Stanley Druckenmiller (Trades, Portfolio) is a billionaire investor and the founder of Duquesne Capital Management, which reported ~$2 billion in 13F holdings in its latest 13F filing for the first quarter of 2023, which ended on March 31.
In a May interview with the Sohn Conference, Druckenmiller discussed his forecast for a recession, inflation and some tips on how to invest during these unprecedented times. In this article, I have summarized my notes from the interview and provided some of my own notes for context; let’s dive in.
Unprecedented times
Druckenmiller said the U.S. government spent approximately “$5 trillion” on Covid-related stimulus with the Federal Reserve financing “60% of it." This was an unprecedented amount of stimulus even compared to the financial crisis of 2008, so Druckenmiller said he was “not surprised” that we had 40-year high inflation of 9.1% (as measured by the CPI) in June 2022. “When you have free money, people do stupid things," he said.
According to Druckenmiller, “the worst economic outcomes tend to follow asset bubbles." Therefore, Druckenmiller expects a “hard landing." This would likely result in a “20%+ decline in corporate profits” and unemployment rising from ~3.4% to over 5%, in addition to a number of increases in bankruptcies, which have been historically low.
In order to predict the “timing” of an economic recession, Druckenmiller likes to analyze specific industries such as trucking, which he says is “extremely weak” right now. This is usually a “six to eight month” early indicator of a recessionary environment. Retail is also weak, and then we have the regional banking crisis. Druckenmiller points out that the median regional bank has “43% of its loans in commercial real estate” with the majority being offices. However, due to the rise of remote working and high interest rates, commercial real estate could be in trouble as asset prices are expected to fall.
Another warning sign is an “inverted yield curve” which has been a major indicator of a recession in the past. The yield curve typically follows a linear path in which investors demand higher interest rates on Treasury securities the longer they hold them. However, in this case, the 10-year T-bond rate is ~3.468%, while the three-month rate is higher at above 5%. This basically indicates that investors see more risk over the next three months, as opposed to 10 years in the future.
Druckenmiller's initial assumption was that a recession would start between the fourth quarter of 2023 and the first quarter of 2024. However, due to the aforementioned information, he “wouldn’t be surprised” if it actually started in the second quarter of 2023.
Forecasting inflation
Forecasting inflation is incredibly challenging for Druckenmiller, who says he can “make a case” for inflation being at 8% in three years and also a case for deflation.
A possible indicator to analyze is the “money supply,” which Druckenmiller points out is down year over year but still up massively over the past few years as it grew by 30% to 40% just a few years ago.
For example, M1 money supply, which is the money outside the U.S treasury and Federal Reserve banks, rose from close to $4 trillion in 2019 to a peak of $20.6 trillion by January 2022. It is now only corrected down to ~$19 trillion.
Therefore there is still “a lot of liquidity” out there. Bringing everything together, Druckenmiller expects inflation to fall from 4.9% in April 2023, to between 3% and 3.5% in the next six to nine months.
Will this recession be worse than 2008?
Druckenmiller says he “doesn’t know what the Fed will do” as there is a chance after the asset bubble bursts “Humpty Dumpty” won’ be able to be put “back together again." This may lead the Fed to inject more stimulus, which could result in a stagflation scenario, categorized by slowing growth and high inflation.
The good news is Druckenmiller doesn’t forecast this will be worse than 2008, but he says it is naive to not be open-minded about something “really bad happening."
Where to invest in this environment
According to Druckenmiller, commodities could be an investment option in the current economic environment, and “Copper is in the tightest position” he has ever seen. This is not a position he would take going into a “hard landing,” but coming out of it, with the tailwinds from the electric vehicle industry and expected infrastructure spending, Copper could be a “huge beneficiary."
Housing could also be interesting as, despite the rise in interest rates, there is a “structural shortage” in single-family homes. Therefore, surprisingly, this asset class could be a “big beneficiary” on the way out of a recession.
Growth stocks could also be interesting. Biotech has “underperformed” over the past couple of years. Druckenmiller is particularly interested in areas such as cancer research and the use of viruses to kill bacteria, which could be useful given many bacterial infections are becoming resistant to antibiotics.
In addition, we have Artificial Intelligence (AI), which Druckenmiller believes is “very, very real” and could be as “impactful as the internet." It could be a “beautiful opportunity” but also a “hard landing” similar to the dot-com bubble.
Druckenmiller admits to getting exposure to AI via Nvidia (NVDA, Financial) and Microsoft (MSFT, Financial). He states its not clear to him that if we had a recession “Nvidia would go down."
This is surprising to me as Nvdia’s share price had doubled from December 2023 to May 2023, yet its revenue is still struggling from the cyclical decline in the gaming industry. The signs point to the price increase being mostly due to AI hype.
Druckenmiller also says he owns “gold and silver” given the monetary and fiscal situation.
In general, Druckenmiller likes “concentrated bets, fat pitches and to swing big." But when you “don’t see a fat pitch, let them pitches go by." He believes it's best to “preserve your capital” until the opportunities “present themselves."
The debt ceiling
There is a lot of fear regarding the potential breaking of the “debt ceiling” or the “debt limit” in the U.S. This is the total amount of money the U.S. government is authorized to borrow to meet its existing legal obligations.
Druckenmiller believes the fear around the debt ceiling is overblown. An analogy he uses is the breaking of the debt ceiling would be like a small wave hitting a pier, but the bigger issue is the "200-foot tsunami” related to the broader economic factors such as the pension crisis.
The “fiscal gap” is amount the government would need to raise taxes today in order to maintain its spending plans. In the United States, that is 7.7% of GDP. This means the government would need to raise “taxes by 40%” or cut “spending by 35%," according to Druckenmiller.
In comparison, France has a fiscal gap of 2.4% and its government is “addressing the problem," according to Druckenmiller.
