“Often Wrong, Never in Doubt”

Stan Druckenmiller’s Economic Club Speech – Part 1

The statement “often wrong, never in doubt” from famed investor Stanley Druckenmiller got a good laugh from the audience at The Economic Club of New York, where Druckenmiller spoke on June 3, 2019. It was a master data-driven class on the economy, market cycles, and investing. This two-part series analyzes the hard facts referenced in the talk.

On Monetary Policy Contributing to Bubbles

“Really loose monetary policy greatly contributed to the Financial Crisis… When we had a one percent Fed Funds rate, in 2003, after to me it was pretty obvious the economy had turned, and I think the economy was growing at 7-9% nominal in Q4 of 2003. That wasn’t enough for Fed.” (@ 8:50)

As you can see below1, in both the early 1990s and early 2000s recessions, the Fed continued to cut after GDP growth picked up; this is the Fed’s insurance cut at work. While you can’t go directly connect this to the Fed causing the Financial Crisis, the Fed certainly has left little to chance in managing through recent downturns.

“Every bust I had ever seen was preceded by an asset bubble and generally setup by too loose policy…and the latest one at that time period that had just occurred was obviously Japan…after the Plaza Accords.” (@ 9:53)

Again, this was spot on. Japan employed insurance cuts, during the 1986-87 recession after the Plaza Accord and from 1991-1994.2

On Corporate Profits and Debt Since 2010

“So corporate debt in 2010 was $6 trillion; it’s now $10 trillion, so it’s grown 65%…During that same period, corporate profits grew from $1.7 trillion to $2.2 trillion…that’s cumulative over 8 years. On a $4 trillion increase in debt, we got $500 billion in corporate profits, but it’s worst than that. The interest cost on that extra $4 trillion in debt only went up 23%, from $475 to $565 billion. So, think about the horrendous return productivity of capital here. You increase your debt 65%, but your interest costs only go up 23%; you would think your profits would explode with that formula; they went up 29% over 8 years, not in 1 year…you might ask, wait, wait, corporate profits have been great! No, I’m talking about total corporate profits, not earnings per share.” (@ 12:50)

Druckenmiller’s concern is valid here. During two recent periods of falling rates and thus falling Cost of Debt, Interest Coverage rose dramatically for US corporate borrowers. 3

However, this is not the case in the current era since 2010.

Data has been normalized to aid in comparison

On Buybacks and Capex

“During that time period, $5.7 trillion buybacks, financial engineering, versus $2.2. trillion…in capital expenditures, and if you got back to 2010…buybacks were 20% of capital expenditures, they’re now 55%, with a much higher stock market.” (@ 14:12)

I confess I had difficulty validating these numbers. The best source I could find implied that while buybacks had exceeded Capex in 2018, the aggregate since 2019 was much closer.4 I continue to seek out better data to validate this point. Regardless of the actual numbers, buybacks are up a lot, relative to Capex.

S&P 500 Capex and Buybacks Since 2010
$ billionsBuybacksCapex
2010300425
2011400500
2012400575
2013475600
2014550650
2015550625
2016525600
2017500600
2018825700
Total4,5255,275

On Tech Versus Traditional Industries

“It’s not Google or Facebook, they’re spending their brains out on innovation; it’s old dying retail companies, companies with by the way 24 square feet per capita, in this country, and that number is 3 in Germany and 2 in China.” (@ 14:52)

A quick check of retail in the United States confirmed that we have a lot of retail space, so much so, that it has actually grown since 2006, despite the boom in e-commerce.5

On Bankruptcies

“Here we are in probably the most innovative, I would say economic disruptive period since the last 1800s, and you hardly see any bankruptcies, because there have been no market signals from the Fed.” (@ 15:13)

This one surprised me. shocked me. It brought together Druckenmiller’s points that low rates should be driving Capex, R&D, and increased corporate profits for market innovators, not buybacks that perpetuate dying industries and companies.6


source: tradingeconomics.com

On Washington’s Ability to Respond to a Recession

“But there is one other problem with all this. That’s our Government. Government responds to market signals too and the clowns in Washington, unless they get a signal from the bond markets, they’re just going to keep spending. So, for the first time in history, we have massive deficits at full employment; estimates are this year there will be a $1 trillion, God help us if we get into a recession, if you just take the mean of what happens in a recession, that would go to $1.8 trillion. Debt to GDP has gone from 65% to 105%.” (@ 15:30)

Most enlightening about looking back at U.S. government spending in response to recessions and unemployment is the sobering fact that we are nearing spending levels as a percent of GDP last seen during the Great Depression. While we are certainly going through was Ray Dalio calls a beautiful deleveraging of what is an approximately 70-year long term debt cycle, Druckenmiller’s concern is a legitimate one, were economic conditions to deteriorate significantly from here. 7

Data has been normalized to aid in comparison

On Deflation

“Fear of deflation prevented them from doing so. There’s this belief at the Fed, that if you’re near the zero bound, you’re near deflation, and that can cause, that’s the bogeyman that we dealt with in the 1930s, the Japanese dealt with. But I’ve near seen a deflation happen because you were near the zero bound, everyone was preceded by an asset bubble.” (@ 16:20)

