Traders Interview: Michael Steinhardt Talks With Larry Connors

• November 9, 2001
• Larry Connors

Two weeks ago, I had the honor of speaking with hedge fund legend Michael Steinhardt. When I was preparing to interview him, I was looking most for insight into his trading style and his trading strategies. Turning each investor’s $100,000 into over $48 million dollars in 28 years (after fees!) from trading is not something one sees on a daily basis. Was Steinhardt’s edge some magical trading strategy or some magical system? The answer is absolutely “No.” Is Steinhardt a financial genius? In my opinion, he’s smart – very smart. But probably no smarter than many of the members of TradingMarkets.com.

Steinhardt’s edge is a combination of his intensity to get an edge with knowledge, combined with a mental intensity that few people could survive. It’s his ability to measure himself and his performance hourly, every day, for 28 straight years. Most individuals would self-destruct under such intense pressure. But for the few, like Michael Steinhardt, who can do this, the results are simply spectacular.

Here is my talk with him. If you are looking for a “Holy Grail” trading system, you’ll be disappointed. You won’t find it here. If you’re looking for some insight into what it takes to mentally succeed at an extreme level, Michael Steinhardt has the answer.

Larry Connors: I want to tell you, your book, No Bull: My Life In and Out of Markets, is terrific – it’s been a week and a half since I got it — and I’ve read it twice.

Michael Steinhardt: Really? Thank you. I appreciate that.

Connors: OK, real quickly on your trading style. It’s a top-down approach. Everything begins with market direction? Is that correct?

Steinhardt: Not everything, but a lot of things begin with markets. But the real philosophy isn’t that so much: It’s to come in every day with the idea that you are devoting that portion of your life, that you are devoting most of your energy that day, to making money. And that day will be measured — because the stock market has this wonderful thing where almost everything is measured. A success will be when you do well, and a failure will be when you don’t do well.

It’s not a phenomenon that you measure irregularly or every year or even every month. You really measure it every day. If you think about it that way, you think about the opportunities that develop every day. Those could be the call from some guy at an institutional desk who has a big block of something, or a sense that there’s a change, or something you see in the newspaper, or something that provokes you based on some past experience.

While this doesn’t reflect the totality of your portfolio, it reflects some portion of it and something that you might do that might add some increment to your overall performance based on what you saw that day. Therefore, it’s not only a matter of what you asked in your question in terms of top down or bottoms up, or anything like that.

It’s a matter of using every opportunity you can, of all sorts of types — from the theoretical and cerebral to the “chasing down new issues,” (pardon the expression) that I used to do because my measure of myself was my performance. Period. And if that performance could be enhanced by spending time, getting in a little early and listening to all the block indications, and seeing if I could pick up some hint of something by doing that, that was part of my game.

Connors: In your book, you talk a lot about your intensity — the aggressiveness of your management style. I came away from it saying, “This is really a large part of this man’s edge. This is the reason for this phenomenal performance. His edge is his intensity. It’s almost your willpower, and it’s beyond 99.9% of what anyone else on Wall Street brings on a daily basis. Is that an accurate assessment? Do you perceive it that way?

Steinhardt: I do. I wish I could say it were otherwise, frankly. I wish I could say that if I, in some dilettantish way, came in and said, “Copper! Copper!” (laughs) Copper is the metal of the early 21^st century!” And I just made a judgment and I went home, and in two years I came back and I made a fortune – or supposedly what Buffett does. I mean, it doesn’t have the same intensity. It doesn’t consume the same energy; it’s not as emotionally draining. The way I did it is not an ideal way to do it, it seems to me, in terms of one’s lifestyle. But I do answer your question in the affirmative, as a function of intensity, as a function of the feeling that my own self — and my sense of self — fluctuated with performance.

Connors: To me, another fascinating, eye-opening thing that I read in your book was when you say, “A track record over the years was achieved through intense devotion to the principles of long-term investing that was tempered by my compulsive need to have monthly, weekly, and even daily profits.”

