The big news in Friday’s US trading session was the much weaker than expected US employment data. Employment for the month of April came in at 160,000, much less than the 200,000 new jobs forecast.
This means the US Federal won’t raise interest rates in June as many expected. Now, the expectation is that the next rate rise will come in September. And when September nears, December will become the month for the anticipated rate rise…
Or maybe by that time the pretence of a coming rate rise will be gone altogether and the market will be looking at more easing measures.
That’s certainly the view of investment legend Stanley Druckenmiller. His recent presentation at the Sohn Conference in New York is getting a lot of airplay. And it’s not pretty. Titled ‘The Endgame’, Druckenmiller isn’t at all confident about the future.
Keep in mind that Druckenmiller isn’t some kind of permabear. His investment record speaks for itself (30% average annual return from 1986–2010). But he knows market conditions are simply not set up for anywhere near these types of returns in the future.
And he points the blame squarely at central banks and the Fed in particular…
‘…smoothing growth over a cycle should not be confused with consistently attempting to borrow consumption from the future. The Fed has no end game. The Fed’s objective seems to be getting by another 6 months without a 20% decline in the S&P and avoiding a recession over the near term.
‘In doing so, they are enabling the opposite of needed reform and increasing, not lowering, the odds of the economic tail risk they are trying to avoid. At the government level, the impeding of market signals has allowed politicians to continue to ignore badly needed entitlement and tax reform.’
I mentioned this point last week when discussing Australia’s latest interest rate cut. That is, in cutting rates, all we are doing is increasing debt, which means we’re borrowing consumption from the future. The problem is that the future is now!
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Druckenmiller also had a go at the insanity of Chinese policymakers:
‘While we were worried about bank assets to GDP in 2012, incredibly, credit has increased by 70% of GDP in the 4 years since then. Just to put this in perspective, this means that since 2012 the Chinese banking sector has allowed credit to grow by the amount of the entire Brazilian GDP per year!
‘Picture the entire Brazilian production in new houses and infrastructure. Incredibly, all this credit growth has been accompanied by a fall in nominal GDP growth from 15% to 5%.
‘This is an extremely toxic cocktail for companies that have borrowed at 10% expecting 15% sales growth. Our strong suspicion therefore is that a large part of this growth is just credit flowing to otherwise insolvent borrowers.
‘How else to explain the lack of NPL [non-performing loan] problem in heavy industries hit by lower prices and sales growth?’
He says that the latest debt surge will only buy a little more time for China, but it increases the risks of much larger problems down the track.
The upshot of all this is that Druckenmiller thinks the bull market is exhausting itself:
‘If we have borrowed more from our future than any time in history and markets value the future, we should be selling at a discount, not a premium to historic valuations.
‘It is hard to avoid the comparison with 1982 when the market sold for 7x depressed earnings with dozens of rate cuts and productivity rising going forward vs. 18x inflated earnings, productivity declining and no further ammo on interest rates.’
Let’s have a look at a chart of the S&P 500 to see whether it gives us any clues about the coming of Druckenmiller’s ‘Endgame’.
The chart below shows the S&P 500 from 2011. The rally looks to have peaked in 2015. I’ve placed a number of arrows at the recent tops over the past year. What’s interesting to note is that each successive top was marginally lower than the preceding one.
Here are the details for each top:
- 22 May 2015 — 2,134.72 points
- 24 July 2015 — 2,132.82 points
- 6 November 2015 — 2,116.48 points
- 22 April 2016 — 2,011.05 points
Source: Market Analyst
It’s been nearly a year now since the all-time high on the S&P 500. Since then, you’ve seen three attempts to make new highs — all have failed.
That’s a sign of weakness. While it doesn’t necessarily mean stocks will plunge… what doesn’t go up usually goes down. Given the recent turndown after the 22 April peak, my guess is that you’ll see the S&P 500 head back down towards the lows reached at the start of the year.
If Druckenmiller is right, it will go much lower. And, as if I didn’t like the hedge fund legends’ views enough already (nothing like a bit of confirmation bias to start the week!), he finishes with this:
‘On a final note, what was the one asset you did not want to own when I started Duquesne in 1981? Hint…it has traded for 5000 years and for the first time has a positive carry in many parts of the globe as bankers are now experimenting with the absurd notion of negative interest rates.
‘Some regard it as a metal, we regard it as a currency and it remains our largest currency allocation.’
He’s talking about gold. Druckenmiller rightly sees gold as a currency, not a commodity. He knows that the constant striving for short term growth will lead to a destruction of currency values.
But destruction against what? Everything is relative. When you hear talk about the collapse of a currency, you must ask yourself, against what? It is very difficult for a major currency to ‘collapse’ against another major currency. The political implications are too huge.
But all global currencies can absolutely collapse against gold. In fact, it’s already started. Gold is now approaching US$1,300 an ounce, after finishing 2015 below US$1,100 an ounce.
A new bull market is underway.
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