Stanley Druckenmiller “Humbled” by Recent Trading Gaffe
Stanley Druckenmiller has scored some big wins in his career, including teaming up with George Soros to “break” the Bank of England. He is owning up to the big mistake he just made.
Investor Stanley Druckenmiller hasn’t always been right about the markets, although he has been right enough often enough to have put together some legendary stories, such as how he and George Soros shorted the British Pound in 1992 and brought the Bank of England to its knees, and how he made a quarter of a billion dollars in 2008 when just about everyone else got knocked to the ground.
While George Soros usually gets credit for taking on England and coming out on top, Druckenmiller played a central role in this as well, as Soros’ right-hand man at the time. This extremely bold move certainly would not have been possible without Soros’ willing to take on the high risk of this, but they had to be sure of the numbers enough to do it, to allow these two gentleman to play chicken with the Bank of England in the way they did and be right.
Soros and Druckenmiller saw weakness with the British Pound at the time and believed that it was decidedly bullish and decided to jump on the move. Forex traders do that all the time, and there is really no long and short with forex in the same way that there is with stocks, where to go short you have to borrow stock and sell it in advance, and buy it back later.
Forex trading instead involves taking a long position in one position or another, for instance going long USD against another currency such as the GBP, where if USD increases in value against GDP, you make money. Exchange rates with currencies trend like stocks and other assets do, and people use this to both speculate on trends continuing or to hedge against currency risk by looking to cover potential losses caused by unfavorable exchange rate trends.
If you are speculating, you are simply betting on one currency increasing in value over another while you are in the trade, like these two men did back then when they understood how precarious the British Pound was at the time in comparison to the German Mark. If you are hedging, you might be getting revenue in another currency and worry that the value of this other currency may drop, resulting in your making less money in your own currency, where your forex bet will offset this and provide you with more stability in running your business.
Central banks are also in this game, and pretty heavily, as one of the prime roles of central banks is to seek stability with the currencies that they manage, even though this isn’t talked about very much. Central banks also use monetary policy to influence these rates, for instance putting up rates when they want the currency to appreciate in value versus other currencies.
To call taking on a central bank a daring move would be an understatement, where taking them on here means that you will not only seek to make money from the trade but to take them on directly where you know they will be pulling out all the stops to beat you and get their side to come out on top. It wasn’t the billion dollars that these two men made from this that has this trade stand out so much and make so singularly impressive, it was that they actually did go to war with the Bank of England, pitting their little David against the massively powerful Goliath.
Goliath had been badly weakened though, which they recognized and capitalized on. In a nutshell, the British Pound was pegged to the German Mark at a fixed exchange rate as part of the agreement for Britain to join the European Exchange Rate Mechanism (ERM). By not permitting currencies to float against one another, this forces the weaker economy of the two to keep their interest rates artificially high as well as continuing to place huge forex trades betting on themselves to maintain the arrangement.
Taking Down the British Pound Would Overinflate Your Ego if Anything Would
Soros and Druckenmiller believed that if the Pound were subject to enough selling pressure, this could force the hand of the Bank of England where they could no longer support this artificial valuation and would have to leave the ERM and have the Pound drop to its true value.
Forex trades are highly leveraged and this meant that the men could manage to take out a position big enough to potentially bring down the house. This did come with quite a bit of risk but the risk of GDP moving against them was a lot smaller than the mother lode they would make if the value of the Pound could become untethered from the Mark.
They believed that the Bank of England did not have enough currency reserves to withstand the attack that they planned, as this arrangement had stretched them very thin already. There was no halfway here, as they either had to fully support the fixed exchange with the Mark or they would have to unplug it and let it fall big.
The two sides went to war and the result became known as Black Wednesday, where the word black with financial markets refers to events of historical damage, such as Black Monday with the stock market. Soros and Druckenmiller bet on black though as the Bank of England ran out of money and was forced to give in and open up this dam, and history was indeed made.
It wasn’t just the billion dollars that the men made on Black Wednesday that makes this so notable, as both the brilliance and the audacity of this move that made it the most epic forex trade of all time by a long shot, going toe to toe with a central bank this big and taking them to the mat.
Almost 30 years have passed since and Druckenmiller built on his lustrous career and his own hedge fund that, among other things, famously capitalized on the blackness with stocks during the 2008 crash. His fund did fabulously, booking impressive gains year after year, and with all this going for him, it wouldn’t be all that inappropriate for his head to grow a little, or even a lot in this case.
Success in investing has a tendency to make investors pretty arrogant, and this is a quality that you see even with those less successful. This makes investors less likely to recognize and admit their mistakes, to their detriment, where when the results of an investment run counter to their trades, they can stubbornly hang on and pay a lot bigger price.
Warren Buffett is a good example of how confidence can be taken too far, as he is famous for ignoring results and even goes as far as to boast that he does not pay attention to how his stocks are doing, even when his mistakes become painfully obvious to everyone. His hanging on to his airline stocks in 2020 is just one example, and his hanging on to them through the crash and selling at the bottom, with their subsequently taking off after he got out, was a mistake so epic that it might not even be possible to replicate even among the rankest of amateurs.