And then about 10 pages later, you say, Warren Buffett has said, “If you’re not willing to own a stock for 10 years, do not even think about owning it for 10 minutes.’ The truth of the matter is I’ve never owned a stock for 10 years but have had the unique and profitable experience of owning some very good companies for 10 minutes.” How do you balance those two philosophies?

Steinhardt: Well, the word “balance” is an interesting word there, and I’m not sure you do “balance” those two philosophies — and often they’re in conflict — but the technique that I used was based upon my history as an analyst.

Somehow, I took the view that by doing analytic work and making the sorts of judgments that are long-term in nature, I would come to certain conclusions — that I would use those conclusions for both longer-term judgments, as well as trading.

While there may be some question about how relevant longer-term judgments are in trading, maybe that dubiousness is somehow tempered by the fact that there is an element of timing in whatever you do. Particularly if one is focused on a company or an industry and there’s a sense that things are changing, if one can conclude quicker than the rest of the world what those changes are going to be – even though they are of a long-term nature, they often have a short-term impact.

So that’s the sort of thing I try to do: To think about things that led to some perception of truth. Truth is a funny word, but truth has a certain timeless quality. But then, when you narrow it down, the truth that you think you’ve found before the rest of the world that will result in a 30% or 40% gain in a year (if it results in a 12% gain in two weeks) — the equation’s really changed.

Connors: Is the timing of that “truth” instinctive and intuitive?

Steinhardt: (sighs) To some degree, yes, and when I would ask myself a question, “Why was I able over a long period of time to make better market calls than most people?” I had the feeling that there was an issue of it being intuitive. Then the question is, “What does intuition mean?” And I thought intuition meant the cumulative, non-conscious experiential phenomenon that led one to make conclusions that on balance were better than others’.

On specific areas of timing, then it was sometimes not so much intuitive, but experiential. If an analyst came in and said, “I think that Mr. X or Analyst Y is changing his view on thus and so, and it’s not quite as good as it once was,” there is an element of, you know, “He’s going to change his estimate for the next year or two,” — but if you can be there a little quicker than most, in terms of getting in the position to take advantage of that, I mean, the results could be defined in a narrow time frame (which was your question) — this isn’t intuitive, it’s really experiential.

There used to be the phrase — maybe there still is — of “first call” which is one of those marginal issues in our business. (Should there be a first call and is it proper, and shouldn’t information be disseminated at the same time?) And the sense I have, and it’s perhaps a bit of a distant sense, is that in the last periods, the relative advantage of first calls has been greatly diminished by a more homogeneous distribution of information, but maybe not so.

Connors: If that’s true, obviously whatever edge you had is an enormous edge. Is that edge balanced off a little bit now because of the dissemination of information, or would you just be attacking this game a little bit differently because that edge might have gone away.

Steinhardt: I felt with perhaps one or two caveats, reasonably comfortable in going into areas where I did not have so much of an experience edge and being able to function well in those areas, because so much of the judgments I used started out with a macro-orientation, so when I speculated in bonds (even though I didn’t have nearly the experience in bonds that I had in stocks), I felt relatively comfortable fairly quickly, although I must say on one level it was a rather amateurish comfort, because I didn’t even know the phraseology of the bonds — and I’m not sure I could totally understand analysis that related to the yield curve and stuff like that.

But I certainly could understand, you know, the sense of where people thought the economy was going and what a disparate perception would be, in terms of broader economic judgments and their likely implication in terms of Fed policy, stuff like that, which was sufficient I thought, to allow me to function in a lot of markets. It may be a cliche at this point, but the idea of “variant perception” really works — and it works in most markets.

Connors: You talk about that in the book. Can you go in a little bit deeper? What does variant perception mean and how does an individual apply it? If you were teaching me to apply variant perception to my own trading, what would that mean?

Steinhardt: Well, it seems to me, and this is going to sound a bit cavalier but I think we should start that way: If you can have on one basis or another, a conviction about something that is meaningfully off consensus, and that conviction turns out to be correct, you can say that just those facts alone should almost always result in profits. Now that’s a strong statement.

