It’s almost impossible to read anything about the financial markets these days without reading how inflation is weighing on the global economy and markets. The skyrocketing inflation has made it more important than ever to invest with macro conditions in mind. Some may consider Stan Druckenmiller to be one of the greatest macro investors of all time.
At the Sohn Investment Conference last week, Stan Druckenmiller of Duquesne Family Office shared the strategy he once used to outperform others significantly during rampant inflation. He also talked about what he’s doing now to deal with the current inflationary period.
The stock market as a signal for economic conditions
Historically, Druckenmiller has often used stock market conditions as signals for what’s about to happen in the economy. He explained that he doesn’t use the types of signals traditional economists use to predict the economy, like employment, macro factors and top-down statistics.
Stan started his career as a bank analyst and learned from inside the stock market that it had a remarkably “prescient” message about future economic activity. He explained that stocks usually lead fundamentals by about six to 12 months.
Additionally, Druckenmiller pays attention to industries that lead and lag the economy, with housing being the most obvious. He explained that if these leading industries are turning up or down, it signals what the economy is about to do.
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No more signals from the bond market
Historically, Druckenmiller has also found the bond market to offer signals about upcoming economic conditions, although that has changed. He said that the bond market hadn’t signaled anything over the last 10 or 11 years because the world’s central banks have been manipulating bond prices.
According to Druckenmiller, the 10-year Treasury was the most important signal in the bond market, but it is no longer. He noted that forecasters said last summer that the bond market was saying different things as the 10-year dropped, but he doesn’t believe the bond market was actually saying anything.
Central banks have been buying trillions of dollars worth of bonds, “manipulating” the price, so any potential signals that could have come from the bond market have been tainted. On the other hand, Duquesne believes that the stock market contains no such tainting.
Leading and lagging industries
In addition to housing and homebuilders, in particular, some other industries Stan looks at for economic signals are trucking and, to a lesser extent, retail. He noted that homebuilder stocks were down 50% from their last high, while trucking stocks were down 40% to 50%.
Homebuilders had no change in fundamentals and are even booming, while trucking companies are reporting record earnings. Stan also feels that retail is significantly weaker than it should be, given the “supposed” GDP numbers. As a result, he sees declining retail as an early signal that there may be trouble ahead. Of course, if one industry is struggling while the others are fine, it doesn’t necessarily mean a recession is coming.
Over the years, the best investors have changed their strategies, and Druckenmiller points out that what the original value investor, Ben Graham, once did just doesn’t work anymore. Graham used to buy companies that owned more assets than their market capitalization, but that doesn’t work anymore.
When he started investing in the mid-1970s, Stan started in equities, but he learned that moving into bonds, commodities and foreign currencies was necessary during a bear market. In fact, he enjoyed higher returns in bear markets than in bull markets. he did that by focusing on bonds and Treasuries and ignoring equities.
He noted that he has never seen an environment with 8% inflation and weak bond yields of around 3%. The lack of precedent has made investing in the current environment significantly more difficult than at any other time in history.
Dealing with the unprecedented environment
The interviewer asked Druckenmiller how his positioning has changed recently, and he said he had been making money up until about six or eight months ago. He described his positioning as a “matrix” of shorting fixed income, shorting stocks and not doing much in currencies but owning some commodities, specifically, oil.
However, Stan adds that things are getting much more challenging now because he’s seeing definitive signals that the economy may be weakening. As a result, he’s not comfortable owning bonds and is now less comfortable shorting fixed income than he was three to six months ago.
Many stocks have de-rated 60% to 70%. Stan has lived through enough bear markets to know that investors can get their “head ripped off” in rallies if they start shorting stocks too aggressively. He anticipates returning to short equity positions at some point if the market affords him to do so.
However, if the market does not, Duquesne hopes to sidestep a decline, which he described as “not the worst thing in the world.” He added that the fixed-income market has gotten much more complicated, but playing in so many asset classes grants him the luxury of not playing in one of them.
Druckenmiller will be surprised if he doesn’t short the dollar at some point in the next six months. He described foreign exchange as “interesting” and still owns energy and other commodities. He noted that the war in Ukraine gave the commodity trade an extended life. Amid the energy transition and ESG, he could look to short energy, but that could last five to 10 years.
Concentration over diversification
He also offered some other insights into what his portfolio looks like right now. Druckenmiller disagrees with the traditional wisdom taught in business school, which is that highly diversified portfolios have less risk. On the contrary, he believes that the bigger risk for investors is getting in trouble when their longs or shorts get “stale.”
The fund keeps a more concentrated portfolio and added that investors who keep 15% to 20% of their asset base in macro positions will avoid getting stale. He advised investors to remain paranoid, constantly reevaluate their open positions, and keep an open mind.
Interestingly, Duquesne also tends to move on an investment thesis first and then research it later. He explained that investors who wait two or three weeks before moving while they investigate an idea often miss 60% to 70% of the move. Although that might not be the asset’s long-term move, Druckenmiller emphasized that the entry price is critical.
If he likes an idea intuitively, and it ticks a bunch of boxes on his macro matrix, he moves quickly to put the position on. Then if the position works out, he adds to it, but if it doesn’t, he gets rid of it. According to Druckenmiller, entering quickly gives investors a chance to get in before others recognize the story they saw. However, if there is a real story, others will probably notice it within 10 days.
Michelle Jones contributed to this report.