Warnings From a Survivor of the Consensus-Bet Bloodbath

Editor's note: Stocks have marched higher since their October lows. But these volatile times will lead to winners and losers... And according to Joel Litman – founder of our corporate affiliate Altimetry – investors need to be extra careful to avoid the pitfalls today.

In this piece, adapted from a recent issue of the free Altimetry Daily Authority e-letter, Joel discusses one famed investor's change in outlook... and why it could be a warning sign for many companies in the months ahead.

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

But it can sometimes feel that way.

It's an old Wall Street adage that the market will inflict the most pain it can... on as many people as 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. It was a self-fulfilling prophecy. The more hedge funds that piled in, the lower prices seemed to go. The 10-year Treasury yield rose to a peak right around 5% in mid-October.

But like anything in the market, the fun couldn't last forever...

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. As I'll explain today, one fund manager has a history of going against the grain. And his current outlook could serve as a warning sign for investors and their portfolios.

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. So 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. So he started shorting stocks again. His fund returned 11% while the average hedge fund lost 19%.

And in October, 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 Treasury bonds couldn't keep falling forever.

So he flipped his trade. And it's a good thing he did...

Treasury bond prices have rallied hard since then. The 10-year yield is back below 4.3% as a result.

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

We should pay attention to this move. Druckenmiller thinks that before yields start rising again, they could continue to be pressured by the weakening economy...

According to him, company profits could fall by 20% to 30% and commercial property values will plunge. Plus, he has noted that pandemic stimulus is "running down."

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

That's a reason for investors to be cautious right now... especially when it comes to owning stocks.


Joel Litman

Editor's note: Wall Street has been quietly selling billions of dollars' worth of stocks... So if you've been feeling like the other shoe is about to drop, it's time to pay attention.

Tonight, at 8 p.m. Eastern time, Joel and his team are joining forces with Chaikin Analytics founder Marc Chaikin to share an urgent announcement about a specific type of crisis they see unfolding...

If they're right, even following the mainstream crisis playbook – staying on the sidelines in cash – could put your money at risk. So make sure you hear what Joel and Marc have to say. Their discussion is free to watch online, but you must sign up in advance... Save your spot for tonight right here.

Further Reading

Several signals can help you watch for signs of a recession. Right now, one of those economic indicators is getting close to flashing a warning sign. So make sure to keep the big picture in mind when choosing your investments... Read more here.

It pays to know when to be offensive and defensive in the market. And during volatile times like today, it doesn't hurt to play some defense. Here's a classic example of why it's a good idea to practice patience – and make a game plan... Learn more here.