May 28, 2021
By Steve Blumenthal
“I will say it’s about the most challenging time to talk
about the market and the economy I can remember since I got in
the business. I actually believe we are in the most unique set of
economic circumstances that I’ve seen in my career, and certainly
in the post war period. I believe, policymakers are failing to acknowledge
how unique this period is. And I think the consequences of that could be
with us for years if not decades to come.”
– Stan Druckenmiller,
Former Chairman & President, Duquesne Capital
Today, my intention was to share with you my high-level notes and concluding thoughts from the Mauldin SIC2021 Virtual Conference. I wrote last week, “For me, the White and Fisher discussion, led by DiMartino Booth, stole the SIC2021 show. Why? Simply because it provided a crystal-clear window into what’s going on at the Fed. The grand finale was the White/Fisher/Mauldin/Felix Zulauf panel discussion. It was outstanding.”
I personally like to consider an investor’s perspective and compare and contrast that to the views of the people who set the value of money: central bankers. William White and Richard Fisher’s presentations were blunt and provided an insider’s view of the Fed’s inner workings.
Today, the game plan was to set the stage with the investment perspective from one of the greatest investors of our time, Stan Druckenmiller, douse the dream that “the Fed has our backs” with a concise summary of White and Fisher interviews, and––if time permitted––conclude with a summary of the closing panel discussion. However, I need to call an audible. Or else you will have less time to enjoy your holiday weekend, and my editing team will be late to theirs. (And… daddy could use a cold IPA.)
So, let’s break it up into two letters (maybe three) and begin this week with Druckenmiller’s keynote presentation to the USC Student Investment Fund’s annual meeting. It’s powerful, important, and next week will douse the dream. I promise you will have a clearer understanding of what is going on inside the Fed.
Before we jump in, just a reminder to be mindful of our current investment starting conditions. If valuations were better and interest rates higher today, we’d have less reason for concern (think 2009). Of course, that is not the case at this particular moment in time.
Here’s a quick take (red dots indicate high risk):
The vast majority of investors are positioned 60/40. Within the 60% equity bucket, capital is overweight cap-weighted indices. Within the 40% fixed income bucket, real interest rates are negative. Let’s take a look:
And it’s not just inflation-adjusted negative interest rates; inflation-adjusted earnings have dropped below zero by the most we’ve seen in 40 years. (H/T David Rosenberg, Early Morning with Dave, 5/27/21.)
Here’s a different view. Note the red dots in the next chart (red dots are bad):
Grab that coffee and find your favorite chair. Druckenmiller, Trade Signals, and some summary thoughts follow.
This week’s On My Radar:
- Stanley Druckenmiller – USC Student Investment Fund Annual Meeting Keynote
- Trade Signals – Intermediate-Term Trends: Bullish Trends in U.S. Fixed Income, Equities, and Gold; Dollar Bear
- Personal Section – Summary Thoughts
USC Student Investment Fund Annual Meeting Keynote
By Stan Druckenmiller
Select summary highlights in bullet-point format…
Now, why do I say the period is so unique?
- Well first of all, the COVID-induced decline that we experienced last spring was both violent and abrupt, and, to put it into math terms, we had five times the decline in the average recession in 25% of the time. Think about that.
- Monetary and fiscal policy response to that was equally unprecedented. It’s not pleasant to remember back last spring, but if you think about that period, I think we were all terrified that we were experiencing a potential black hole, not only in our lives, but the but the in the economy itself with potentially catastrophic circumstances consequences.
- If you look at the policy response it was extremely aggressive, led by the Cares Act. In three months, we increased the government deficit more than the last five recessions combined.
- If you added up all those recessions’ effect on our budget, and the size of the budget deficit, combined, they do not equal how much the budget deficit increased in three months last spring.
- The Fed response was equally aggressive and unprecedented, they did more QE in six weeks last spring, than they did in the entire period from 2009 to 2018. Which was unprecedented in and of itself, and a lot of people were questioning the size of that.
- The peak month during that nine-year period was when Bernanke did $85 billion in QE, we’re still buying $120 billion (per month) in securities well after the six weeks that I talked about.
