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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Any other major trades come to mind? I'm particularly interested in your reasoning for putting on a trade==== How large a position did you put on? ==== About $2 billion. ==== Did you have any difficulty putting on a position that size? ==== No, I did it over a lew days time. Also, putting on the position was made easier by the generally bearish sentiment at the time. The Deutsche mark actually fell during the first two days after the wall came down because people thought that the outlook for a growing deficit would be negative for the currency. ==== Any other major trades come to mind? Im particularly interested in your reasoning for putting on a trade.==== In late 1989 I became extremely bearish on the Japanese stock market for a variety of reasons. First, on a multiyear chart, the Nikkei index had reached a point of overextension, which in all previous instances had led to sell-offs or, in the worst case, a sideways consolidation. Second, the market appeared to be in a huge speculative blow-off phase. Finally, and most important-three times as important as everything I just saidthe Bank of Japan had started to dramatically tighten monetary policy. Heres what the Japanese bond market was doing at the same time. [Druckenmiller shows me a chart depicting that at the same time the Nikkei index was soaring to record highs, the Japanese bond market was plummeting.] Shorting the Japanese stock market at that time was just about the best risk/reward trade I had ever seen. ==== How did you fare at the start of the air war against Iraq when the U.S. stock market abruptly took off on the upside and never looked back? Were you short because the market had been in a primary downtrend before that point? If so, how did you handle the situation? ==== I came into 1991 with positions that couldnt have been more poorly suited to the market price moves that unfolded in the ensuing months. 1 was short approximately $3 billion in the U.S. and Japanese stock markets, and I was also heavily short in the U.S. and world bond markets. 1 started to change my market opinion during the first two weeks of 1991. On the way down, the pessimism regarding the U.S. stock market had become extreme. Everybody was talking about how the market would crater if the United States went to war against Iraq. Also, the breadth was not there. Even though the Dow Jones index had fallen to a new recent low, only about eighty of the seventeen hundred New York Stock Exchange stocks had made new lows. By January 13,1 had covered my short S&P futures position, but I was still short stock. On that day, I spoke to Paul Tudor Jones, who had just returned from participating in a roundtable discussion sponsored by Barrons. He told me that eight out of the eight participating money managers had said they were holding their highest cash position in ten years. Ill never forget that the S&P was near 310 and Paul said, 340 is a chip shot. I was already turning bullish, but that conversation gave me an extra push in that direction. I was convinced that once the war started, the market had to go up, because everyone had already sold. ==== Why didnt you wait until the war had actually started before you began buying? ==== Because everybody was waiting to buy after the war started. I thought it was necessary to start buying before the January 15 deadline set by the United States. ==== Had you switched completely from short to long before the huge rally on the morning following the start of the air war? ==== I had in the Duquesne Fund because it was more flexible. In Soross Quantum Fund, we had switched our S&P futures position from short to long, but we still had a huge short position in actual stocks. A large portion of this position was in the bank and real estate stocks, which were difficult to cover. We were fully long within a few days after the start of the war. ==== How did you fare after the smoke cleared? ==== As incredible as it may seem, we ended up having an up January after going into the month with a $3 billion short position in equities worldwide, a $3 billion short position in the dollar versus the Deutsche mark, and a large short position in U.S. and Japanese bonds-all of which proved to be the exact wrong positions to hold. ==== Why did you have such a large short position in the dollar versus the Deufsche mark? ==== This was the same position we had held on and off for over a year since the Berlin Wall had come down. The basic premise of the trade was that the Germans would adhere to a combined expansionary fiscal policy and tight monetary policy-a bullish combination for their currency. ==== What caused you to abandon that position? ==== There were two factors. First, the dollar had been supported by safe-haven buying during the U.S. war with Iraq. One morning, there was a news story that Hussein was going to capitulate before the start of the ground war. The dollar should have sold off sharply against the Deutsche mark on the news, but it declined only slightly. I smelled a rat. A