The slow fuse

By Colin Twiggs
May 12, 2016 5:30 p.m. AEST (3:30 a.m. EDT)

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Hedge fund legend Stan Druckenmiller, founder of Duquesne Capital, recently warned of another financial crisis:

"The Fed has no end game. The Fed's objective seems to be getting by another 6 months without a 20% decline in the S&P and avoiding a recession over the near term. In doing so, they are enabling the opposite of needed reform and increasing, not lowering, the odds of the economic tail risk they are trying to avoid....."

Druckenmiller is not the only one to raise concerns about the level of debt being used to leverage growth through stock buybacks instead of for productive capital investment. While window-dressing may look good on company reports, it cannot conceal the fact that corporate debt is rising while earnings are falling.

Shrinking profit margins also warn of a down-turn.

And capital investment is falling as a percentage of GDP. Normally this coincides with a decline in employee payrolls and precedes a recession but here employment is still growing at 2 percent a year. While this continues there is room for hope.

Rather than rely on employment numbers, growth in the dollar value of weekly payrolls (total employment x average weekly hours x average hourly wage rate) offers a more accurate prediction of GDP growth. Again, there is no sign of a down-turn. So far.

Further declines in profit margins or capital investment would be cause for concern.

Past experience has taught that it takes time for economic fundamentals to filter through to the bottom line and affect stock prices. Like a slow fuse, the problem may be evident for months before the effect is felt. In 2006 the yield curve inverted but it took more than a year for stocks to fall. As Keynes succinctly put it:

Markets can remain irrational a lot longer than you and I can remain solvent.

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