- The final thing that happened last spring was the Fed crossed a lot of red lines in terms of what they would backstop in terms of the corporate debt. Also in the municipal market.
- The results were very emphatic: corporations increased their debt in a recession by over a trillion dollars in response to the Fed backstopping that debt. I don’t believe it’s ever happened before.
- Just to put that into perspective in the great financial crisis, they shrunk their balance sheets $500 billion, which is much more consistent with historical activity.
- The good news is this resulted (I’d say pleasantly surprisingly) in a very abrupt and strong recovery. And in that context, it was a good risk reward to enact policy expecting a deep and protracted recession in the spring of 2020. It worked. It was dynamic, it was bold.
- However, a lot has changed since then. By the fall, the outlook had already brightened considerably, and policy makers continue to accelerate fiscal deficits; they are going to reach 30% of GDP and just under two years.
This is a chart of the cumulative fiscal deficit from the start of the recession, of all the recessions that I mentioned earlier, since 1980.
- And you’ll see a top five lines are the four recessions that preceded this one.
- The black line represents all those added up together. Remarkably, the red line is what we’re doing in 2020 and ’21.
- Again, the boldness of what they did and the beginning of that chart when you’d say first five or six or seven months, makes a lot of sense. But what’s very surprising, is we’re continuing to double down on these policies, even after it’s quite apparent, you’ve had a very strong recovery in the economy.
- The Fed’s easy money printing is almost two times all previous fed incursions into money printing.
Now, what we have observed in recent months is the sharpest recovery from any downturn in recent history.
- Despite losing 11 million net jobs during 2020, personal income grew at the fastest rate it’s grown in 20 years.
- Think about that, while 11 million people were losing their jobs. We ended the year with a strongest growth and personal income in 20 years.
- The unemployment rate has recovered 70% of the initial hit in just six months. It typically takes 25 months for this to happen.
- Even after the sharp fall of five times the average recession, we’re already back in terms of GDP. GDP to pre-COVID levels of just five quarters. The average recession takes seven quarters, but don’t forget we’re coming back from a much deeper hole that was five times as deep as that observed in the average recession.
- It is unnecessary, and frankly reckless that $575 billion of the $850 billion in direct transfers of the two-and-a-half trillion of expected QE are being provided after retail sales were about pre-covered trends and after vaccine confirmation.
So if you look at the red line on the chart I have up. That is 2020. I think we can all agree, it doesn’t look anything like the other recessions, which are more traditional in nature, much more violent, increased unemployment, and then a huge snapback and a much shorter period of time.
I think even moderate voices will agree that their level of support has been excessive. Let me show you how excessive it actually has been.
- This is a chart of retail sales over the last 20 years. They’re currently above pre-COVID trend by 15%.
- Look at the period from 2008 to 2014.
- It took six years to get retail sales back on the trend. And after the great financial crisis. But if you look at the current period, we had a sharp V bottom out, and I mentioned the Cares Act that’s check one.
- Then we have more fiscal stimulus. Last fall, after vaccines, repairing and after it was apparent that we were in a very unusual recovery, and now as you know, we’ve just passed another trillion-and-a-half in stimulus, when retail sales are 15% above trend.
What does that mean exactly? If you took the increase in retail sales from 2016 to 2020 on this chart, that’s 3% a year and a recovery, we’ve just done that in six months, we are absolutely booming. We are above trend by frankly five years and six months.
The Fed is constantly reminding us of monetary policy ads with long and variable lags.
- Why, then, is the Fed still providing emergency financial conditions when their recovery—as I’ve shown—is in full acceleration?
- Why is the Fed buying $40 billion in mortgages a month, when we are clearly running out of housing supply?
- Not only is the Fed still providing record amounts of accommodation; it is promising not to raise rates until after 2023. Even when the recession is already over.
- If the Fed raised rates in the first quarter of 2024, as indicated, it will be 41 months after recovering 70% of the drawdown and unemployment. That was the chart I showed with the red line earlier.
- What do you think the average number of months is before the Fed’s first hike after a 70% employment recovery in the post-war period? Chairman Powell is predicting 41 months before Fed’s first rate hike.
