The Fed is Having a Party and Everyone Has Left

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Last week, the NYTimes held a conference where investors and CEO were interviewed on the theme of “Playing for the Long Term”. Because, after the conference, you really understand that the short-term does not look good.

On the panel of the Dealbook Conference held in NYC, with personalities like Al Gore, Carl Icahn and Reed Hastings, what caught my attention was the interview with Stan Druckenmiller. CEO of Duquesne Capital Management and worth 4.4B$ according to Forbes, what made Stan famous is the historical currency short that he and George Soros pulled on the British Pound in 1992. They made a cool 1 billion $ of profit with the trade which is sometimes referred to as the ‘trade that broke the bank of England’.

Needless to say, this guy knows his job.

What he thinks of the current economic environment is interesting and pessimistic. The situation of the US economy and how the FED has maintained rates close or at 0% for 7 years now is an extreme environment. With the FED now talking about raising rates he believes this whole thing “is going to end badly”.

I’d recommend watching the interview with Druckenmiller below, it’s 25min well spent:

At one point in the interview, Druckenmiller explains his current feeling on the US stock market:

“In terms of equities, I’m working under the primary assumption that we may have started a primary bear market in July[…] I can see myself getting very bearish, but I can’t really see myself getting really bullish.”

If you remember, I also wrote an article in July titled The key reason why the stock market is ready for a crash and reached similar conclusions. Corporate America hasn’t been able to increase profits for the last 4 years and most of the financial growth has come from buybacks, M&As and other financial engineering, but not from actual growth, efficiencies or innovation.

we may have started a primary bear market in July

This artificial growth and the fact that the stock market has been flat for an entire year now does feel like something that isn’t sustainable. Something needs to give for the equilibrium to be re-established.

Commodity prices have gone down because demand has been decreasing. China is slowing, Russia isn’t doing great and Europe is stuck in low-flation

Naturally, at the end of the interview, a puzzled member of the audience asked him what the heck normal investors should do? Stan’s recommendation: hold on to cash.

“It’s very hard to short stocks, it’s sounds great in theory, but it’s very difficult […] Probably the asset I’d get into if this was unfolding would be cash, if I was a normal investor (ie: not making billion $$ profits).”

To me this feels like 2000, except this time the FED is hosting the party.

After the financial crisis of 2008, everything was falling apart and the FED came to the rescue. They hosted the most impressive party the stock market had seen in a long time. Companies were bailed out, rates were set to record lows, it was the Fed’s open bar.

the asset I’d get into if this was unfolding would be cash

For 7 years now, the market has had a great time and the S&P500 went up 200%.

Lots of free food, lots of alcohol, great ambience, there were no risks and lots of opportunities.

You get it, it’s been a great party.

But all the good things have to come to an end. Most of the guests have left already but some of the folks who enjoyed the open bar more than they should are still partying as if it could go on forever. They like it, it’s too good. “Just one more hour” they say.

They probably won’t leave on their own, they’ll have to be kicked out. And they’ll walk home only to wake up the next day with a massive hang-over.

Could it be a different kind of party this time?

Sure, of course it could. But let’s not kid ourselves.

Thanks Ben & Janet, it’s been a great party. I’ll be leaving now before something stupid happens. Equities have been good, but I’ll switch to cash now.

I’ll be ready when the next party comes around though. Just let me know.

-Nick.

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2 COMMENTS

  1. So I gather you are selling all your investments in favor of cash right now because you fear a market downturn, is that correct? If so, how are you going to handle any capital gains? How will you know when the market has hit bottom and it’s time to get back in? What if you’re wrong and the market keeps going up for another few years before the next crash? Do you really think you’re smarter than the market and the millions of other investors out there?

    • Hi Ryan – I am not selling all my investments in favor of cash, but I have done 2 things.
      First I have stopped contributing to my investments in stocks in favor of cash and second I have reduced my exposure to stocks to ~60% equities. Most of that is within my 401k so there would be no tax on gains.

      It may seem like a sudden decision, but this is something that I have been working on for the last 6 months. Instead of looking at this as market timing (which I wouldn’t know how to do), I try to look at this from a value perspective. I think it is difficult today to make a case that stocks are undervalued, or even fairly priced, and I think it would be reasonable to consider that stocks could substantially underperform over the next 10 years. As it is, I think there is a large downside potential with minimum upside, so I’m sort of hedging my portfolio.

      I’m a huge fan of (low-cost) index investing but I’m not a fan of keeping my automatic contributions on if I feel like it isn’t a good investment.
      But as you say, I do not have a crystal ball and I could very well be wrong, so maybe I’ll write a post with my analysis to help the discussion.

      Thanks for the feedback!

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