second factor was the talk that Germany was going to raise taxes. In other words, they were going to reverse their expansionary fiscal policy, which would eliminate one of the primary reasons for our being long the Deutsche mark in the first place. In one morning, we bought about $3.5 billion against the Deutsche mark. ==== The United States is experiencing a protracted recession and extremely negative consumer sentiment [at the time of this interview, December 1991]. Do you have any thoughts about the long-term economic prospects for the country? ==== In my view, the 1980s were a ridiculous repeat of the 1920s. We had built up the debt-to-GNP ratio to unsustainable levels. I became more convinced about the seriousness of the problem with all the leveraged buyouts of the late 1980s, which made the overall debt situation get worse and worse. I have never believed that the current economic downturn was a recession; I have always viewed it as a debt liquidation, which some people call a depression. Its not simply a matter of a two-quarter recession. Its a problem where you build up years of debt, which will act as a depressant on the economy until it gets worked off over a long period of time. A debt liquidation tends to last for years. ==== Given your very negative long-term view of the U.S. economy, are you holding a major long position in bonds? ==== I was long until late 1991. However, an attractive yield should be the last reason for buying bonds. In 1981 the public sold bonds heavily, giving up a 15 percent return for thirty years because they couldnt resist 21 percent short-term yields. They werent thinking about the long term. Now, because money market rates are only 4.5 percent, the same poor public is back buying bonds, effectively lending money at 7.5 percent for thirty years to a government thats running $400 billion deficits. The current situation is Just the inverse of 1981. In 1981 the public should have seen Volckers jacking up of short-term rates to 21 percent as a very positive move, which would bring down long-term inflation and push up bond and stock prices. Instead, they were lured by the high short-term yields. In contrast, now with the economy in decline, the deficit ballooning, and the administration and the Fed in a state of panic, the public should be wary about the risk in holding long-term bonds. Instead, the same people who sold their bonds in 1981 at 15 percent rates are now buying them back at 7.5 percent because they dont have anything better to do with their money. Once again, theyre not focusing on the long term. ==== Your long-term performance has far surpassed the industry average. To what do you attribute your superior track record? ==== George Soros has a philosophy that I have also adopted: The way to build long-term returns is through preservation of capital and home runs. You can be far more aggressive when youre making good profits. Many managers, once theyre up 30 or 40 percent, will book their year [i.e., trade very cautiously for the remainder of the year so as not to jeopardize the very good return that has already been realized]. The way to attain tmly superior long-term returns is to grind it out until youre up 30 or 40 percent, and then if you have the convictions, go for a 100 percent year. If you can put together a few near-100 percent years and avoid down years, then you can achieve really outstanding long-term returns. ==== What else have you learned from Soros? ==== Ive learned many things from him, but perhaps the most significant is that its not whether youre right or wrong thats important, but how much money you make when youre right and how much you lose when youre wrong. The few times that Soros has ever criticized me was when I was really right on a market and didnt maximize the opportunity. As an example, shortly after I had started working for Soros, I was very bearish on the dollar and put on a large short position against the Deutsche mark. The position had started going in my favor, and I felt rather proud of myself. Soros came into my office, and we talked about the trade. How big a position do you have? he asked. One billion dollars, I answered. You call that a position? he said dismissingly. He encouraged me to double my position. I did, and the trade went dramatically further in our favor. Soros has taught me that when you have tremendous conviction on a trade, you have to go for the jugular. It takes courage to be a pig. It takes courage to ride a profit with huge leverage. As far as Soros is concerned, when youre right on something, you cant own enough. Although I was not at Soros Management at the time, Ive heard that prior to the Plaza Accord meeting in the fall of 1985, other traders in the office had been piggybacking George and hence were long the yen going into the meeting. When the yen opened 800 points higher on Monday morning, these traders couldnt believe the size of their gains and anxiously started taking profits. Supposedly, George came bolting out of the door, directing the other traders to stop selling the yen, telling them that he would assume their position. While