When Druckenmiller Speaks, We Listen

The closest thing to a god in markets (30% CAGR over 30 years, no down years)

Value investing isn’t just about cheap multiples per se (i.e. cigar butts). It’s about price vs. value (i.e. what you pay vs. what you get), and how much your risk:reward exposure is. To boil it down to one word, it’s about asymmetry.

And who better to represent asymmetry in markets than George Soros — who infamously took down the Bank of England on Black Wednesday. His lieutenant at the time, Stan Druckenmiller, recently gave a sterling interview (pun intended) full of incredible lessons for professional value investors.

Almost Didn’t “Never Had A Down Year” (43:05)

“But Nikolai, they're making like 4% to 5% a day (in tech stocks). I mean, the market is still roaring going into March (2000). And I'm watching this, and I'm getting really annoyed with myself that I'm not still in this trade. And then around early March, I can't take it anymore. And I told you earlier, I'm not emotional. This was a real emotional, really dumb move. I buy everything back. I think I missed the top by about an hour. So I buy back all these tech stocks. And within a week, I know I'm dead. And Quantum goes from like up 14% to up 1% in a week.”

Druckenmiller is well-known for not having a down year throughout his entire 30-year career — but this was almost not the case. By his own admission, he apparently missed the peak of the dotcom bubble by an hour. This resulted in the Quantum Fund zeroing out all its gains within a week of the bubble bursting — and was down -17% by the time he liquidated all his tech positions.

Fortunately, his astute purchase of Treasuries towards the end of the year resulted in a quick +40% gain, which brought the fund back into the black. We’ll discuss his insights behind this trade below.

50% Dollar, 25% Oil, 25% Interest Rates = S&P Earnings Trajectory (46:50)

“And two days later, in his daily missive, he (Ed Hyman) has a regression analysis. And it says it's 50%, I think, currency, 25% oil, and 25% interest rates. And it looks one year forward, and it predicts earnings. And it's predicting that earnings are going to decline 36% the next year. And the Wall Street consensus is they're going to go up 18%. So a combination of that, listening to my clients, and the fact that Greenspan's got a tightening directive on, which I think is inappropriate.”

This part of the interview was particularly intriguing to me. Druckenmiller claims that a regression analysis by the renowned Ed Hyman composed of 50% dollar, 25% oil and 25% interest rates signaled the future trajectory of corporate earnings.

Those of you wondering what the correlation between the three might be should find this Reddit thread enlightening. User longshortequities described it as, “Inflation from oil price increases leads to higher rates leads to higher dollar, which is unappealing for the markets”.

In any case, it was this insight which led Druckenmiller to put on his aforementioned record-saving trade, thus allowing him to hold onto his throne of never having a down year.

Fed Has Declared Victory Too Early on Inflation (2:50)

“If we go back to the '70s, there was an episode with OPEC that set off an inflation, you had a recession. And inflation came down, I think, from about eight to three. And then went back up again (…) I don't have conviction like I had in '21 that inflation was going to go up. That's when the money supply was growing 40% and all sorts of things were happening. And I'm not going to have conviction. But I also don't have conviction that they've snuffed this thing out and won the battle.

And to cut 50 basis points with credit spreads tight, gold at new highs, equities roaring, no sign of weakness, material weakness in the economy. And of course, there's some spots. That just makes me nervous that this thing could turn up again. What would make it turn up again? What would be the factors? I think what I just said, easing into financial conditions.”

There’s a pretty telling chart that’s been floating around recently — I’ll just leave it below and let you do the interpretation in conjunction with Druckenmiller’s quotes above:

Powell is Obsessed with Soft Landing (4:19)

“Why is it so urgent for the central bank to cut given this? Honestly, I don't take the nefarious view that Powell is doing it for quote unquote political reasons. I do think he's obsessed with the soft landing. And I think he's obsessed with his legacy and having made the mistake he made in 21. And he's being egged on by other economists and the press.

To me, the Fed's job is to avoid the big, big mistakes like the '70s, like the great financial crisis, like the big inflation we just had. But all this fine tuning and worrying about a soft landing, that is not the job of the Fed. The job of the Fed, in my opinion, is to maximize employment for the long term, not for the next three months or the next four months. But I think the Fed's obsession with nailing this so-called soft landing--

I would remind everybody that the reason we're having a landing is because they let inflation go from 2% to 9%. Yeah. So there was no need for a landing for 20 years. But I think that's what they're obsessed with. I don't really-- I don't know.”

AI Won’t Replace Human Fund Managers (39:57)

“Do you think machines can take the place of humans when it comes to investing?”

“No, I don't. But I think they can work as a co-pilot, and the combination can beat anything a mere human could be. I'm lucky enough to have known Garry Kasparov for a long time (…) he was probably one of the first guys to use machines to train himself and work with them. I could see the same thing happening with money management. I don't think the pure machines, they'll make money because they have a disciplined process and there's math. But I think if you could find an intuitive investor who's using AI and other things to supplement, I think that would probably be the top investor in the world, not a machine.”

