Wednesday, December 13, 2017

Distortion, Misallocation, and One Way Up

"You know, there's fortunes to be made--hundreds of millions of dollars--betting against this bubble. Just wish I had a million."
--Gordon Gekko (Wall Street: Money Never Sleeps)

ZeroHedge discusses a recent CNBC interview with Stan Druckenmiller. The legendary hedge fund manager, now retired but managing a multi-billion dollar family fund, became legendary for consistently putting up 30%+ annual returns.

This year has been different. "I would have to say it's probably the worst year I've had relative to the set of opportunities out there," he confessed. Although he's done well in stocks, "I've really, really mistraded macro," which, presumably refers to positions involving currencies, bonds, and other instruments that capture large-scale (macro) economic changes. "I'm not up anywhere near 30%," he laments, "I'm not up double digits."

While he may have mistraded his macro thesis from a timing standpoint, Druck seems confident in the endgame associated with his big picture view. "If you took the Taylor Rule a normal interest rate given our economic circumstances would be 4%. Interestingly, we're at 1%. In Europe, it would be 2%; they're at -0.4%. In Sweden, it would be 3.75%; they're at -0.5%. That doesn't even count the bond buying."

When asked about the consequences of keeping rates at such suppressed levels, Druckenmiller responded, "Well, the consequences are huge because we've distorted market signals and we're causing all sorts of what I would call misallocation of resources." [emphasis mine]

This distortion and misallocation goes far beyond the crypto-bubble. "Bitcoin, art, wine, equities, credit--you name it--everything is one way up. And there are huge distortions taking place...and when you get a misallocation of resources, it really hinders growth in the long run." [emphasis mine]

Understand the logic: distort market signals (i.e., suppress interest rates) --> misallocate resources --> create one way up asset classes --> vaporize resources when those bubbles pop --> less economic resources available for investment in the long run.

Traders like to say that when you get the timing of a trade wrong, then you're wrong. That's obviously how Druckenmiller sees it w.r.t. his investment performance. In the long wrong, however, Druck's macro thesis is likely to play out with near certainty.

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