For example, making good returns from 1969 to 1982 was pretty darn tough as the S&P 500 was essentially flat during those 14 years, while it was pretty easy to make solid returns from 1982 to 2009 as the S&P 500 compounded at 12.3% and went up nearly 20 times (when you put the whole 41 year period together the S&P 500 compounded at 9.4% and turned a $10,000 investment into just under $400,000).
14 years markets were flat, still WB and GS made great returns!
In fact, to provide some perspective on how hard it is to stick to any strategy long-term, we have data that shows that over the past 20 years (a period only half as long as the Soros period) the S&P 500 Index has compounded at 8%, yet the average investor in mutual funds has only made 3% (from the Dalbar Study) because investors are not very good at sticking to a strategy and letting compounding work for them.
Soros was deeply impacted by his mentor and embraced core tenets of Popper’s teachings including the Human Uncertainty Principle (a foundational element of Reflexivity) and the Advocacy of Falsification
Popper’s theories were rooted in the ideas of Human Fallibility (the idea that thinking participants’ knowledge of any situation is always partial and distorted by their biases and misconceptions) and Complexity Theory (the idea that the world is more complex than our capacity to understand it), which, ultimately, led to the concept of Reflexivity (that participants partial, biased or false views led to inappropriate actions that impacted the actual system in which the participants are interacting). To Popper, Human Uncertainty arose from two notions: 1) that it was impossible to know what others know, or don’t know, and 2) that other participants may have different interests, or values, relating to the system in which you are engaged.
When John Burbank from Passport Capital spoke at our iCIO event, the title of his speech was “Price is a Liar,” a concept that Soros expounds upon when he says, “the generally accepted view is that markets are always right, that is, market prices tend to discount future developments accurately even when it is unclear what those developments are. I start with the opposite view. I believe the market prices are always wrong in the sense that they present a biased view of the future.”
Cisco’s market cap is only $139 billion (down from the peak of $555 billion) and it is highly unlikely that will ever hit $1 trillion, as Hauwei in China has a different plan on which global company will dominate the network equipment space in the future. To show Reflexivity in action, not one of the 37 Wall Street Analysts at the time had Cisco rated anything lower than a “Buy” or “Strong Buy” (not a “Hold” or “Sell” anywhere to be seen) at the precise peak in the stock, a stock that would then essentially decline nearly in a straight line for the next decade and a half.
Soros has described how this virtuous cycle can lead to market bubbles, driven by Reflexivity: "stock market
bubbles don't grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception. Every bubble consists of a trend that can be observed in the real world and a misconception relating to that trend. The two elements interact with each other in a reflexive manner."
leading companies and they were willing to pay any price (regardless of fundamental values) to “not miss out.” Investors believed that these companies would remain dominant and they had a misconception that the timeless rules of Capitalism (high profits attract competition) and Creative Destruction (innovation continues and new companies surpass the old leaders) no longer applied. In fact, at the peak of the bubble, the market capitalization of those three companies was $1.3 trillion and instead of rushing to sell those ridiculous valuations short, the opposite occurred and a stunning amount of capital, equivalent to 85% of all the money ever invested into technology focused mutual funds up to that point, flooded into the market in the first four months of 2000, rushing to buy, not sell these bubblicious names.
We have written in previous letters about Charles Kinderberger’s seven-year cycle of booms and busts that follow the business/economic cycle, which results from the interplay between “Insiders” (those with the greatest knowledge of companies like owners, management and professional investors) and the “Masses” (those with the least knowledge about companies like retail investors and rules based funds).
Soros goes on to say that "money values do not simply mirror the state of affairs in the real world; valuation is a positive act that makes an impact on the course of events. Monetary and real phenomena are connected in a reflexive fashion; that is, they influence each other mutually. The reflexive relationship manifests itself
most clearly in the use and abuse of credit. It is credit that matters, not money (in other words, monetarism
is a false ideology).”
In the mad scramble for loan creation during the final phase of the Housing Bubble, the government
created an environment of essentially free money by allowing the big agencies, Fannie Mae and Freddie Mac (or Phony and Fraudie, as I often affectionately refer to them) to securitize loans to the bottom of the barrel risks with crazy terms like no money down and incredibly low “teaser” interest rates. Soros has a comment that applies here as well, "when interest rates are low we have conditions for asset bubbles to develop. When money is free, the rational lender will keep on lending until there is no one else to lend to."
Then, yet again, what were Mr. Kindleberger’s “Masses” doing at the peak? Why, of course, they were loading up on index funds, that were loading up on what had run the most (in classic reflexive fashion), the banks and financials, so when Citi and BofA fell (95%) and Phony and Fraudie fell (99%), investors learned, yet again, that price is a liar.
participants who push markets to extremes, resulting in the booms and busts we have all experienced over the years. Soros has an important belief related to this construct, that "the financial markets generally are
unpredictable. So that one has to have different scenarios... The idea that you can actually predict what's
going to happen contradicts my way of looking at the market."