- What do you think the average after that kind of recovery has been since World War Two? Four months. Four!
- And according to the Chair, they are not even thinking about ending $120 billion a month in bond purchases. Simply put, the fastest and strongest recovery from any post-war recession is being met with the Fed’s easiest response on record… by a mile. Policymakers say, “We need to go big to avoid downside risks and avoid this stagnation experienced after the great financial crisis.”
- But as I have shown, comparisons with the great financial crisis are completely inappropriate.
What about the risks of financial stability? The worst economic periods of the last century have followed the bursting of asset bubbles––think the 1930s after the 1929 bubble burst and think about the great financial crisis after the housing bubble burst.
- With Dogecoin, which was started as a joke, with a $60 billion market cap, and they have NFTs on everything you can spell out there, is there any doubt in anybody’s mind that we are in a bubble––not to mention the stock market, and the GDP is well above any level that we’ve seen in the past century?
- More obviously, what about the risk of fiscal dominance and loss of our reserve currency status?
This next chart shows foreign purchase of US bonds. Frankly, US Treasurys have been the go-to assets for global portfolio managers for the better part of 20 years; they’ve particularly been attracted to them as a safe haven in so-called risk-off periods. Look at their period surrounding the great financial crisis, look at all the green above the line.
- Something stunning happened last March. In the middle of the equity meltdown, foreigners aggressively sold Treasurys. As we propose the Cares Act. So I’ll never forget it: right in the middle of the worst part of the equity meltdown in the third week of March, there was an 18-point decline in the bond market.
- We didn’t know what it was at the time, but we found out months later through Fed accounts that foreigners had sold a trillion dollars’ worth of bonds in response to the Cares Act.
- Again, this has never happened before. But they are watching our behavior, most of which I’ve outlined in the last five or 10 minutes, and they’re frankly saying, “no mas.”
- Asians and others have been purchasing Chinese assets, who have done no QE and much less fiscal stimulus in response to COVID, and they’re doing just fine, thank you very much with China representing 20% of world GDP, and only 1.6% of global portfolios, and the US representing 25% of GDP, but 28% of world portfolios.
- With China at 1.6% of global portfolios, this process is probably early rather than late.
And the last thing the US needs is interest rate burdens.
Back in 2013, I was worried about baby boomers turning 65. The problem is Social Security and Medicare. We’re on a pay-as-you-go system. I said then that we’re about to receive all these benefits, but there were less workers available to provide it—that was the problem I outlined back then.
- We are now throwing $6 trillion of extra spending into the pot, just as a great boom accelerates. Ironically, one of the answers I would give when I was inevitably asked what to do about the problem: I said we should raise the age of Medicare. People are living longer; people are healthier.
- Surprisingly, the Biden administration is requesting to lower the age of Medicare to 60, creating a $400 billion hole in the name of infrastructure. I mean, seriously, you can’t make it up.
- All of this spending has been encouraged by the Fed and aided and abetted by QE and low rates to finance it.
- There is no way yields would not have gone up without the Fed financing, all the things that I’ve been showing the last five or 10 minutes.
- But look at this chart. The CBO projects that the new debt level, despite drastic cuts in growth and non-entitlement spending—that’s the gray line—will result in interest expense of 27% per year.
- If the 10-year was to normalize to 4.9%.
- Simply put, the system cannot handle it, so the Fed will be forced to monetize the debt. Think about that 27% of GDP just in interest costs alone. That’s basically all the money we’ve spent in COVID relief in the last 12 months.
Like many post-war periods that have seen inflation and financial repression by central banks, despite not having had to finance a major war, I believe we have crossed the Rubicon.
- And this is the only solution (the Fed forced to monetize the debt) for this unnecessary and self-inflicted situation from this radical monetary and fiscal policy outline.
- Currently, 85% of the world’s transactions are done in dollars. I think we have crossed the Rubicon, as I’ve said, and for the first time in my career, I believe we will lose this reserve currency status, and all the benefits that come with it within 15 years.
