Druckenmiller at Sohn 2022

Stanley Druckenmiller spoke recently at the 2022 Sohn Conference, sharing his views on the global economy, markets and his investment process. Much of the conversation focuses on topical issues like inflation and interest rates - and there are some interesting insights to be gleaned. But this may also be the best interview I’ve heard yet about Druck’s investment process and mental models. Kudos to John Collison for drawing this out.

I always learn a lot from Druck precisely because he’s so different from my value investing gurus. For example, I found it fascinating to hear him say, “one of my jobs is to manage myself”. He believes in streaks and will "dial himself up" when he's hot and "dial himself back" when he's cold. The latter seems crucial to preserving his mental reserves and willingness to swing at the next fat pitch. He illustrated this with the example of his trading in 1999 and 2000 when he was down in both years, recognised he was "an emotional mess" and so purposefully took a break before coming back stronger than ever.

It's of course up to everyone to decide for themselves how to manage their personal and emotional biases as part of being a long term investor. And there's no right or wrong answer. However, I think this is an important part of the investment process that too few people acknowledge and actively manage - even in years like this one.

Druck also emphasises the importance of investing across asset classes, both to find more opportunities and to better manage risk. For example, in Bear Markets, his playbook is simply to not own equities! Having a better understanding of the connections between liquidity, the cycle and asset prices is something I’d like to work on more over the coming years.

What follows are my highlights from the conversation. I hope you find them useful.

On Managing Yourself

When he doesn't know what to do, Druck takes a break. And that's OK:

Things are a lot harder now because we're now getting definitive signals that the economy may be weakening, particularly at the front end. And while I'm not comfortable owning bonds, I'm much less comfortable being short, fixed income to the, to the degree. I was three to six months ago when it looked like a much better risk reward and even stocks. So many companies have been derated by 60 or 70% and I've lived through enough bear markets that if you get aggressive in a bear market on the short side, you can get your head ripped off in rallies.

So currently I'm, I'm coming in every day and I'm looking at my screen, but I'm pretty much taking a break. I'm waiting for a fat pitch. I'm not shooting at any pins to use a golfing analogy. My anticipation is I will be going back to the short equity position at some point, if the market affords me, if not, hopefully I'll just sidestep a decline. That's not the worst thing in the world.

Druck believes in streaks and so manages himself when he's hot and cold:

I've also found as an investor, I believe in streaks, you see it in baseball, you see in everything else. I see it investing. Sometimes you're seeing the ball. Sometimes you're not one of my number one jobs is to know whether I'm hot or cold. And when I'm hot, I'm supposed to turn the dial way up. Not not say, okay, I'm up 40% this year. Let's go. This will look good at the end of year, go take a break. No, you gotta make hay while you're hot. And then when you're cold, the last thing you should do is try and make big bets to get back to even you should, you should tone yourself down. So believe it or not, that's, that's part of the, all your eggs in one basket. Not only do I have to see the, see the investment that really excites me, I also have to see myself sort of being in a good, in a good trade trading rhythm.

Druck illustrates the idea of taking a break with his experience in 1999 and 2000 when he lost money and, as he describes it, was an emotional mess. Distance from the market gave him the confidence and clarity he needed to seize the moment:

The, the long version is very simple. It actually started quite a while before I I, I didn't do it in the beginning, but sometime I believe in like March of 99, I got the brilliant idea to short like 10 internet stocks, which were up like seven or eight fold at Soros. And I think I put 200 million into the quantum fund short and within about four weeks, the 200 million investment was a 600 million loss. I didn't just misstate that I lost eight time. I'm sorry, four times. Well, three times my investment. So because the 200 million went to 800 million, then I covered it.

So I was very bruised. I was down mid teens. I'd never been down double digits before and I was, I was exhausted. And then I kind of backed off. And for a few months I realized Greenspan was doing this huge easing program because of the Asian financial crisis, but there was no crisis in the United States, but we were pumping all this money in and I could see the, the tech revolution.

And I said, oh my God, I've gotta go along. So one of the things I did was hired two, two people in their twenties who were sort of gun slingers because I knew gets back to Bitcoin. Now I knew the younger people knew the new companies like Veritas and Risine and that kind of stuff. I didn't know how to spell them. So we then I'm down like 16% or something. We pivot into this stuff in the summer. And by the end of the year, we're up 42% net. We have this massive year. I go into George in January and I said, this is crazy. We're in a bubble. I'm selling all the technology stocks. So I sell them. This is January. And then the two gun slingers are still there. They have little small accounts, so I can size them up when they're hot or cold per hour or their conversation.