On the contrary, he would acknowledge the uncertainty, as well as his own biases and misconceptions, and boldly make decisions and investments. He states very clearly, "you have got to make decisions even though you know you may be wrong. You can't avoid being wrong, but by being aware of the uncertainties, you're more likely to correct your mistakes than the traditional investor."
He then goes on to explain why it is so hard for most investors to admit when they are wrong, to accept that they have made an error, and to correct the error before it grows into a more costly mistake. I have been fortunate to interact with many of the very best investors in the world, to talk about their investment strategies, and all of them talk about the ability to limit the losses when you make a mistake. Soros, as always,thinks about the concept with a philosophical perspective, "once we realize that imperfect understanding is the human condition there is no shame in being wrong, only in failing to correct our mistakes."
Making mistakes as an investor is inevitable, but failing to correct your mistakes is inexcusable and can, in the worst circumstances, be cataclysmic to your wealth. Soros has also stated very clearly why this concept is perhaps the most important concept in investing in saying "I'm only rich because I know when I'm wrong. I basically have survived by recognizing my mistakes. I very often used to get backaches due to the fact that I was wrong. Whenever you are wrong you have to fight or take flight. When I made the decision, the backache went away." Being wrong means you are losing money. Losing money means you are eroding the power of compounding, and given George’s amazing long-term track record of compounding, he clearly never stayed in pain very long. You can’t compound at 26.3% (for any period, let alone 41 years) if you don’t recognize your mistakes and take swift and decisive action to correct your errors. Peter Lynch was famous for saying that the best way to make money was to “let your flowers grow and pull your weeds” (another way of saying fix your mistakes). The problem is that most investors do the opposite, they pull their flowers at the first sign of making a profit and they let their weeds grow because they are too proud to admit they are wrong or too stubborn in wanting to show the world that they are right. On the flip side, Stanley Druckenmiller, who worked for Soros for many years has been
quoted often in describing the most valuable lessons he learned from his mentor and said, "I’ve learned many things from him, but perhaps the most significant is that it’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong. The few times that Soros has ever criticized me was when I was really right on a market and didn’t maximize the opportunity. 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 you’re right on something, you can’t own enough." I love so much about this quote because it encapsulates so much investment wisdom and should be a mantra for any investor striving to achieve long-term success. Investing is not about ego; it is not about being right; it is about making money. Great investors don’t care about being wrong -- they correct mistakes and move on, they focus on the next play, not the last play. But most importantly, great investors know when they have an edge and they are not afraid to push their position. The difference between poor investors and great investors is “Losers Average Losers” and “Winners Press Winners.” I have written about this
before, but every Tiger Cub I have ever talked to has said the same thing about the Big Cat (Julian), “he had an uncanny knack to double, UP.” Another great quote, from Peter T. McIntyre, is applicable here, “confidence comes not from always being right, but from not fearing to be wrong.”
Soros has said "if I had to sum up my practical skills, I would use one word: survival. And
operating a hedge fund utilized my training in survival to the fullest.” Soros survived a Nazi occupation of Hungary and a myriad of life struggles in his path to establish a unique investment philosophy rooted in the Darwinian ideal of survival of the fittest (adapt or die) and that philosophy and strategy has produced one of the world’s greatest investment track records.
Soros describes one of the ways in which you may be able to tell when a trend is exhausted as “short term volatility is greatest at turning points and diminishes as a trend becomes established. By the time all the participants have adjusted, the rules of the game will change again." Volatility is generated when investors without conviction cannot hold their position as the trend begins to change. The early adopters of a trend are the most knowledgeable and have the greatest time horizon, so they are able to hold through the normal ups and downs that occur in the markets. As the trend matures, the latecomers, who are simply chasing the past performance, have little conviction in the trend and can be easily shaken out when the original investors begin to take profits and move on. That high level of volatility is indeed a telltale sign of turning points (both up and down) in the investment markets. One of the biggest reasons for that is that the bulk of the investment capital is controlled by large institutions and Soros describes the problem very well in saying "the trouble with institutional investors is that their performance is usually measured relative to their peer group and not by an absolute yardstick. This makes them trend followers by definition." That trend following behavior exacerbates the reflexive process and leads to higher highs and lower lows, resulting in lower overall returns for the average investor and institutions as a group, but also leads to truly outstanding returns for investors like Soros who understand Reflexivity and have the discipline to take the other side of these short-term investors’ movements.
Creds: Anish