I’ve never said this before, I’ve never even thought of it before. At present, there’s no alternative because of the lack of the trust in the communist dictatorship in China, and the message here apparently is, I don’t know who’s gonna replace us…
- But my best guess is the biggest threat is a crypto-derived ledger system that will be invented by a group from an army of engineers leading universities like USC.
I will conclude my remarks with how my family office is positioned given this background. This comes with a huge word of caution. For those who don’t know, I mean, my immediate view is very flexible, and I do change my mind. I see I’ve used up my 20 minutes, let me just say that, for obvious reasons we are positioning ourselves for the dollar. I think you’ll understand that from what I presented in the presentation.
- One might ask, in terms of shorting the dollar. Why did the dollar not go down when foreigners started selling bonds last March and have continued to sell them through today?
- So, as opposed to $500 billion in bonds flowing into the United States a year, they are now flowing out. The answer is: it happened in COVID. And COVID was extremely beneficial for companies that serve the digital economy.
- It just so happened that the FAANG stocks, and many US companies like Zoom were better positioned to deal with COVID than any of our foreign counterparts, so we had a huge inflow into the equity market here. It made up for the change in the bond flow, but once valuations got high, that dissipated, and the dollar peaked out in July.
- We’ve recently had a bounce that I think it’s unsustainable, frankly because US growth outlook has picked up relative to others because of our vaccine rollout. But as soon as the vaccine rollout catches up in Europe and Asia, which I don’t think will be far behind. I think the downtrend of the dollar will resume.
- We are short global fixed income, the booming economy I’ve outlined. I just think 1.6% on 10-year Treasurys is a ridiculous price, particularly relative to history that has traded right on top of nominal GDP, which is running at 10%. I’m not predicting that we’ll never get there (10%).
- The other way we positioned ourselves for this inflationary outcome, is we’re long all sorts of commodities; long oil, long copper, and we are long grains. Pretty much if it moves, we are long it in the commodity world.
- And finally, equities. We are long, but I will be very surprised if we don’t make the exit by the end of this year.
I was lucky enough to start Duquesne as Ronald Reagan entered with Paul Volcker running the Fed. And as you know from my many commentaries, everyone pretty much agrees that the combination of Jerome Powell and the Biden administration is an unraveling and the exact opposite of what Reagan and Volcker did.
- If Reagan and Volcker were so bullish for markets, I don’t think what we’re doing now in terms of regulation, taxation is sustainable (nor bullish for markets).
- And I will remind those of you invested when Ronald Reagan was elected, because of Volker you lost a lot of money in the first 18 months. So they did not take a myopic view and the dividends paid 20 years.
- I think today we’re very much in the opposite situation.
[SB here: The presentation concluded with a fun story Stan shared with the students about his year years in the business. Worth the read:]
Stan: I was hired when I was 23 years old at Pittsburgh National Bank, and I worked for a very eccentric brilliant investor who made me Director of Research when I was 25. This was 1978. Director of Research was the number two position in the investment division of the bank. And all the people that will be reporting to me were 35 or 40 years old and they had MBAs, and I did not have an MBA, and I was a little confused. When I walked into my boss’s office––also I was a little cocky––he said to me, “You know the reason I’m promoting you, above of all these people?” I said no.
He said, “For the same reason they send 18-year-olds to war: you’re too stupid and young to know not to charge.”
I said, “What do you mean?”
He said, “We’ve been in a bear market since 1968. It’s been 10 years. You can’t see them but I have scars from being in a bear market for 10 years, and you’re going to need to be able to pull the trigger, and I think you’re going to be able to do that because you’re too young and too inexperienced and you won’t have any scars.”
That man, taught me many things:
- A, to use technical analysis, which in academia at that time had always been frowned upon. So I used Fundamental and Technical Analysis. I would never buy a stock, unless the fundamentals were great and the chart was great.
- And he also taught me probably the most important lesson: to never ever think in the present. That’s a good way to lose money.
- Try to envision a world 12–18 months out, how different it might be because security prices will be much different.
- There’s not one thing in the world that doesn’t affect the price of some security somewhere, and if you can envision the world 12–18 months ahead, and not look at historic earnings or where we are now, you’ll make money.
