The Legends Vote With Their Feet


Stanley Druckenmiller founded his hedge fund Duquesne Capital in 1981. From 1986 onward he maintained average annual returns of 30%. He also managed George Soros’ Quantum Fund from 1988-2000. During that latter period he famously facilitated Soros’ “breaking of the Bank of England” trade: the legendary trade which netted over $1 billion in a single day.


Druckenmiller closed Duquesne Capital in 2010, stating that he was no longer able to meet his investment “standard[s]” in the post-2008 climate (he made money in 2008 before the Fed began to alter the risk landscape).


Druckenmiller’s key strength has always been macro-economic forecasting. That he would feel the capital markets were not offering him the opportunities he needed says a lot.


Seth Klarman is another investment legend who is returning capital to clients. Widely considered to be the Warren Buffett of his generation, Klarman recently cited a lack of “investment opportunities” as the cause for his decision to downsize his legendary Baupost Group hedge funds.


Other legends or market outperformers who have returned capital to investors or closed their funds to outside investors are Carl Icahn and Michael Karsch. Indeed, even value legend Warren Buffett is sitting on the single largest amount of cash in the history of his 50+ year career as an investor, stating that stocks are “fully valued” at current levels (Buffett largely does not believe in shorting the market, so his decision to be in cash is a strong indicator of opportunities).


These men are masters of the capital markets. They are voting with their feet and pulling their capital out of them. Given that their personal compensation is closely linked to assets under management and profit sharing, this decision is akin to the choice to forego additional wealth that could be made quite easily (none of these individuals would have trouble raising several billion more in capital) rather than trying to find opportunities in a challenging market.


This is not a permanent situation. At some point once the great adjustment occurs there will be very compelling opportunities in the markets. However, today I see a dearth of them.


·      US-based blue chips and other premium companies are trading at decent valuations, but the macro picture is unattractive (in 2012, 10 companies accounted for 88% of profit growth in the S&P 500).


·      Bonds appear to be at the beginning of an environment of rising rates. An entire generation of bond managers have not experienced a bear market in bonds before.


·      Emerging markets are increasingly risky from a geopolitical perspective (nationalization of resources, etc.). Moreover, the inflationary pressures created by loose monetary policy at Central Banks make for civil unrest and wage hikes. These in turn shrink the US/ emerging market wage differential (note that Apple, Bridgestone and many others are moving manufacturing facilities from China to the US for this reason).


·      Commodities are highly influenced by China and Brazil. I am concerned that there are in fact very serious problems emerging in the shadow banking system in the former would could result in a banking crisis there (I’ll be devoting the majority of next month’s issue to this topic). The latter country is experiencing another bout of inflation that has already brought two million people out on the streets in protest.


This is not so say that money will not be made in any of these asset classes. I am merely outlining the risks I see in these asset classes.


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