This is a sentiment I share. I find it difficult to imagine a financial layman having the ability to input adequate AI prompts — the need to comprehend so many different possibilities and the iterative feedback loop of output A serving as input B implies that you can’t reduce market analysis to a single all-inclusive prompt. Perhaps chain-of-thought reasoning can change that; but I highly doubt it, since there’s also a subjective behavioral economics aspect embedded in market prices.

However as Druckenmiller put it, I can see professional fund managers quintupling their output if they “sharpened the saw” by introducing AI methodologies into their existing financial workflow.

Don’t Get Into Markets Unless You’re Passionate About It (50:00)

“First of all, if they're going in it for the money, they should go elsewhere. There's too many people in the business like me that just love the game and the passion for reasons I just articulated. And they're not going to win. And it's not a fun game if you're losing. It's horrible. I just told you how I respond to drawdowns.”

I find myself agreeing with Druckenmiller’s quote. Markets move at a faster pace than the Tech sector — sands are consistently shifting at lightspeed, and if you snooze you lose. Peter Lynch has famously admitted to being a workaholic:

I haven’t gone to a football game in four years. I haven’t gone to a hockey game in six years. I haven’t gone to a Celtics game in five years. I think I read one book in one year. I don’t even read the newspaper.

I’ve worked every Saturday for seven or eight years — I mean seven in the morning. In the last six months I’ve started working some Sunday mornings at home. Three weeks in a row I worked 82 hours. — Peter Lynch

If you don’t enjoy it, you’re going to be looking for ways to optimize your workflow. Unfortunately that’s not how markets works — you genuinely need to consume information from the furthest reaches of the Internet in order to stay competitive. There are far easier ways to make more money than compounding capital by 15% in a risk-free manner.

Analyst Skillset ≠ Portfolio Manager Skillset (51:04)

“I would say an analyst skill set in our business is completely different than a portfolio manager skill set. Once in a while, you'll get an overlap. But I would be careful if they really love the analyst part, which is where we all start, of thinking they have to become a portfolio manager. I've seen it ruin people's lives who weren't built for trigger pulling, so they should be open-minded.”

Analyzing businesses exercises a different muscle in the brain as compared to managing portfolios — the former is quite left-brained, while the latter requires creative mental gymnastics. Businesses tend to operate according to a fixed set of rules, whereas markets move in ways that defy the imagination.

Understanding macro also requires an understanding of fiscal (Treasury) and monetary (Fed) policy; which in turn requires having a handle on economics. I’m just glad that PMs only have to manage market exposure — there’s an entire world foreign to even us at the central bank level (e.g. repo plumbing, CB swaps).

If you’re interested in entering this business, Druckenmiller is right in that it pays to figure out early whether you should specialize in stocks or managing portfolios. They’re both intellectually stimulating in different ways — unless you have the appetite for both.

“How Much” > “Win vs. Lose” (37:44)

“I think the major thing I learned with him is it's not whether you're right or wrong, it's how much you make when you're right and how much you lose when you're wrong.”

In many disciplines, success is characterized as having a one-track mind to the goal (e.g. business, sales, etc.) In markets however, the excessive number of factors affecting prices requires investors to hold dozens of different considerations in their head and balance all of them against each other simultaneously. This renders the “one-track-mind to the goal” approach ineffectual; investors must consider all possibilities or risk getting sideswiped by a train.

Given the outsized number of possibilities involved in any given trade, the “target price” approach of forecasting precise market outcomes becomes less relevant. To minimize the mental overhead of predicting the impossible, the investor focuses on what he can control — by estimating exposure to both the upside and downside, with respect to both volatility and risk. This makes fund management a question of controlling for “how much” rather than “win or lose”.

The ideal scenario is one of risk:reward asymmetry — where regardless of the actual outcome, one either makes a lot or loses very little. This is encapsulated in Monish Pabrai’s quote, “Heads I win, tails I don’t lose much”. In Druckenmiller’s case, their bet against the pound involved either a 200% potential gain or an 8% potential loss. This was because markets were so sure at the time that the Bundesbank would do whatever it takes to keep the UK in the ERM.

Unfortunately, this was not to be so. Germany had just reunified a couple years ago, and West Germany’s rapid investment to rehabilitate East Germany’s industrial sector led to an economic boom. This led to the Bundesbank raising German rates to keep inflation under control — amidst a policy environment which as Druckemiller put it, was still carrying the scars of hyperinflation from the Weimar era.

The Deutschemark’s appreciation pulled up the entire basket of ERM currencies, requiring neighboring member countries to raise rates to stay within ERM guidelines — something the UK’s receding economy at the time could ill afford. Amidst the Italian lira’s recent 7% devaluation, Bundesbank’s President Helmut Schlesinger got the snowball rolling when he mentioned in an interview that “there would have to be a more comprehensive realignment of currencies in Europe”. This was taken by Druckenmiller to mean that the UK would have to exit the ERM — and the rest is history.

While Druckenmiller admits in the interview that they didn’t get a chance to fully implement their bet before markets caught on, it still demonstrates their tactical adherence to asymmetrical bets rather than precise outcomes. They did not have to win if losing only involved a maximum loss of 8%, while winning would yield a 200% return and write them into the history books.

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