listen to them. Why bother? Why make the man angry?
Whether or not someone like Arthur Lerner could fathom what reflexivity was all about, George Soros had decided that it was time to test his theories in the marketplace. He felt confident they would be able to give him a competitive advantage.
"I was putting my money where my mouth was and I could not afford to dissociate myself from my investment decisions. I had to use all my intellectual resources and I discovered, to my great surprise and gratification, that my abstract ideas came in very handy. It would be an exaggeration to say that they accounted for my success; but there can be no doubt that they gave me an edge."
The first industry Soros watched closely for the Double Eagle Fund was real estate investment trusts.
In 1969, Soros established a solid reputation by pointing out, in a widely circulated memo, the advantages of investing in a new vehicle called the real estate investment trust (or REIT). Sensing a boom/bust sequence, he likened the REITs' cycle to a three-act play, predicting correctly that REITs would experience a boom, but then go too far, and eventually collapse. Showing great prescience, he concluded that "since Act III was at least three years away, I could safely buy the shares." He was right, and he earned a handsome profit. When, as he had forecast, the REITs became overblown in 1974, Soros went short, making another $1 million. This early exercise in testing his marketplace theories encouraged Soros immensely.
He applied his theory as well to the conglomerate boom of the late 1960s and made money, he acknowledged, "both on the way up and on the way down." Initially, he saw that high-tech companies were going on acquisition sprees, inflating their earnings and impressing institutional investors. Soros believed that the "bias" of these "go-go fund managers" would feed conglomerate stock prices. He bought heavily. Later, he sold short and profited nicely when the decline ensued.
In 1970, Soros teamed up with Jimmy Rogers, a Yale graduate, class of 1964, who had been raised in Demapolis, Alabama.
Soros and Rogers. What an investment team they would become. One of the best ever on Wall Street.
Rogers had studied PPE - Politics, Philosophy, and Economics at Oxford University in England, and that had made an impression on Soros the Anglophile and would-be philosopher. During his two years in the army, Rogers acquired a reputation as a specialist in discovering good stocks. He even took charge of his commanding officer's stock portfolio.
Rogers's first job on Wall Street was with Bache & Co. In 1968, with only $600, Rogers began trading in the stock market. Two years later, he began working for Soros at Arnhold & S. Bleichroeder. Then, however, new brokerage firm regulations came into force, which did not permit Soros or Rogers to get a percentage of the profits from their company's stock trades. Arnhold & S. Bleichroeder did not want the two men to leave. But Soros and Rogers had the itch to become independent money managers. They departed and set up their own firm.
In 1973, they established Soros Fund Management (SFM), housed in rather spartan three-room offices that overlooked Central Park in New York.
Far from Wall Street.
What an odd idea in those days. Why would anyone interested in investing locate himself so far from the hub of power?
Jimmy Rogers liked to explain that since he and George Soros did not fall in line with typical Wall Street thinking, there seemed no good reason to be located within the Wall Street precincts. More important to Soros, the office was just a block from his fashionable cooperative on Central Park West.
The work style at SFM was far more relaxed than the usual hectic pace at Wall Street firms. During the summers, employees wore tennis shoes to work, and several, including Rogers himself, rode bicycles to work. Soros and Rogers liked the informal atmosphere around the office. They hoped to be able to keep it like that. No matter how much money they made. Still, everyone put in 80 hours a week on the job.
At the start it was just the two of them, Soros the trader, Rogers the researcher. Well, three-a secretary.
The office seemed small. Yet there was much the two of them could do. It turns out that there was virtue in their small size. They could concentrate on the task at hand and not worry about tripping over bodies, about having to deal with lots of paperwork, about handling the myriad chores that erupt when offices get large.
Yet, they mastered the trade. They kept the fund's capital in stocks. To bet on commodities and currencies, Soros and Rogers used futures or borrowed money. Unprecedented in its scope, the Soros Fund traded in all of the various markets, including currencies, commodities, bonds, and stocks. From their start in 1970 until they finally parted ways in 1980, Soros and Rogers never had a losing year. Others on Wall Street talked about them with growing respect. They seemed to know much more than anyone else about where the economy was moving.
