A gathering of major hedge fund managers Wednesday received an unlikely message: Corporate America has been cannibalizing itself for the sake of “reckless” short-term financial gains.
This wasn't some liberal like Sen. Elizabeth Warren talking, but investment legend Stanley Druckenmiller, speaking before the Sohn Investment Conference in New York.
Druckenmiller, who was George Soros’ second-hand man during their hedge fund’s historic winning spree, castigated corporations for focusing more on financial engineering than organic growth. In particular, Druckenmiller argued that stock buybacks and other rewards for financiers and shareholders have far outpaced research, development and capital expenditures such as plant improvements.
“The corporate sector today is stuck in a vicious cycle of earnings management, questionable allocation of capital, low productivity, declining margins and growing indebtedness,” Druckenmiller said. “You can only live on your seed corn so long.”
In previous business cycles, corporations have spent roughly evenly on what Druckenmiller called capital spending — research and development plus investments in office and plant equipment — and on financial maneuvers, including stock buybacks and mergers and acquisitions (M&A).
But since the financial crisis, Druckenmiller said, capital spending has increased $250 billion while buybacks and M&A have grown three times faster, by $750 billion.
It would be one thing if this reflected soaring profits. But while corporate profit margins have been historically high in recent years, much of the cash returned to shareholders has been financed by issuing debt.
This trend goes back decades. A study last year by John Jay College economics professor J.W. Mason found that for every dollar of debt taken out by corporations, just 10 cents on average goes to productive investment, compared to 40 cents in the 1960s and 1970s.
Druckenmiller’s comments echo those of numerous money managers and politicians, ranging from BlackRock CEO Larry Fink to Hillary Clinton, the latter of whom noted the torrid pace of buybacks in her plans to reform the financial sector.
But Druckenmiller, a Republican, delivered his remarks at an interesting venue — a conference populated largely by hedge fund managers. Hedge funds regularly mount activist efforts at corporations to demand higher shareholder payouts in the form of buybacks and dividends. Last year, hedge funds launched 70 such campaigns, nearly half of which were successful, according to FactSet.
In fact, shortly after Druckenmiller spoke, Greenlight Capital CEO David Einhorn extolled General Motors' record of returning capital to shareholders. It was only following a campaign by four major hedge funds last year that GM increased its pace of buybacks.
Druckenmiller, who now manages only his family wealth, refrained from criticizing his fellow hedge funders. But he had plenty of words of warning for the rest of the world, which he characterized as careening toward a debt cliff. The Federal Reserve’s low interest rates had helped fuel ballooning liabilities in America, while China’s growing household and real estate debts are a looming disaster, he said.
Altogether, Druckenmiller sees a bad end coming: “The bull market is exhausting itself.”