The United States has faced four major periods of deflation prior to the 2008 Financial Crisis. Druckenmiller is spot on. Each deflationary period was preceded by a bubble, and none were near zero bound interest rates. 8

Major Periods of Deflation in the United States
Deflationary PeriodInterest Rates RangePrior Bubble
1818–18215 to 6%Prices of US land in the south and west, cotton (US main export at the time), wheat, corn and tobacco grew into a bubble following the end of the Napoleonic Wars in 1815 as the European economy was beginning to recover from wars and demand was high for agricultural goods from America.
1830s to 18434 to 5%Prices of US land, cotton, and slaves grew into bubbles with easy bank credit by the mid-1830s.
1873–963 to 5%Economic problems in Europe prompted the failure of Jay Cooke & Company, the largest U.S. bank, which burst the post-Civil War speculative bubble.
1930–19332 to 3%Roaring 20s Bubble

“I just don’t understand the 2% inflation obsession. We had 3% deflation in the late 1800s and the economy grew at 8% real for 10 years. We had inflation of less than this level with the Fed Funds at 4, and we were just fine.” (@ 17:17)

Right once again. The United States has experienced numerous decades of economic growth during periods where the dollar fell in value.

S&P 500 Capex and Buybacks Since 2010
DecadeFed Funds Rate RangesChange in Dollar ValueGDP Growth
1890sn/a-8.8%41.5%
1900sn/a8.3%52.9%
1910sn/a82.1%134.4%
1920sn/a-14.5%17.2%
1930sn/a-16.8%20.4%
1940sn/a70.0%58.4%
1950s0.93-3.9920.7%38.7%
1960s1.73 - 9.15%24.0%51.6%
1970s3.71 - 13.78%87.1%36.9%
1980s5.89-19.10%50.5%36.1%
1990s2.92-8.29%27.5%34.7%
2000s0.12-6.53%24.6%16.0%
2010s0.07-2.41%17.4%22.6%

On the Fed Missing the Platform Economy

“Marginal cost of those pictures is zero…In GDP accounting, ok, since you are not paying 50 cents to go and get your Kodak film processed, it actually subtracts from GDP accounting. Now I understand they get some advertising and it goes over here. But there is no way to measure this stuff…there was a study out of MIT that you’d pay $18k a year to use Google Search…all this stuff is free, so it’s mismeasured…same thing with inflation…we don’t know what GDP is, we don’t know what inflation is, we are in the middle of a productivity boom, and I’m not convinced that -1%, -2% deflation [would] be bad.” (@ 19:00)

This is a big topic and beyond the scope of this post. I direct you to an article published in the American Enterprise Institute and a report produced by Oxford Economics and Huawei.

On Economic Predictors of the Stock Market

“By far, the best economic predictor I have ever met is the inside of the stock market. I don’t mean the stock market, I mean the inside of the stock market. And that’s looking at cyclical companies within the stock market. And I particularly like, cause it tends to be the right kind of timing, trucking, retail, that kind of stuff, the Russell 2000. So, if you just look at the periods I’ve analyzed, generally, those stocks start going down, and defensive stocks and secular growth stocks start going up on a relative basis.” (@ 23:03)

Stocks have staged a resounding rally since this speech, but the point still holds. While the broader S&P 500 is at all-time highs, cyclical sectors like retail, financials, energy, and small caps are down double digits from their all-time highs.9

Market Sector Performance Versus All-Time Highs
Index/SectorTickerReturn Since All-Time High (as of 6/20/19)All-Time High Date
S&P 500SPXat all time high6/20/19
Consumer StaplesXLPat all time high6/20/19
UtilitiesXLUat all time high6/20/19
Consumer DiscretionaryXLY-1%5/24/19
TechnologyXLK-1%5/1/19
Health CareXLV-3%10/1/18
NYSE CompositeNYA-4%1/26/18
IndustrialsXLI-4%1/29/18
MaterialsXLB-10%1/26/18
Russell 2000IWM-10%8/31/18
TransportationIYT-11%9/14/18
FinancialsXLF-12%5/31/07
BiotechIBB-19%7/20/15
RetailXRT-20%8/22/18
Regional BanksKRE-21%6/7/18
EnergyXLE-38%6/23/14
S&P MetalsXME-71%6/30/08

Footnotes:

  1. FRED Economic Data on U.S. GDP growth and Fed Funds Rate
  2. Japan data from www.countryeconomy.com
  3. FRED Economic Data on corporate debt, corporate profits, and interest cost. Data normalized
  4. Bloomberg article
  5. CoStar report courtesy of Barrington Capital
  6. Trading Economics
  7. FRED Economic Data on U.S. Debt/GDP and Unemployment Rate
  8. Deflation and Interest Rate History
  9. Yahoo Finance, Standard & Poors

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Any opinions or forecasts contained herein reflect the personal and subjective judgments and assumptions of the author only. There can be no assurance that developments will transpire as forecasted and actual results will be different. The accuracy of data is not guaranteed but represents the author’s best judgment and can be derived from a variety of sources. The information is subject to change at any time without notice.

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