In 1971, the Fund was worth $12.5 million, a year later, $20.1 million. From December 31, 1969, until December 31, 1980, the Soros Fund gained 3,365 percent. Compare that with the Standard & Poor's composite index, which advanced in that same period only 47 percent.
By the end of 1980, the fund was worth $381 million.
Because it was a private partnership, the fund had a few advantages over other, more conventional, funds. Most important, it could sell short, an exercise that carried too much risk for some investors.
It sounded like a harmless enough technique. But to some, it had the ring of being unpatriotic.
They all but said: How can someone bet that a company is going to do poorly? What kind of American are you, anyway? Don't you have faith in your own economy? What kind of person are you, trying to exploit someone else's bad fortunes?
Soros didn't care. For him, the technique worked like a charm, yielding large gains in American and overseas markets. The fund also leveraged itself through the purchase of stock on margin. One dividend for the Soros Fund was its small size; freed of burdensome bureaucracies, it could move in and out of a stock position far more easily than large firms.
Soros and Rogers meshed well together. "Usually, if we disagreed," Rogers explained, "we just did nothing." Not always, however. If one felt strongly about a trade, he got his way. "Once we worked things through," said Rogers, "it was pretty clear that the trade was either right or wrong. When we thought something through, a consensus was formed. I hate to use that word, because consensus investing is a disaster, but we almost always seemed to come together."
They prided themselves on being independent-minded.
That was going to be their downfall-eventually. They were so independent-minded that they would in turn ffnd too many things wrong with each other.
But for the time bung, they functioned like a well-oiled machine. Neither thought he could learn much from other Wall Street analysts, the ones who, according to Rogers, simply followed the herd. They selected their own stocks.
And they read. Everyone read. They subscribed to 30 trade publications, including Fertilizer Solutions and Textile Week. They perused general-interest magazines, looking for social or cultural trends that might prove valuable. Hundreds of companies had SFM on their mailing lists. The fund's files included financial records of over 1,500 American and foreign firms. Each day Rogers pored through 20 or 30 annual reports, hoping to find some interesting corporate development or the glimmering of a long-range trend-something that others couldn't quite see.
The "something" they searched so assiduously for was a sudden change.
Soros was on the lookout for sudden changes in a stock group, changes that no one else had yet identified in order to test his theory. As Rogers put it, "We aren't as much interested in what a company is going to earn next quarter, or what 1975 aluminum shipments are going to be, as we are in how broad social, economic, and political factors will alter the destiny of an industry or stock group for some time to come. If there is a wide difference between what we see and the market price of a stock, all the better, because then we can make money."
One example, in the early 1970s, was the "sudden change" Soros found in the banking industry.
In 1972, Soros sensed that change was about to occur in that sphere. Banks had the worst of reputations then. Their employees were considered stodgy and dull, and few believed that the banks would rouse themselves from their deep slumber. Understandably, investors
"Look for a sudden change in the stock market, a change not yet identified by anyone else."
showed no interest in their shares.
Soros, however, had done his homework and found that a whole new generation of bankers, fresh from the top business schools and ready to act aggressively on behalf of their employers, was taking over, quietly but decisively. These new bank managers were focusing on the bottom line-and that was bound to help the prospects of bank stocks. The managers were using new ffnancial instruments, and the banks' earnings performances were looking up. Bank stocks, however, sold at virtually no premium. Many of these banks had reached the limit of their leveraging capabilities. To continue to grow, they needed more equity capital.
In 1972, the First National City Bank hosted a dinner for security analysts in an unprecedented display of aggressiveness. To his obvious chagrin, George Soros did not receive an invitation. But the dinner spurred him into action. He wrote a brokerage report and called it "The Case for Growth Banks," arguing that while bank shares had been going nowhere, they were about to take off-contrary to what others thought. Timing the publication of the report to coincide with the bank's dinner, Soros laid out his arguments for getting behind the bank stocks. He recommended some of the better-managed banks. In time, bank stocks began to rise, and Soros garnered a 50 percent profit.
