"When You're In A Ditch, Stop Digging"
Wise words reiterated by a legendary money manger. Between Druckenmiller and Gundlach, it's starting to feel like we might have problems on the horizon.
A little over a week ago, two living legends of the financial markets got together for a fireside chat. Duquesne Capital Founder and President Stanley Druckenmiller answered questions from Tudor Investment Corporation Founder and CEO Paul Tudor Jones. For me, the entire video is decent but the quote that made the most headlines when the video spread earlier this week was Druck’s absolutely scathing critique of US Treasury Secretary Janet Yellen:
When rates were practically zero, every Tom, Dick, and Harry in the United States refinanced their mortgage. Corporations extended. Unfortunately, we had one entity that did not and that was the US Treasury. Janet Yellen, I guess political myopia or whatever, was issuing 2 years at 15 basis points when she could have issued 10 years at 70 basis points or 30 years at 180 basis points.
I literally think if you go back to Alexander Hamilton, it was the biggest blunder in the history of the Treasury. And I have no idea why she has not been called out on this. She has no right to still be in that job.
Amazing. Druckenmiller elaborated on the blunder by explaining that the result of the mistake will lead to interest expenses on the federal debt hitting 144% of current discretionary spending in the coming years. I understand why Druck is so agitated. But I do think it’s important to keep some things in mind; when you’re selling your own IOUs, you can only move what there is market demand for. Was there actually much of a market for 10-years at 70 bps?
I’m not so sure. To be clear, this is not to let the little mushroom-headed money troll or any of these people off the hook by any means. A few days later, DoubleLine Capital Founder/CEO Jeffrey Gundlach went on Bubblevision for nearly a half hour to react to “FedDay.” Again, the entire video is worth a watch in my view:
Gundlach essentially echoed many of Druck’s points about the enormous problem that comes from rolling over debt with interest rates that it seems will now be higher for longer - if the Fed is to be believed. After Gundlach laid out the issues and explained why layoffs are imminent, Ritholtz Wealth Management CEO Josh Brown - who I suspect was fishing for reasons to keep his clients in stonks - asked this piece of pure perma-bull perfection:
What if… higher for longer ends up serving, actually, as stimulus for the 20% of wealthy households that are now earning tons of money on their cash, don’t really care what a mortgage rate is because they own their home. Is that a situation where the wealthy continue to spend? Thereby negating what would normally happen with higher for longer? And one other thing to throw into the mix, if the unemployment rate starts to climb, as you suggest, couldn’t that also perversely be stimulative? Think about how great that would be for all of the employers who have been dying based on all of the salary increases and minimum wage hikes; couldn’t we have the situation where actually higher for longer is better? Higher unemployment is healthier? And actually that ends up prolonging the economic cycle and not ending it?
Side bar from ya boi: while listening to this, I thought to myself, “these are the guys I’m betting against. This man is literally trying to talk himself into how layoffs and dried up borrowing means higher stocks. I’m not short enough.” Here was Gundlach’s response:
I don’t know, Josh. I mean, there’s some logic to that. I think that the wealthy people, they have savings. They have wealth by definition. And so them getting a higher interest rate of 6% instead of 2%, I’m not really sure that motivates spending exactly. I think it just makes them wealthier. So I don’t really know about that.
Jeff then went into greater detail refuting Josh’s hopium and got into service sector trends. I really recommend watching his entire answer but he ended it with this:
I’m going to go back to my number one point that I started this segment on, and that is higher for longer means we have a massive interest expense problem. A massive interest expense problem in this country that is going to be, I believe, the next financial crisis. So that’s what I’m more focused on. Not Scrooge McDuck having more money in his vault.
I mean wow. So simple and clear. For those of you who have been here the last two years, it may not come as a shock that what Gundlach and Druckenmiller are currently describing is exactly why I thought the Fed was never serious about hiking in the first place:
We know what will happen if the Fed doesn’t pivot; debts by the public and private sector can’t be refinanced in a way that make them more serviceable. When that happens, everything collapses; stocks, bonds, and more importantly, the entire real economic system. Unless all of those results are intended (entirely possible), the more likely outcome seems to be an imminent Fed pivot.
I wrote that in late August 2022. Rates were 2.4%.
I’m as shocked as anyone that the Fed kept going. I’m a bit more shocked that Josh Brown is trying to talk himself into staying long the index with the 2-year at 5% and the Buffett Indicator still ahead of both GFC and dot com peaks:
I guess when you’re a hammer everything looks like a nail? Who knows. Wouldn’t you know it it though, the entire market appears to be filled with hammers as the S&P ripped nearly 2% the day after “FedDay.”
It’s as if Jerome announced a cut and a return to asset purchases yesterday. And yet… rates are still at 5%. Stocks are still wildly overvalued by just about any measure. And the “counterparty risk” hedging assets (Gold, Bitcoin) have been ripping for a month. A sign the Fed is indeed done? Perhaps. Or maybe an indication that the entire system is dealing with considerable stress under the hood. We’ll find out soon enough. Until then, here were my HSEP moves heading into the weekend…
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