Last month’s meltdown in internet stocks has kept me up at night. No,
it’s not because I lost a lot of money. I like net stocks but still
believe in a balanced portfolio. Actually I’ve been troubled because
the sell off has been missing the big “why.” Well, last week brought
the answer, and I’m sleeping a lot better now.
Throughout the downturn I kept looking for the usual horror stories –
you know, the overextended on margin kind of thing, but the worst anyone
could come up with was a universe of investors with about 2 1/2 percent of
their assets on margin. We didn’t hear about any one diving out of
windows or, thank God, any desperate day traders off on shooting
sprees. Mutual fund mangers didn’t report withdrawals, and, in fact,
had net inflows. So who, I wondered, was selling, and who was hurt.
Last week we found out. It turns out that it was none other than the
legendary financier and hedge fund operator George Soros and his chief
lieutenant, a/k/a portfolio manager, Stan Druckenmiller. No postal
shoot outs here, but when the cannon finally went off it was
Druckenmiller who ended out on the street — poorer, no doubt, but, by
most standards still well off.
Like hedge fund manager Julian Robertson before him, Druckenmiller has
had a hard time adjusting to the new, low inflation, high growth
economy. Druckenmiller’s stock performance record was built in the
early 1990’s, when the economy still had cycles and inflation was still
a factor in the investment equation. In other words, the days when you
could make money the old fashioned way — by making huge cyclical
But that method of investing hasn’t worked for a while, and, last year
Druckenmiller was faced with the task of turning around the
underperforming but still eight billion dollar Quantum Fund. So he
turned to the only thing that was working in the market — internet and
technology stocks. No, Virginia, it wasn’t mom and pop who drove these
stocks to their dizzying heights of late 1999 and early 2000, it was the
same professional investors who kept telling us how “overvalued” they
were. In essence, Druckenmiller made his own performance in 1999 by
buying the same stocks he now admits he didn’t understand.
So if you buy something you don’t understand, you probably won’t be the
first to catch on when people start to sell, which they did earlier this
year. Why? Well, for starters, P/E multiples had risen by about
50%,which is often a sell signal. Too, those investors who had gains —
and there were lots of them — needed to raise tax money. Finally, the
first quarter is a lousy time historically for tech stocks, anyway.
So, fully leveraged, Druckenmiller was caught in a downswing. His boss,
George Soros, who admits the kind of bets he used to make don’t work any
more, probably hastened the decline by pulling the plug. According to
what I’ve read, the (formerly) $8 billion Quantum fund admits to being
down about 30% this year and is ready to return cash to all its
investors (unlike Julian Robertson, who distributed the assets to other
managers). In other words, Quantum, except for Soros’ stake, is
liquid. It has sold its holdings. I’ll bet other hedge funds are in
the same position, since they often follow each other.
So now that you know (1) why these stocks went to dizzying heights, and
(2) why they fell to earth you’ll probably sleep better, like me. And
with that out of the way, you can start focusing on the value part of a
group that has undergone a serious correction. And don’t loose any sleep
over Soros and Druckenmiller, either. Even at half its former value,
the Quantum fund is formidable, and I’m always impressed by someone who
knows when it’s time to fold his hand and move on. Remember that the
next time the multiples expand by 50%.