Warnings From a Survivor of the Consensus-Bet Bloodbath

The market isn't out to get anyone in particular...

And yet, it can sometimes feel that way.

It's an old Wall Street adage that the market will inflict the most pain it can on the most people it can. That's because investors tend to follow the pack... So when the consensus goes wrong, the carnage spreads fast.

Even professional hedge funds fall victim to herd mentality. For the past several months, hedge funds have amassed their largest short on U.S. Treasurys in history.

Big names like PIMCO's Bill Gross and Pershing Square's Bill Ackman started shorting U.S. Treasurys earlier this year. They expected yields to rise... and therefore, prices to fall.

It wasn't long before shorting Treasurys became one of the most popular trades on Wall Street. And for a while, it was a self-fulfilling prophecy. The more hedge funds piled in, the lower prices seemed to go. The 10-year Treasury yield rose to a peak right around 5% in mid-October.

The fun couldn't last forever, though...

The market has since started punishing hedge funds. Treasury prices and yields reversed course. Many hedge funds, Ackman's included, are rushing to close their short positions in the near term.

That said, not everybody let themselves get burned. Today, we'll discuss one fund manager with a history of going against the grain... and what his current outlook means for your portfolio.

While Stanley Druckenmiller was part of the consensus trade, he saw the signs to get out fast...

Druckenmiller founded Duquesne Capital in the 1980s. And since then, his moves have been among the first warning signs for coming recessions.

During the dot-com bubble of the late 1990s, Druckenmiller saw that the huge interest in tech stocks wasn't going to last. He ordered his fund to short tech.

And while the bet was a bit early... it was the exact right thing to do, considering how far the tech industry fell.

Leading up to the 2008 financial crisis, Druckenmiller saw how dangerous the housing market had become. Once again, he started shorting stocks. His fund returned 11% while the average hedge fund lost 19%.

And last month, Druckenmiller bought two-year Treasurys.

Almost every hedge fund seems to agree that interest rates will stay high in the long term. With so much of the market in consensus, Druckenmiller knew Treasurys couldn't keep falling forever.

So he flipped his trade.

It's a good thing he did...

Treasurys have rallied hard since then. The 10-year yield is back below 4.4%.

Druckenmiller thinks that before yields start rising again, they could continue to be pressured by the weakening economy.

He won this bet at the expense of other managers like Ackman and Gross. Both of them have closed their short positions for now.

According to Druckenmiller, company profits could fall by 20% to 30%... and commercial property values will plunge. Plus, consumers are running out of cash. He believes this could be the first shoe to drop.

In short, Druckenmiller is gearing up for a recession. He has a long track record of calling downturns right before they hit.

That's yet another reason for investors to be cautious... especially when it comes to owning stocks.

Regards,

Joel Litman
November 29, 2023

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