And in, as you just said, they're making like 8% a day and it's driving me outta my mind cuz I'm outta the market. So we're now getting into March and there's the little devil here going March of 2000, the little devil here is going do it, do it. And the little devil here's saying don't do it, don't do it. And I think I missed the top by an hour. And you said, I bought a few things. I didn't buy a few things. I put like, I think 6 billion and which turned into a massive loss two or 3 billion. I knew like five days after I did it, but the whole exit was messy. So now I'm down like 18% again. And I had just been down 18% the year before. And I'm literally like an emotional mess. And to your point, I know I'm an emotional mess.

So I go into Soros and I say, I'm quitting. I need a break. I'm exhausted. I write a letter to the Duquesne investors I had, I had, you know, two firms going and I said, I'm, I'm going on sabbatical. I might come back. I might not right now. I'm a mess. If you want your money, here's the number, just call. We'll send you all your money back. I did cheat a little. I said, if you take your money out, I might not let you back in, but you're free to take it all out. Okay. So I go to Africa with my kids. I don't allow myself to see a TV or read a financial newspaper. So I don't know where anything is. So it's a true break, which is something I'd advise young traders to do. If you take a break, take a break, don't sit there and like trade your own account and mess around.

So I come back on Labor day, cuz my kids are going back to school and I'm sure my wife doesn't want me around the house. So I open up a newspaper and I can't believe it. The NASDAQ has recovered like 70 or 80% of their losses. S and P is almost back to the high, but oil is up. Interest rates are up and the dollar is up by the way, that might sound a little familiar. And this has always been terrible for corporate earnings looking forward. So I mentioned this to my good friend, Ed Hyman, I go, what's going on? And I said, oil is up. Interest rates are up. And the dollar's up. Why, why is the market up? In the meantime, I'm calling all my ex clients who are small businessmen. I didn't have big fancy clients and they're all telling their businesses terrible.

Okay. So Ed sends back a regression thing two days later showing that if you have oil interest rates, he, he plugged in the percentages and the dollar up this amount earnings the next year forward based on history go down 35%. And the average earnings estimate of the wall street guys is up 18. So I then get the idea and I'm down. And one of my trading rules is you don't trade a lot when you're down, but I've had a break. My mind is fresh. I just love this idea. So I put 350% tenure equivalent of the fund into treasuries betting that green span as a tightening director will reverse and will go into a recession and to make a long story short, I make 40% in the fourth quarter, even though I had given up on the year and decided I was finally gonna have a down year, that's the end of the story.

I will go to my grave believing if I had sat in my office whole year, grinded away, looked at the screen. I would not have had my brain was too messed up in may and it would not have gotten unmissed up watching that price action. I will go to my grade believing it was by stepping aside and clearing my head that enabled me not only to see the trade, but to have the gumption, to put it on in size because I needed that four months to rebuild my confidence.

If you're not passionate, then do not pursue this career:

Well, the first thing I'd tell them is if you're not really passionate, if you don't love this stuff, go do something else…

And the fact that every event in the world affects some security price somewhere. And the fact that I'm so intellectually stimulated, trying to imagine the world 12 to 18 months from now versus the way it looks in the present and security prices, how they would reflect that. I just find it so stimulating. It makes everybody think I'm a hard worker because I'm attracted to the game.

On Investing

Do not invest in the present:

I think the great thing about my original mentor in Pittsburgh was he made me focus on what moves the stock price. Like you can't just say, Stan, okay, this is a great company and the earnings are great. He said, tell me how people are gonna think differently in 18 or 24 months about the situation than they're thinking. Now that would be my number one advice to the young people do not do not invest in the present. It's not what moves stock prices change, moves them. And I want you to try and envision a different world in a year and a half from now and where these security prices would trade versus now, given the world you envisioned, that would be my number one advice to a young person getting in the business.

Druck’s play is to simply avoid equities in a bear market in favour of bonds. However, bond prices are still too high and so he does not think that trade will work this time:

I've always made even higher returns in bear markets than bull markets. But the way I did it was just pretty much ignore equities, take them off the table, buy bonds by treasuries and go home. Well, I've never present, been presented a cocktail where you have 8% inflation. You think the economy might, we can and bond yields 3%.

It's an analog with no precedent in history. So for the golfers out there going into the situation we're describing, I feel like I'm about to play around a golf without a driver and without a 60 degree wedge because bonds which have been my go-to asset in terms of, of a recessionary bear market atmosphere, they may work, but there's good reason to believe things may be different this time.