- But if you’re buying things that are very popular now, you’re probably going to lose money because things tend to change, and everybody else’s long too.
That’s what he taught me, my second mentor I was lucky enough to work for George Soros and that I can put in a nutshell, which is:
- It’s not whether you’re right or you’re wrong; it’s how much money you make when you’re right, and how much you lose when you’re wrong.
- He was constantly telling me to size up (increase) my positions. I’ll never forget, I walked into his office and told him (the fund at the time was $7 billion) that I wanted to put a $7 billion position on long the Deutsche Mark and short the British Pound.
- I explained my reasoning to him, which I thought was very sound. He looked at me with the most disgusted look, and I was getting angry just with the body language feedback I was getting. And he said, “Look, you only get an opportunity like this––this is a one-way bet––maybe two or three times in your career, and you’re just not betting enough. We shouldn’t put 100% of the fund in this trade we should put 200% of the fund in the trade, because the most you can lose is a half a percent and you can make 20% on it so your risk reward is tremendous.”
I was shocked when I went there (to work for Soros). He was not as good at predicting security prices to me, but he always seemed to make a ton of money, because he would size his position accordingly.
You can watch the full presentation and Q&A here.
Trade Signals – Intermediate-Term Trends: Bullish Trends in U.S. Fixed Income, Equities, and Gold; Dollar Bear
May 26, 2021
Posted each Wednesday, Trade Signals looks at several of my favorite equity market, investor sentiment, fixed income, economic, recession, and gold market indicators.
For new readers – Trade Signals is organized into three sections:
- Market Commentary
- Trade Signals — Dashboard of Indicators
- Charts with Explanations
Notable this week:
The model signals for US equities, fixed income, and gold are bullish. A few notable charts to keep on your radar this week.
Every once in a while, I take a look at this next chart. What it shows is that since 1901, the DJIA has been in a cycle of creating new wealth 25.90% of the time (black lines). It spent 40.80% of the time recovering from losses (green lines) and 33.30% of the time falling – bear markets (red lines).
Trade Signals – Dashboard of Indicators follows next. Green continues to dominate the dashboard. Click HERE to go to the balance of Wednesday’s Trade Signals post.
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.
Personal Note – Summary of Thoughts
“Stay close to people who feel like sunshine.”
I spend Saturday mornings with coffee in hand. One of the first things I do is pull up Mauldin’s weekly Thoughts from the Frontline and begin reading. If you are not reading his letter already, I recommend you start. Google it and sign up. Tomorrow, I know he is writing about inflation/deflation and sharing his perspective on his conference, which ended 10 days ago. Economists, geopolitical analysts, famed investors, venture capitalists, Fed officials––what a mix.
David Rosenberg, Jared Dillian, Bruce Mehlman, Barry Habib, Ivy Zelman, Constance Hunter, George Friedman, Emily de La Bruyere, Louis Gave, Mark Yusko, David Rubenstein, Marin Katusa, Joe Lonsdale, Barry Ritholtz, Jeff Immelt, Lacy Hunt, James Bianco, Felix Zulauf, Liz Ann Sonders, Peter Boockvar, SPAC panel, Ed Yardeni, David Hay, David Bahnsen, Ian Bremmer, Ron Baron, Byron Wien, Gerald Jordan, Doug Kass, Ben Hunt, John Hussman, Cathie Wood, Karen Harris, William White, Howard Marks, and Richard Fisher. Host Ed D’Agostino interviewed me on the closing day.
As a quick aside: If you are a client and interested in a link to my video interview with Ed, please email me at email@example.com. I talked solutions.
I was asked this week what I learned from the SIC2021 conference. It’s summarized in today’s and recent OMR missives. White and Fisher provided us with invaluable information. A reminder that markets are bigger than the Fed, and caution to remain vigilant.
Record market valuations, zero-bound interest rates, negative real interest rates, and leverage. The Fed is once again enabling bad actors (think Archegos Capital Management and the bankers who provided them with insanely leveraged swaps). How did that get past bank risk officers? How did sub-prime happen? In a word: Greed.
