Stanley Druckenmiller (Trades, Portfolio) is one of my favorite investors to listen to due to his sardonic sense of humor and no-nonsense takes on the state of capital markets. He’s willing to admit when he is wrong and talk openly and honestly about what he finds difficult to understand in the world today, which is a sharp departure from the attitude of many of the talking heads and pundits these days.
In this BloombergÂ interviewÂ from Dec. 18, 2018, he talked candidly about how algorithmic trading systems have disrupted his investment process and how he has had to adapt to this new world.
The role of algos
Druckenmiller, who formerly worked with legendary investor George Soros, has said on numerous occasions that the way the market generates signals for investors has changed in a big way. He hasn't said algorithmic traders are necessarily doing anything fundamentally wrong, just that they have made his own life and work difficult. A key part of his investment philosophy has always been that the market is always right, so it doesn’t matter how clever you are or how good your thesis is -- if the market is giving you a clear signal that you are wrong, then you have to go with it.
Machines, however, have different motivations from human investors and traders. They rely on complex decision-making systems that are not easy to interpret for other market participants. To make matters worse, different algorithms will often respond differently to the same event, making it even harder to make sense of price action. Druckenmiller said that, as a result, market signals do not convey as much information as they used to:
“[It used to be] that if a company was reporting great earnings and everyone loved it and the stock didn’t perform well for three or four months, almost inevitably something happened that you didn’t foresee six months down the road. And I’ll never forget about two or three years ago, Facebook had reported great earnings. The stock was like $122, opens at $131 after hours and like three days later it’s trading at $116. So the analysts come in and they’re saying 'nothing’s wrong, it’s great.' I said no, you’re wrong, kid. Something is gonna come out that you just don’t know yet, something terrible. Anyway, a year later the stock is at $220. So that didn’t mean anything."
So while price action used to act as a valuable counterweight to news and commentary, it is now largely noise. This is bad news for trader-investors like Druckenmiller, who used to have a significant edge in being able to "read the tape" and discern what was actually happening behind the scenes. Nowadays, the movement of a stock in the immediate aftermath of an event “doesn’t mean anything other than some hedge fund is doing something.”
With all that being said, Druckenmiller still prefers to look at price signals rather than the news, but the role of the former in his process has been greatly diminished. As a result, and by his own admission, he is no longer able to generate the same returns (30% annually for 30 years) as he used to.
Read more here:
- Is Today's Monetary Policy Effective?
- Warren Buffett on Calculating the Intrinsic Value of High-Growth Businesses, the St. Petersburg Paradox and Common SenseÂ
- Howard Marks: Nothing’s Riskier Than a Widespread Belief That There’s No RiskÂ
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