Stanley “Stan” Druckenmiller, chairman and chief executive officer of Duquesne Family Office LLC, speaks during the 21st annual Sohn Investment Conference in New York, U.S. (Photographer: Michael Nagle/Bloomberg)

Even Stan Druckenmiller Doesn’t Know Where Markets Go Next

(Bloomberg) -- The only question for Stanley Druckenmiller: How much worse does it get?

After a wild three months in the financial markets, the billionaire investor is warning that trading conditions may become even more challenging as central banks withdraw stimulus from a global economy that’s already slowing. He anticipates lousy returns on stocks for years to come and has been buying U.S. Treasuries on the expectation that yields will keep dropping.

“If you look at the indicators I have historically used in my business, they’re not red yet, but they are definitely amber and they are setting off warning signs,” Druckenmiller said in an interview with Bloomberg Television. “The highest probability is we struggle going forward.”

That’s a prediction worth heeding. Before closing Duquesne Capital Management in 2010, Druckenmiller, now 65, was considered the greatest hedge fund manager of his generation. He used a gift for seeing macroeconomic signals in stock and bond prices to predict the last four recessions and generated average annual returns of 30 percent for three decades with no down years.

Yield Curve

The warning signs Druckenmiller sees include declines of more than 20 percent since September in economically sensitive stocks and an inverted short end of the U.S. government yield curve.

Druckenmiller isn’t predicting another recession yet. But he said prospects for the economy are highly dependent on monetary policy, and this week he urged the Federal Reserve to hold off raising interest rates at its meeting on Wednesday.

Even Stan Druckenmiller Doesn’t Know Where Markets Go Next

“It’s just a time for caution,” he said in the interview. “You want this bubble to unwind slowly now, because if you don’t, and let’s say these indicators turn red, you may have to do a lot more crazy monetary stuff and actually it’ll be more of a problem.”

Druck’s Picks

Druckenmiller, who now manages his own family office in midtown Manhattan, said he typically avoids betting against the stock market in times of economic uncertainty because “you get these vicious rallies, you get squeezed out of shorts.” Instead, he often prefers owning Treasuries, since they tend to appreciate when the Fed has to slash borrowing costs to stoke growth. He said one of his best trades ever was buying two-year notes in late 2000, after the dot-com bubble burst but before the central bank cut rates 11 times over the following year.

To watch the hour-long interview with Druckenmiller, click here.

This time, Druckenmiller said he owns two-, five- and 10-year Treasuries. If the Fed tightens policy too much and is forced to reverse course, “it’s not inconceivable to me at all that the 2-years are back to 50 to 60 basis points in a couple of years,” from about 2.70 percent today, he said.

For similar reasons, Druckenmiller said he has been short “all the financials,” including banks, because they generally benefit as interest rates rise and suffer as rates fall.

At the same time, Druckenmiller is long “secular growth” stocks and he cited Microsoft Corp., Salesforce.com Inc., ServiceNow Inc. and Workday Inc. because they’re active in cloud computing. He said he expects them to outperform the market in both a growing and shrinking economy.

“Everything has to convert to the cloud,” he said. “If we get in a mild recession, demand goes up because it’s a way to cut costs.”

Trump Factor

Druckenmiller said making money is tougher than it used to be, partly because of the “powerful impact on markets” President Donald Trump has had. One example is China-U.S. trade: While Druckenmiller believes Trump and President Xi Jinping eventually will strike a deal, he said he doesn’t have the same level of confidence in his political analysis as he does his economic forecasting.

“It’s tough because economic signals and economic puzzle-solving is something I’ve done for a long time,” he said. “How all this politics is going to play out, I’m not so sure.”

Binary Outcome

The same applies to Brexit. While Druckenmiller made his name as an investor shorting the British pound and “breaking the Bank of England” with George Soros in 1992, he’s reluctant to bet on or against the currency today because a so-called hard Brexit is a binary outcome: Either it happens or it doesn’t and there’s no way to be sure which is more likely.

Druckenmiller is clearly more comfortable in “macro” territory and monetary policy remains the biggest variable in his outlook, especially now that central banks globally have curtailed bond purchases and begun quantitative tightening.

“The air can be let out of this balloon without causing another financial crisis,” he said. “I think it’s possible, but it’s hard to believe markets will not have struggling returns the next three to five years.”

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