Position sizing is crucial:

What I learned [from Soros] was sizing is probably 70 to 80% of the equation. It's not of 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.

Druck has a bias towards growth stocks:

I have a bias toward growth stocks. Luckily not so big of a bias that I didn't ignore it the last year or two, but I think if you can envision a company that three to five years from now is gonna be in a much, much better situation than it is today. Long term, that's my bias, where to go, but yes on a cyclical basis, I've always [believed in mean reversion].

When you have large positions, you must be constantly paranoid:

When you've got 15, 20% of your asset base, or someone times in macro positions, I'll have two or 300% believe me, they're not getting stale and you have to have ruthless discipline, and you're coming in every day, just to quote Andy Grove, you could not be more paranoid and you're constantly reevaluating. And I think it leads to an open mind.

Today's Economy & Market

The odds are for a hard landing:

Well, the answer is, I don't know, but the probabilities of being a soft landing are pretty remote. John. historically I think we've only pulled off two or three in history. The one I lived through and remember so well was the 94 95, but we've never had a soft landing after inflation's gotten above four and a half percent. And the situation we face now is extraordinary where the fed where are we these days? I guess we're at 75 basis points that can't keep up, but even the projections of 2%, you're so far behind the inflation rate and there's so much wood to chop and there's been such a broad asset bubble going into it. It's very hard for me to say that the probability's favor of soft landing, indeed. I think they aggressively point to a hard landing. Anything's possible. As I said earlier, I've been wrong plenty of times in my career, but betting on a soft landing to me is a real is a real long shot.

Druck's base case is for a recession in 2023:

So I assume and I pretty strongly assume we're gonna have a recession sometime in 23. I just don't know whether it's gonna be in the early part or the later part.

It may be early but there are bad signals coming from US Retail:

that one's a little tainted now because in COVID retail went to a hundred percent of the wallet from about 85%, cuz we weren't going outside and traveling, going to football games, but even taking that into account retail appears to be much weaker than it should be given what the so-called GDP numbers are printing. So right now there's a, there's a signal albeit early that there may be trouble ahead.

He still likes Energy and sees the trade lasting several years:

But I think the reasons we're still there is we just see this thing as being more sustainable because of ESG and all the reasons we all know about that it can last a while and that doesn't seem to have been priced in the stocks, but it's not a classic Duquesne play because it's now become widely recognized. But I don't just sell something because people talk about pain trade. I don't care about pain trade this or that. We, we think these companies are still cheap relative to what we see a year or two out. The big problem would obviously be if you have a horrendous worldwide recession, but we'll look for we're looking for demand, destruction and energy, but so far we don't see it.

Big Tech is too cheap to short but not cheap enough to go long:

Not yet. I'm just too I'm too bearish on the world to go there yet. Although I will say that they've gotten too cheap for me, for them to be my shorts anymore.

On Markets

The stock market is the best leading indicator of the economy:

Yeah. one of the ironies of my style, maybe it's because I was a dropout of a PhD program in economics, state university of Michigan is that I don't use what traditional economists use to predict the economy, which is things like employment and a bunch of macro top down statistics. In fact, I started my career as a bank and chemical analyst. And over time I learned that the inside of the stock market had a very, very prescient message about future economic activity. And for whatever reason, stocks tend to lead the fundamentals by somewhere between six and 12 months. And you can even go beyond that and look at industries that lead the economy and industries that lag the economy. The obvious one that everyone knows about is housing has traditionally been looked at as a leading in industry. Retail has a slight lead capital goods lag.

And what we've done historically is actually, even though you refer to me as a macro investor, and many people have is we do the macro by a comp compilation of listening to companies and doing a bottoms up analysis of companies that lead the economy and comp, and I'm sorry, industries that lead the economy and industries that lag the economy. And if the leading industries are turning up or turning down, that's a signal and that's worked beautifully. Historically, the other signal which I have found quite ENT for markets is the bond market. Unfortunately the last 10 or 11 years, the bond market has not signaled anything because the central banks took it upon themselves to manipulate bond prices. Which to me is the 10 year treasury has sort of been the most important price in the world. And they took that price outta the equation as a signal.

A lot of people made easy money in 2020 and are likely to leave the markets now feeling very discouraged:

I think there's a lot of bull market geniuses around, and it's not that they love the game. They love winning, but they were surfing with a hurricane behind their back that was giving them these nice waves. They, they may become very discouraged.