Government spending has gone wild with bigger plans in the near future. Inflation is out of the gate and the 10-year has risen to 1.60% from 0.50% a year ago March. That’s a 28% decline in value in long-duration Treasury bonds for those keeping count.
Richard Fisher says the Fed can’t control the 10-year. Druckenmiller believes 4.90% is not out of the equation. Who do you believe? Your brother- or sister-in-law, golf buddy, or a rookie advisor who says the Fed has our backs, or Richard and Stan?
Bill White sees inflation over the next 6–18 months, then deflation in the intermediate term, then out of control inflation. He believes, like Druckenmiller, that the Fed will be forced to monetize everything; thus, his long-term forecast is for inflation (and higher interest rates).
As Druckenmiller put it, “There is no way we can afford to have 30% of all government outlays be toward interest expense, so what will happen is that the Fed will have to monetize that. When they monetize it, I believe it will have horrible implications for the US dollar.”
I’m keeping a close eye on the 10-year Treasury, the Zweig Bond Model, and the dollar. I share the indicators with you each week in Trade Signals (part of my own weekly ritual). The yield on the 10-year will advise us of when the Fed has lost control of the narrative. The Zweig Bond Model is an excellent trend model. (By the way, it’s currently in a bullish buy signal.) The point is there are a number of ways to risk manage your fixed income exposure––something that makes great sense with the inflation risks and rising interest rate risks that we face. Watch the 10-year and watch the dollar.
The truth is no one knows when the wire gets tripped. What we can measure is the level of risk: record high valuations, ultra-low interest rates, overconcentration, and record high leverage mean risk is high. A decline of 66% in the S&P 500 Index gets us back to fair value.
Personally, William White’s outlook on inflation and the direction of interest rates resonated most with me. Bottom line: the next decade is not going to look anything like the last.
I also think Felix Zulauf is correct. Felix sees sharp declines and sharp recoveries in our future. Picture a series of “V” shaped market price patterns. Down 20%, the Fed comes in to rescue… sharp down, sharp up. In the past, major stock market declines would bottom, bounce, and the lows would get tested. Technicians would buy the retests. It was classic investor behavior stuff. Felix says expect no retests. The Fed is playing a new game. More on White, Fisher, and Zulauf next week.
In summary, my best advice is to risk manage what you’ve got (tight stop-loss triggers and/or option hedging) and buy into periods of panic. Vs are likely until confidence in the Fed is lost. Then we get the -66% back to fair value, or whatever the correction to fair value will be at the time. Best guess is there are a few more years left before the big one. I don’t think we are at that point yet. But I could be wrong.
Within our multi-family office, we are playing a totally different game. Instead of low-yielding bonds, we like diversifying to well-collateralized short-term private credit for our CORE holdings. Short-term just in case inflation is out of the barn and runs away from us in five years. This gives us optionality to reset at higher yields. We also favor trading strategies and smarter beta option hedged ETFs, and we like late-stage private equity and disruptive technologies for our EXPLORE holdings.
If you are in highly concentrated equity positions with embedded long-term capital gains, you can hedge your exposure with options in a cost-effective way. If we get V patterns as I suspect, options hedging may prove very effective.
My overall message is to simply identify the state of the game we are in and adapt accordingly. I’m concerned, of course, for the social divide we find ourselves in––but I’m not concerned about the potential for growing wealth.
Next week, we’ll close out the SIC2021 conference: White, Fisher and the closing White, Fisher, Mauldin, and Zulauf panel.
Stay Close to People Who Feel Like Sunshine
Susan sent me a picture in a text yesterday and I loved it. Great advice.
Applies to animals too…
There is so much to cover and so little time. I am trying hard to keep these weekly missives as short as possible, and I know there’s room for improvement. It’s a bit of a labor of love for me. Putting pen to paper really helps me learn. The last few weeks have been particularly fun. I do hope OMR gets you thinking, challenges your views, and helps you to shape your game plan. Please know, I know I’m not perfect. And always open to receive your candid feedback and thoughtful debate.
Wishing you a great Memorial Day weekend,
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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