Stan Druckenmiller is one of my favourite managers. I always listen to what he has to say and I usually agree with most of his views (I disagreed with his bullish China call a few months back, obviously). This week he gave an interview at the NYT Deal Book Conference and I recommend it to everyone. Here is the link,
The interview is worth listening to in full, but I just want to share my spontaneous thoughts on two of the topics he touches in the interview: Larry Summers and Amazon.
Larry Summers and what’s wrong with modern macroeconomics
Druckenmiller is of the opinion that the Fed has been overdoing it with ultra-low rates and QE and thereby encouraged investors, governments and corporates to engage in risky and irrational activities such as stock buybacks near record highs instead of business investment. Andrew Ross Sorkin, the host, notices that in a recent WSJ article, Nobel laureate Michael Spence has echoed a similar view.
The Spence article is interesting because it has triggered an angered response by Larry Summers, the outspoken former Treasury Secretary to whom it is completely inconceivable that lower interest rates can be responsible for reduced business investment on the margin. Therefore he calls Spence’s claims nonsense. When asked about his opinion on the dispute, Druckenmiller states that the real world differs from Summers`s classroom models and that in the real world “short terminism” coupled with low interest rates leads to gambling, rather than investment.
How to make sense of that?
Without knowing for sure, it is likely that Lawrence Summers bases his view on some macro model (given that he is a macroeconomist) that looks at the world in terms of aggregates. In these models there is usually only one “price-level” – the aggregate price level – that matters and the dynamic effect of changes in variables is analyzed evoking the famous “ceteris paribus” assumption. In these models a lower interest rate always leads to higher investment “ceteris paribus” – all else equal. Macroeconomists are so convinced of their models that when they see falling business investment and falling interest rates at the same time, it must be because the interest rate is not low enough. Hence the “liquidity trap” chatter and the call for negative interest rates.
Needless to say: this is utter rubbish!
The interest rate is not equally important for all industries. It depends on whether the industry is early stage or late stage (see the famous Hayekian triangle). An economy that is dominated by early stage industries such as Australia and Canada will show more interest sensitivity in aggregate investment spending than those that are dominated by late stage industries. For a complex economy such as the US it is difficult to say what dominates, but the evidence could mean that later stage industries (services!) dominate. Those industries that are early stage, such as shale gas and real estate, have experienced a boom in the US, it just was not big enough to raise aggregate investment which is what Keynesians and Monetarists are obsessed with.
Given that Stocks are long-term assets, stock buybacks decisions too are very sensitive to interest rates. By lowering interest rates the relative attractiveness of stock buyback vs. capex in early stage industry increases. It can be argued that buybacks “crowd out” business spending.
What’s more, in the real world, it is never “ceteris paribus”. When the fed lowers the interest rate or engages in large scale bond buying, it is changing the expectations and relative prices of individuals SIMULTANEOUSLY and not sequentially – which is precisely why economics does not lend itself well to mathematical modelling. In other words it might well be that the benefit from lower rates is offset by some other factor that matters for the investment decision. The aggregate price level does not matter to corporates – just ask the oil industry.
Conclusion: Lawrence Summers is a man with a hammer and Michael Spence is right.
Druckenmiller likes Amazon and thinks that Jeff Bezos is a great entrepreneur who is not focused on the short-term. He notes that Amazon has much more misses in quarterly earnings than for instance IBM (a heavy buyer of its own stock) which he sees as evidence that Bezos does not care at all about meeting short-term targets. I like his way of reasoning and will try to incorporate that metric into my stock screener.
When confronted with the fact that Amazon is barely profitable, Druckenmiller retorts that Amazon has pricing power and could show positive margins whenever it so desires. This is similar to an argument I made recently (here), but I still would like to see some numbers behind Amazon’s pricing potential. Would be interesting to know his detailled thoughts on that.
However whereas I agree that Amazon has pricing power, I do not think that is true for a lot of the “unicorns” who are often priced off traded tech companies like Amazon and Facebook. So what is a justifiable triple digit PE for Amazon might be sheer fantasy in most cases….