It wasn’t the losses that made this so bad, it was how obvious it all should have been, both the fall and the resurgence. Many stocks fell way too much during this time, but airline stocks were at the front of the line. It wasn’t the hanging on that was so alarming, as that’s just Warren’s style, it was the exit that was so terrible.
It didn’t just turn out to be terrible, where getting out here was even somewhat reasonable. While we told you at the time how bad this was, it didn’t take any real insight to figure that out as these stocks were that oversold, and Buffett may have been alone in thinking that this was a good time to get out.
It was clearly Buffett putting such a premium on his beliefs about a stock that had him both hanging on too long and getting out at the absolute wrong time. This is a widespread problem among investors who come up with ideas that often run contrary to market expectations right from the start, and as their errors further unfold, they insist on clinging to them until they reach their threshold of pain, if they ever do.
Druckenmiller’s Humbleness Might Be His Best Trait
Stanley Druckenmiller is of a different sort. In spite of how well his hedge fund has done over the years, he closed it to new business ten years ago, at a time where his confidence of maintaining the same good returns that his investors have been accustomed to was in doubt. The fund still did well of course, especially given that stocks are trading so much higher now than back then, but he’s anything but overconfident.
In contrast, the majority of fund managers, the great majority in fact, churn out poor results year after year with strategies that we can say are broken with a high degree of confidence, and just keep failing year after year with no end in sight and don’t even seem to care. You’ll never see Stanley Druckenmiller doing such a thing as he would no doubt retire before we got to see something anywhere near this bad manifest.
This man is so well regarded that his bearish views earlier in the rebound caused the market to fall significantly, on that day at least. He shared his bearishness on CNBC and the effect was palatable, where stocks took a big dive as he was speaking and stayed down all day.
He told us back then that the risk/return ratio with stocks was the poorest he’s ever seen in his career, a rather bold proclamation that was clearly out of proportion with the market, even though he was far from alone in his misgivings.
We had people tell us to watch out ever since the rebound started, with some real nasty predictions out there involving us going much lower on the move overall, taking out the late March lows and then some, and who knows how lower things could go.
Even we told you to be on guard for such a thing, we also told you that we never want to just imagine monsters and need to wait for the real thing, like the one that appeared in February that took us down so far so fast. While there is a tendency to focus on macroeconomic fundamentals, which can be quite influential at times, this really all comes down to what the market wants to do with all things considered, and nothing influences market like the Fed does, in both directions.
Druckenmiller put too much weight on these fundamentals and nowhere near enough on the effect of the stimulus, and the impact of stimulus is far from limited to its macroeconomic influences. People see this going on and there isn’t any math required other than to just know that this going on in itself moves markets a lot, and can more than offset the economic concerns that we’re still grappling with, as we have seen.
Druckenmiller stuck to his guns, and has now stepped back and taken stock of what actually happened, lamenting on his only making 3% while stocks gained 40%. The tendency among many is to let their excess pride measure things, where they were right but the market was wrong or stupid, rather than accepting blame when it is deserved and wise to do so.
He instead fully recognizes the extent of his mistake and calls the whole experience “humbling.” Even someone who has been investing this well for this long still has lessons to learn, and he admits that he has a better idea of the power of the Fed now in influencing stocks, and not appreciating this enough is what led to his walking away from such a huge move up.
You won’t learn much if you remain arrogant, and it is the much higher degree of humility that has served Druckenmiller so well over the years and continues to do so. You make a mistake, you are open enough to your actually being wrong, you learn, and next time you are more likely to be better.
This defines his legend perhaps more than anything else, as this is far from a common trait even though it is so vital. This is a lesson that some of us have already learned, not to fight the Fed, even in times this extreme, but many still need to learn it. The lockdown has hammered our economy, and it may take quite a while for the economy to recover, but if the mood of the stock market remains positive, the results will be as well, as these results are driven solely by this mood.
We may have shaken our heads when we heard Druckenmiller get so negative about the recovery with stocks back then, as this was possible but not very likely, but we’ve been very impressed with his level of honesty in the aftermath of this mistake.
When dancing with stocks, you always want to let them lead, and if not, they can jerk you in another direction and trip you up. Playing this right involved both knowing that the market likes to dance with the Fed, and while we may think that this time will be different, we need to see how the dance actually plays out.
Druckenmiller may have landed on his keester this time, but as long as we are willing to admit our mistakes, the future bodes well, because we put ourselves in a position to learn, even being so experienced and successful as this man has been. The rest of us need to be paying attention and if we can stay even close to as humble as he is, we’re in good company indeed.
Successful investing is challenging enough without having to battle our ego and have it come out on top while we suffer. Druckenmiller serves as a fine example of how we can at least keep this under control and focus on what is important, becoming better investors, even by way of our failures.
Editor, MarketReview.com
Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.
Contact Monica: monica@marketreview.com
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