If you’re investing in individual stocks, it can be helpful to hear from highly successful people who’ve already done so, including Stanley Druckenmiller.
Druckenmiller is one of the most successful hedge fund managers of our generation. His hedge fund, Duquesne Capital Management, managed $12 billion when Druckenmiller shut it down to manage his personal wealth. However, Druckenmiller is probably best known for “breaking the Bank of England” with famed investor George Soros in 1992. Convinced that the Bank of England did not have enough firepower to support its currency, the two investors reportedly succeeded in shrinking the British pound. Earnings of more than $1 billion.
Druckenmiller no longer manages money for others but regularly shares his views on the market. In a wide-ranging interview on Wednesday, he covered a lot of ground, including opinions about the stock market that are likely to raise eyebrows.
Druckenmiller has had terrible market experience
In the past year, the S&P 500 has taken a beating as the US economy posted negative economic growth in the first half of the year, the war in Ukraine increased global geopolitical risks, and the Federal Reserve adopted a hawkish stance on interest rates to fight downward inflation. .
The federal funds rate has increased by 5% since March 2022. As a result, the Fed’s preferred measure of inflation, the core PCE price index, has fallen to 4.7% from roughly 5.2% last September. That’s fine, but unfortunately inflation remains way too high, given the Fed’s 2% inflation target.
Flat inflation puts the Fed in a difficult position. If it continues to raise rates to lower inflation, it risks tipping the US economy into recession. Manufacturing activity has already contracted in seven consecutive months, and the latest ISM Services data shows that the PMI is similarly skewed with levels indicating contraction.
It didn’t help the economy that banks became increasingly nervous about lending in the wake of three of the biggest bank failures in US history. The Federal Reserve’s interest rate policy has reduced the value of long-term bonds held on the balance sheets of Signature Bank, Silicon Valley and First Republic Bank, contributing to a liquidity crunch caused by higher withdrawals.
Eager to avoid a similar fate, US banks have massively turned off the spigot on lending, tightening lending standards, increasing collateral, and shrinking loan sizes. The combination of high interest rates and banks’ reluctance to lend has already had many, Druckenmiller included, debating whether a recession is inevitable.
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At the Bloomberg Invest conference, Druckenmiller offered a downbeat warning about the economy to investors:
“I would actually argue that since it took so long, the Fed has already ended up raising the final rate, and in fact inflation becomes more consistent the longer it stays in the system; it increases, not decreases, the probability of a downturn.” difficult “.
The higher probability of a sharp decline would not be good news for investors as it would be bad news for corporate earnings. The good news? The recession was so well predicted that earnings may not be down 40% as well as the Druckenmiller you might normally expect. The bad news? Earnings can still drop dramatically.
“I could see corporate earnings going down 20 to 30%… I don’t think a lot of companies are going to get caught on their clothes… I’m worried about tightening credit over the next six to nine months. Obviously, banks are on their way to an economic period, if A recession has already happened, their balances have really deteriorated … If we go into a recession, the real losses come, and they’re things like credit cards, commercial real estate, that sort of thing that I’m concerned about,” Druckenmiller said.
A corporate earnings decline of this magnitude would present a significant challenge for investors, since the valuation is arguably a pricing for earnings improvement rather than deterioration.
The forward price-to-earnings ratio for the S&P 500 is 18. Historically, the S&P 500’s return has been flat one year after such a price-to-earnings rally.
If investors are hoping for additional gains, it will likely require better-than-hoped earnings, leading to bullish revisions in the coming quarters. As it stands, the S&P 500 companies are expected to see earnings per share drop by 6.7% in the second quarter, before rebounding to growth in the third and fourth quarters, According to FactSet.
Given this background, ignoring Druckenmiller’s warning may not be wise.
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