In other words, being a bit more specific: If you view that the year 2002 is going to have an inflation rate of 6% — or 5% — and the world thinks it’s going to be 3% and you turn out to be right, you can almost invariably make money from that. If your view is that IBM is going to earn X (as opposed to Y, which is the Street consensus) and you turn out to be right, you can almost invariably make money from that. So I mean we can go into a range of areas: If you think the dollar is going to collapse next year because the US economy is going to get weaker, and Japan for the first time is going to pick up, you can almost invariably make money from that.

Connor: But why would I be more right making that decision than anybody else who has, for argument’s sake, a bell-curve upbringing and a bell-curve perception of the world?

Steinhardt: OK, that question goes back to the first question you asked in terms of longer-term perception, what we’ve tended to do here is think about those broader issues. What we’ve further thought about — and this may be a stretch for some people — that the application of energy, intellect and judgment to broader areas could lead, on balance, to better conclusions. Now some people may deny this. Some might say that your ability, my ability or anybody’s ability, to predict some macro judgment about interest rates or currencies, or the level of the stock market – it’s all random. If you believe that, then the idea of variant perception, in a broad sense, diminishes a great deal.

But if, on the other hand, you believe that if you were devote 100% of your energy to the idea of studying Japan (for example) and that through that effort you would have a better understanding of Japan, or a sense of change more quickly than other people, then that creates the opportunity for you.

Connors: It’s a knowledge game

Steinhardt: It’s a knowledge game.

Connors: If I came to you and said, “Today is Day One. I want to get into the hedge fund business. I want to achieve what you’ve achieved. What would you tell me to do?

Steinhardt: Well, I’d tell you to start early. I’d tell you to ask yourself questions like: “What do I really care about?” “Does it make me feel really good when I pick what I used to refer to as the moving parts?” You know, a lot of people in the business really enjoy persuading people to do things. A lot of people enjoy trading securities. A lot of people enjoy doing research. There are different things one can do. I really enjoyed being right. That’s what I cared about.

So first you’ve got to really know yourself and know that’s the thing that really makes you happy, that really is fulfilling. That to be right, to make the right judgments is important to you — because without that, you don’t easily have the intensity and without the intensity you’re not likely to give it the necessary energy to be competitively superior.

I think one should look at this game — as a professional in the stock market – as a competitive enterprise and you have to think about the fact that there are nameless, faceless legions of people trying to do the same thing you’re doing and trying to outsmart the market. To do it, you’ve got to be better, smarter, more intense, etc., etc., etc.

So I would start as early in life as possible. I would not think that it could be done by any cerebral process – that it’s a matter of energy and intellect, and emotion and time. I’m not sure I’m saying something that you really don’t know.

Connors: But it’s a philosophy that not only applies to being a hedge fund manager, but applies to being at the top of any game. Jack Welch would probably be saying the same thing, as would Vince Lombardi –

Steinhardt: That’s probably true. The differences, if any, are that with the hedge fund area, you have the great virtue of being measured every day, or every hour, or any time you press a button. And it’s that judgment that dominates. You can’t say, “You know, I would have had a great year except for the fact of Sept. 11.” Or, “I was doing terrifically – except that they ambushed me on the earnings.”

It’s all in the numbers, and once you accept the fact that the numbers are the overall measure and however justified or unjustified your performance is, based upon whatever facts were involved, you have to live with that.

Connors: And the pressures that come from that — with that daily self-imposed performance measurement you’ve set yourself. That’s phenomenal. Thanks for sharing your thoughts.

Steinhardt: You’re very welcome.

Conclusion

Here is your formula for turning $100,000 into $48 million, Michael Steinhardt style:

1. You execute and gain a knowledge edge.
2. And you do this at a 30% average annual rate every year for 28 years.
3. Then you break this down to quarterly and monthly performance benchmarks for 28 years.
4. And then (and this is Steinhardt’s edge) you put unthinkable pressure on yourself to perform and execute at this level every hour, of every day, of every week, of every month, of every quarter, of every year, for 28 straight years.

Few people are willing to play at this extreme level. But for those who are (like Michael Steinhardt), the results speak for themselves.