly measure up to spending to defeat fascism and defend the world’s freedom. Finally, let me address a distortion that is one of the greatest threats to a properly functioning capitalist system. For years now a mix of central – sorry – for years now a mix of financial repression and central bank intervention has made long-term interest rates largely determined by government fiat.
Bond-buying by central bankers, commonly referred to as QE, has become so engrained in current thinking that it is now in the Fed’s conventional toolkit, a tool once reserved for a depression or financial crisis is now to be used at the first inkling of the next recession. For those of us old enough to have seen the dangers of price controls, they led to shortages, wasted resources, and disincentives to invest in what consumers want. They inevitably led to an allocation of resources by political actors in another great affront to capitalism. So, it is most surprising that 40 years after wage and price controls were sadly rejected by every economic textbook and policymakers, today we have settled to allowing the most important price of all, long-term interest rates, to be regularly distorted by public intervention. [Emphasis mine.]
The excuse of this radical monetary policy has been the obsession with a fixed 2.0% inflation targeting rule. The decimal point shows the absurdity of the exercise. Anything below 2.0% was a failure and risked deflation, the boogeyman of the 1930s, to be avoided at all costs. This has meant that years after the Great Recession ended the Fed has not only kept interest rates below inflation but have accumulated an unprecedented $4.5 trillion on their balance sheet by doing QE. Global central banks, in part to keep their currencies from appreciating of these overabundant dollars, have followed with $10 trillion of their own. Now, the irony of this is, over the last 700 years, inflation has averaged barely over 1% and interest rates have averaged just under 6%. So, we are seeing an unprecedented, ultra-monetary, radical monetary expansion during a time of average, average inflation over the last number of centuries. Moreover, the three most pernicious deflationary periods of the past century did not start because inflation was too close to zero. They were preceded by asset bubbles.
If I were trying to create a deflationary bust, I would do exact exactly what the world’s central bankers have been doing the last six years. I shudder to think that the malinvestment that occurred over this period. Corporate debt has soared, but most of it has been used for financial engineering. Bankruptcies have been minimal in the most disruptive economy since the Industrial Revolution. Who knows how many corporate zombies are out there because free money is keeping them alive? Individuals have plowed ever-increasing amounts of money into assets at ever-increasing prices, and it is not only the private sector that is getting the wrong message, but Congress as well. I have no doubt we would have not gotten such a big increase in fiscal deficits if policy had been normalized already. [Emphasis mine.]
Of all the interventions by the not-so-invisible hand, not allowing the market to set the hurdle rate for investment is the one I see with the highest costs. Competition is a better tool than price control for protecting consumers. That applies to Amazon and the bond market. The government should get out of the business of manipulating long-term interest rates and canceling market signals. One final thought: During Obama’s tenure, I was disheartened by the lack of criticism from the Left. Frankly, I think it would have carried a lot more weight than criticism from the Right.
Today I see a similar situation. I am discouraged by the timidity of the criticism of our present direction by many Conservatives. Now, there are many in this audience who have the power of the pen, and I also see a few who have the power of the purse. If you share the principles I have laid out tonight, I encourage you to articulate a better course for our country, a course for which Hamilton would be proud, and assure that America’s best days are ahead of us. Thank you for this wonderful award.
Let’s keep Stan on our radar. I continue to contend that the greatest bubble of all time is in the bond market. The next recession will provide the pop. Liquidity and funding will dry up. Zombie companies will go bust. Asset prices will reset and opportunity will present again. More defense than offense… Participate and protect.
The 10-year and the 30-year “Lines in the Sand”
The 10-year Treasury Note yield is back below the 3.07% line.
Jeffrey Gundlach was out recently stating that the “line in the sand” for the 30-year is 3.22%. Here’s a look at the 30-year Treasury Note yield.
At this writing, the 30-year remains below the 3.22% line.
Both currently sit below important technical thresholds. Both “lines in the sand” remain important. The Fed remains on the higher rate path. I believe both lines will be breached. Higher rates are bad for a highly indebted economy and asset prices in general. Keep the above two charts front of mind.
Further, the next two charts show why many expect the Fed to continue raising rates…
Once last note, take a look at how complacent the Fed was in 2000 and 2006/2007… just saying…
Trade Signals — Mixed Market Signals Persist; Don’t Fight the Tape Slips to -1
S&P 500 Index — 2,713 (05-23-2018)
Notable this week:
Notable changes to the trade signals this week include Don’t Fight the Tape or the Fed sliding to a -1, which is a bearish signal for equities and the Daily Trading Sentiment Composite moving to Extreme Optimism (a reading of 72.22), which is a short-term bearish signal for equities. The other major equity market trade signals remain moderately bullish at this time. The fixed income trade signals remain bearish. The long-term trend for gold remains bullish.
We continue to watch the 10-year Treasury Note yield, since it breached the 3.07% level last week.
The next section walks you through all of the Trade Signals charts.
Important note: Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.
Long-time readers know that I am a big fan of Ned Davis Research. I’ve been a client for years and value their service. If you’re interested in learning more about NDR, please call John P. Kornack Jr., Institutional Sales Manager, at 617-279-4876. John’s email address is firstname.lastname@example.org. I am not compensated in any way by NDR. I’m just a fan of their work.
“Dad, there is a lot of rap music in my play. I’m not sure you’re going to like it,” my son Kyle told me. For the last three months, he has been writing a play. Last night he presented on stage for the first time and let’s just say dad loves Kyle’s rap music and the lyrics. His play was about a kid from the streets of Philadelphia with a talent for graffiti art. Woven into the story were a series of rap songs and last night’s event was the first in a series of readings. I sat captivated for 90 minutes. It was outstanding (yes, I am totally biased). I should have, but in reality I have no idea as to the amount of work he put into it. We, the audience, then gave Kyle some open feedback. I’m really looking forward to seeing what he will create for himself in the years to come. A proud moment for dad.
I was in NYC last Wednesday, doing some consulting work with Rory Riggs and his team and then raced over to the VanEck offices for a webinar presentation to about 1,000 registered investment advisers and brokers. On the presentation with me was Alejandra Grindal, Ned Davis Research’s Senior International Economist and VanEck’s David Schassier, Portfolio Manager, Head of Portfolio and Risk Solutions. Alejandra dialed in from NDR’s Florida office. When we finished the call, I turned to the VanEck team and said, “She is a rock star.”
I enjoy conferences and meetings mostly for what I get to learn. I’m going to ask NDR for approval to share Alejandra’s most recent research write-up with you. And if you are an investment professional, please send me an email and I’ll send you a link to the webinar replay. Some really helpful information was presented. Unfortunately, compliance restricts the replay to investment professionals only.
While in the city, daughter Brianna convinced me to join her for a 7:00 am spin class at SoulCycle. It was like a great party with 30 of my new best friends and music blasting. Kind of a high energy meditation based on how the instructor guided the class. I was most certainly the old dude in the crowd and easily the most out of shape. But boy did I feel the stress I’ve been carrying melt away. It was fun and needed! I’m going to have to do it again.
Enjoy the time with those you love most. It goes by much too fast. And have a wonderful holiday weekend. Wishing the very best to you and your family.
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With kind regards,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
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