Client Portals

Druckenmiller, Markets, SWIFT4 min read

Jun 15, 2022 - Max Osbon ( 6 mins to read)

Stanley Druckenmiller, The Fed & Markets

The Federal Reserve raised its interest rate by .75% yesterday, doubling the current rate from .75% to 1.50%. For context, the previous high was 2.25% in July 2019. We cut the rate to 1.5% by November 2019 and then sent it straight to 0% once Covid started. ‘Don’t fight the Fed’ is considered an undefeated market mantra, and the Fed is still in its tightening cycle while it attempts to bring down demand enough to slow inflation.

Stanley Druckenmiller spoke at the SOHN conference last week, interviewed by John Collison, the 31 yr old billionaire co-founder of Stripe, the payments company. I always make a point to listen to his talks, and you can listen to it here. The takeaways I got from it are as follows:

  • In his 45 years as a CIO, he’s never seen a market without a historical precedent (8% inflation, 3% bond yields, and slowing growth).
  • Valuations reset with many good companies down 60-70% without a change to the fundamentals.
  • He’s sitting on the sidelines at the moment, waiting for a signal, bearish or bullish.
  • He would be “shocked” if blockchain isn’t a force 5-10 years from now.

Fortunately, we’re already very deep into this selloff. While there are obvious challenges in the next few months, many investment opportunities in public markets will likely produce excellent returns over the next few years. We don’t know if the fight between inflation and the Fed will lead to bankruptcies and a deep earnings recession that would drag markets further. We’ve started to see an acceleration in layoffs recently. We are still waiting to invest new capital, which will likely come once the Fed reverses course once the official inflation rate drops.

Dall E Mini – AI-generated images

I’ve been eager to test drive Dall-E 2 by OpenAI. Fortunately, HuggingFace, a leading AI research organization, released their “mini” version of Dall-E. It doesn’t appear as powerful as what Dall-E 2 promises, but it’s been fun to test drive. AI-powered tools will be a revolutionary enhancement for creators once they are accessible. This tool is an important step forward in converting AI’s vast potential into something tangible.

The image in the article today was generated by Dall-E Mini via the prompt, “Pencil Drawing Federal Reserve.” My computer and internet connection took roughly two minutes to create the image, along with frequent errors saying, “Too much traffic, please try again.” You can try Dall-E Mini here. Or you can join the waitlist for Dall-E 2.

One consideration here is the question of who owns the image. Dall-E 2 and OpenAI say they own the rights to the AI-generated images, which is fair if you consider they did all the heavy lifting. How might we pay for and track ownership of AI-produced work?

SWIFT (the banking code)

Mastercard CEO Michael Miebach joked that the SWIFT system might not exist in 5 years. SWIFT is the primary global financial messaging system to send and receive money and securities and is a cooperative monopoly owned by 3500 banking institutions globally. The stablecoin USDC, which is backed 1:1 by USD, can be sent instantly over the Ethereum network to any wallet in the world without using SWIFT.

When DeFi – decentralized finance – was launched a few years ago, there weren’t any non-crypto assets that could operate on those rails. What we got from the first phase of DeFi was a bunch of native crypto tokens being traded and levered against themselves. The important thing is that the rails worked as expected. As real assets slowly get tokenized (like USDC tokenized USD), they can start to operate on DeFi. Although it’s a long shot, the USDC stablecoin is a legitimate threat to the SWIFT system.

Liabilities Driven Investing

We mentioned last week that we would talk about Liabilities Driven Investing, the framework we use to manage risk and build portfolios. All portfolios have beneficiaries: families, pre-retirees, the next generation, a union, or a charitable organization. The portfolio’s assets, liquid and illiquid, are ultimately there to pay for and support current and future expenses for the beneficiary. When you know the details of the beneficiary’s expenses, you can combine them into a present value. That present value of expenses gives you an idea of what needs to be protected today and what will be spent in 5+ or 10+ years.

When counting current assets, you can also present value income streams like annual salaries, bonuses, consulting fees, pensions, and social security. Most retirees effectively have a $1m bond portfolio based on the size and duration of their social security payments. Income can always be discounted at various rates to reflect more conservative outcomes. Ultimately, you use this method to compare your current and future assets and your current and future liabilities. These numbers allow you to insulate yourself from volatile markets with various layers of protective reserves. Risk is not measured in volatility but tail risk or extreme events. When you build your risk models based on volatility statistics, you will eventually be in trouble. See Long Term Capital Management. Let us know if you’re curious about how to apply this framework.

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