Stanley Druckenmiller’s No. 1 piece of advice for novice investors
Stocks rallied last week. The S&P 500 surged 4.7% in what was the biggest weekly gain since June. The index is now up 4.9% from its October 12 closing low of 3,577.03. However, it’s still down 21.8% from its January 3 closing high of 4,796.56.
When markets are as volatile as they have been, it’s easy to get caught up in all the things that are going right or wrong at the moment.https://d-39189650221789106324.ampproject.net/2210272257000/frame.html
And while there’s nothing wrong with keeping current on the present, this is not the right mindset for long-term investors in stocks.
“Do not invest in the present,” Stanley Druckenmiller, the legendary hedge fund manager currently running Duquesne Family Office, said. “The present is not what moves stock prices.”
Druckenmiller noted that this is his No. 1 piece of advice for new investors.https://d-39189650221789106324.ampproject.net/2210272257000/frame.html
In a Sept. 22 episode of the “How Leaders Lead” podcast, Druckenmiller expanded on this (via The Transcript):
“I learned this way back in the 70s from my mentor [Speros] Drelles. I was a chemical analyst. When should you buy chemical companies? Traditional Wall Street is when earnings are great. Well, you don’t want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there’s overcapacity and they’re losing money. What about when they’re losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it’s going to be in 18 to 24 months as opposed to now. If you buy it now, you’re buying into every single fad every single moment. Whereas if you envision the future, you’re trying to imagine how that might be reflected differently in security prices.”
This is theoretically sound as theory says the value of a stock should reflect the present value of a company’s future cash flows.
Druckenmiller is talking about picking stocks. But I think his still serves as a good framework for broadly diversified investors processing macro information coming from economic data and earnings announcements.
The labor market is strong 💪
One big theme of late has been the strength of the labor market. Specifically, the elevated level of job openings signals the need to hire, and the depressed level of layoff activity signals the desire to hang on to employees.
Consider these quotes from recent earnings calls (via The Transcript and RBC Capital Markets):
- “I would note at this point, based on our Q3 performance, we have seen net hiring among our customers. So, we have not yet seen an emergence of recessionary impact in our commercial book of business.” – UnitedHealth Group
- “We’re seeing positive staffing trends with 11 straight weeks of net pharmacist head count increases.” – Walgreens Boots Alliance
- “We are not making major cutbacks across the plant…We don’t see any reason for great draconian measures.“ – Morgan Stanley
Bloomberg reported that Goldman Sachs, Morgan Stanley, Citigroup, JPMorgan Chase, and Bank of America all increased their headcounts in Q3.
Similarly, the past week’s high-level economic reports broadly confirmed these anecdotes. Initial claims for unemployment insurance benefits fell last week and continue to trend at low levels. The Federal Reserve’s October Beige Book said that employment “continued to rise at a modest to moderate pace in most Districts.“ Manufacturing business surveys from the NY Fed and Philly Fed each indicated employment was up in their respective regions in October.
What all this staffing means for the future 🤔
The resilient labor market suggests that demand in the economy continues to be robust.
But that’s the present.
What about the future? What does this mean 18 to 24 months down the road?¹
I think there are at least two basic scenarios to consider.
- Bearish scenario: The economic lull we’re in eventually evolves into recession and we have an extended period of weak demand. Companies that are currently increasing hiring or refusing to layoff workers could see a sharp drop in earnings as weak revenue runs into high labor costs, and profit margins get crushed.
- Bullish scenario: The economic lull we’re in proves short-lived, and growth soon accelerates again. Companies that held on to employees or grew head counts today may not need to compete aggressively for workers in what should be an increasingly competitive labor market. Because they already have extra capacity, these companies will benefit from operating leverage as revenue growth comes with expanding profit margins, which amplifies earnings growth.
What actually happens depends on where the economy heads, which itself is not an easy thing to predict.
But I can’t help but think that given the current state of things, the outlook favors the more bullish scenario. Why? Because the message from the economic data and corporate America is that demand continues to outpace the capacity to supply. Consider this quote from the Fed’s October Beige Book: “Overall labor market conditions remained tight, though half of Districts noted some easing of hiring and/or retention difficulties. Competition for workers has led to some labor poaching by competitors or competing industries able to offer higher pay.“
And consider this from Domino’s: “Staffing remains a constraint, but my confidence in our ability to solve many of our delivery labor challenges ourselves has grown over the past few quarters.”
So demand would have to fall considerably before companies find themselves with too much costly idle labor.
Let’s check back in 18 to 24 months.
The bottom line: Stocks are a discounting mechanism, pricing in what’s expected to happen and not what’s currently happening. Whether it’s 18-24 months out or 20 years out, being in the stock market is about betting on a better future that has yet to be realized and priced in. Now, it’s not particularly clear what’s to come in 18-24 months. (The lesson of the past 18-24 months is that things can certainly go wrong.) But long-term history is very consistent in teaching us that the long-term future always turns out to be betterthan what we are experiencing today.