these other traders were congratulating themselves for having taken the biggest profit in their lives, Soros was looking at the big picture: The government had just told him that the dollar was going to go down for the next year, so why shouldnt he be a pig and buy more [yen]? Soros is also the best loss taker Ive ever seen. He doesnt care whether he wins or loses on a trade. If a trade doesnt work, hes confident enough about his ability to win on other trades that he can easily walk away from the position. There are a lot of shoes on the shelf; wear only the ones that fit. If youre extremely confident, taking a loss doesnt bother you. ==== How do you handle the pressure of managing a multifrtffion dollar portfolio? ==== Im a lot less nervous about it now than I was a few years ago. The wonderful thing about our business is that its liquid, and you can wipe the slate clean on any day. As long as Im in control of the situation- that is, as long as I can cover my positions-theres no reason to be nervous. According to Druckenmiller, superior performance requires two key elements: preservation of capital and home runs. The first principle has been quite well publicized, but the second is far less appreciated. From a portfolio perspective, Druckenmiller is saying that in order to really excel, you must take full advantage of the situations when you are well ahead and running a hot hand. Those are the times to really press, not rest on your laurels. Great track records are made by avoiding losing years and managing to score a few highdouble-digit- or triple-digit-gain years. On an individual trade basis, going for home runs means really applying leverage in those infrequent circumstances when you have tremendous confidence. As Druckenmiller puts it, It takes courage to be a pig,. Another important lesson to be drawn from this interview is that if you make a mistake, respond immediately! Druckenmiller made the incredible error of shifting from short to 130 percent long on the very day before the massive October 19, 1987, stock crash, yet he finished the month with a net gain. How? When he realized he was dead wrong, he liquidated his entire long position during the first hour of trading on October 19 and actually went short. Had he been less open-minded, defending his original position when confronted with contrary evidence, or had he procrastinated to see if the market would recover, he would have suffered a tremendous loss. Instead, he actually made a small profit. The ability to accept unpleasant truths(i.e., market action or events counter to ones position) and respond decisively and withouthesitation is the mark of a great trader. Although Druckenmiller employs valuation analysis and believes it is important in gauging the extent of a potential future price move once the current market trend reverses, he emphasizes that this approach cannot be used for timing. The key tools Druckenmiller applies to timing the broad market are liquidity analysis and technical analysis. In evaluating individual stocks, Druckenmiller recalls the advice of his first boss, who made him realize that the initial step in any analysis is determining the factors that make a particular stock go up or down. The specifics will vary for each market sector, and sometimes even within each sector. Druckenmillers entire trading style runs counter to the orthodoxy of fund management. There is no logical reason why an investor (or fund manager) should be nearly fully invested in equities at all times. If an investors analysis points to the probability of an impending bear market, he or she should move entirely to cash and possibly even a net short position. Recall Druckenmillers frustration at being extremely bearish in mid-1981, absolutely correct in his forecast, and still losing money, because at the time, he was still wedded to the idea that a stock manager had to be net long at all times. There is little question that Druckenmillers long-term gains would have been dramatically lower and his equity drawdowns significantly wider if he restricted himself to the long side of the stock market. The flexibility of Druckenmilters style-going short as well as long and also diversifying into other major global markets (e.g., bonds and currencies)-is obviously a key element of his success. The queen in chess, which can move in all directions, is a far more powerful piece than the pawn, which can only move forward. One basic market truth (or, perhaps more accurately, one basic truth about human nature) is that you cant win if you have to win. Druckenmillers plunge into T-bill futures in a desperate attempt to save his firm from financial ruin provides a classic example. Even though he bought T-bill futures within one week of their all-time low (you cant pick a trade much better than that), he lost all his money. The very need to win poisoned the trade-m this instance, through grossly excessive leverage and a lack of planning. The market is a stem master that seldom tolerates the carelessness associated with trades born of desperation. |
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