The bank turnaround marked the beginning of the great lending boom of the 1970s, a boom that fueled the expansion and amalgamation of corporate America in the 1980s. In accordance with his theory of reflexivity, Soros had identified the start of a boom in a boom/bust cycle.
Searching as well for foreign economies about to take a giant leap forward, Soros sought to capitalize on foreign stock markets. Which countries were opening their markets to foreign investment, which were promoting new policies for economic stabilization, which were committed to market reform?
Soros hoped to reap an advantage for himself by getting in at the wholesale level. "Like any good investor," said one former associate, "he was trying to buy a quarter for a nickel." If there were immature markets, like those in France, Italy, and Japan, Soros took a bead on them. He hoped to invest 6 to 18 months before other investors.
Accordingly, he purchased Japanese, Canadian, Dutch, and French securities. During one period of 1971, one quarter of Soros Fund assets were invested in Japanese stocks, a gamble that paid off when the fund doubled its money.
Soros and Rogers made shrewd stock selections. On one occasion in 1972, an acquaintance informed Soros that a private Commerce Department report described the growing American dependence on foreign fuel sources. Accordingly, the Soros Fund purchased large amounts of stock in oil-drilling, oil-field equipment, and coal companies. A year later, in 1973, came the Arab oil boycott, which caused energy stocks to soar.
In 1972, Soros and Rogers also foresaw the food crisis, and after purchasing stock in fertilizer, farm equipment, and grain-processing companies, earned impressive profits.
And the beat went on. Around this time, Soros and Rogers craftily identified the American defense industry as a potentially profitable source of investment.
In October 1973, Israel was caught by surprise when Egyptian and Syrian armed forces launched major attacks against the Jewish state. In the opening days of that war, Israel was on the defensive, suffering thousands of casualties and losing many planes and tanks. There was some indication that Israel's military technology was antiquated. It occurred to Soros that American technology must be antiquated as well. And, realizing that its hardware was obsolete, the Pentagon would have to spend large amounts of money to revitalize it.
This thesis had little appeal to most investors. Defense firms had lost so much money once the war in Vietnam ended that financial analysts did not want to hear anything more about them.
Early in 1974, however, Rogers began to keep a special eye on the industry. The potential in the defense industry encouraged Rogers to hit the road. He traveled to Washington, talked with Pentagon officials, and journeyed to defense contractors around America. Soros and Rogers grew even more convinced that they were rightand the others were going to miss out on something big.
In mid-1974, George Soros began scooping up defense stocks.
He bought Northrop, United Aircraft, and Gruman. And, though Lockheed seemed threatened with extinction, Soros took a bet on that company, investing in the firm in late 1974.
He and Rogers had acquired one vital piece of information about these companies. They all had major contracts that would, when renewed, provide fresh earnings over the next few years.
Early in 1975, the Soros Fund began investing in firms that supplied electronic warfare equipment. Israeli air losses during the Yom Kippur War had been due largely to the lack of sophisticated electronic coun-termeasures needed to neutralize the Soviet-manufactured weaponry in Arab hands.
They also noted that the modern battlefield was fundamentally changing. A whole new arsenal of modern equipment was now state-of-the-art: sensors and laser-directed artillery shells and "smart bombs."
All of this was going to cost a good deal of money. Soros and Rogers were right, resulting in large earnings for the fund.
What was Soros's secret at this juncture?
Infinite patience, to start with.
Then, a highly developed sense of where to find "gold" in the stock market. Everyone looked for the "gold," everyone had a theory where it could be found. Soros, however, had his antennae attuned to the movements of the financial market, searching all the time for some mysterious signal that something was afoot.
When he picked up the signal, he homed in on it, never letting on to anyone why he was moving in one direction and not another, testing his instincts against the reality of the market.
He knew he was good.
All he had to do was look at the bottom line year in and year out.
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