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This Legendary Investor is Preparing For a Big Downturn - Should You Believe Him?

By Jessica Alling – Mar 8, 2014 at 7:00AM

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Undoubtedly one of the best investors living, George Soros is upping his game in preparation for a big market correction. Should the average investor do the same?

Source: Flickr/Irekia

Each quarter, Main Street investors get a glimpse of what portfolio moves the pros have made in the past few months. One of the greats, George Soros, has been preparing his Soros Fund Management LLC for a big market correction -- should you do the same?

The man
George Soros is one of the most successful hegde fund managers of all time. His Quantum Fund has returned over $40 billion to investors since its inception, including $5.5 billion last year alone.

Working with funds since the late 1960's, Soros has had plenty of time to study the market and its temperamental moods.

In fact, before opening his first fund, Soros developed the theory of reflexivity: see share prices rising? Market sentiment would be positive and entice new investors to the table, increasing buying and driving prices higher. This happens until the scenario is no longer sustainable and then a new negative sentiment drives action in the opposite direction.

So it goes, on and on in the "virtuous or vicious" cycles.

Predicting the future
Soros is highly sited for his 2008 prediction of a "superbubble" that had been building for 25 years and was ready to pop. With quick and decisive action, Soros had hedged his fund's portfolio, ultimately leading to a 32% -- or $4 billion -- return for 2007, a year when the S&P 500 index recorded a 5.5% return.

So given the all-time highs reached by the market's biggest indexes over the past year, there are plenty of investors convinced that a big correction is on the way -- and George Soros is one of them.

During the fourth quarter, Soros's fund more than doubled down on its bearish position for the S&P 500, increasing its holdings of put options the SPDR S&P 500 ETF, which tracks the index. The increased value of the puts make it the fund's largest position, commandeering 11% of the funds holdings, or $1.3 billion.

Approach with caution
When investors see a professional making such drastic increases in his fund's position on a bearish outlook for the market, it can be tough to avoid getting overly jumpy.

But before you take drastic measures to hedge against the possibility of a market correction like these two pros, remember this: George Soros predicted three market collapses and only one actually materialized.

The New Paradigm was Soro's third book predicting doom and gloom for the market. The first two, The Alchemy of Finance (1987) and The Crisis of Global Capitalism(1998), included stout arguments for collapses that never occurred. Even Soros acknowledge his proclivity for crying wolf, saying that after "the boy cried wolf three times ... the wolf really came."

The lesson for investors is that, while professionals have opinions about what will happen, not a single person on the planet knows exactly how the market will act in the coming days. Of course a correction will happen, ups and downs are inevitable, but trying to time the market can lead you down a very expensive path littered with losses.

So what do you do?
With the Soros fund holding its largest position in the put options, it may be grossly overestimating the chances of a correction. In fact, the S&P 500 finished 2013 up 30%, before having a rough start to the year. Even with sharp declines in late January to early February, the index is up 0.75% year to date, and has gained over 8.8% since the beginning of the fourth quarter 2013.

Luckily for Soros, his fund can absorb some of the risk that comes with rising price of the index. You on the other hand, would likely lose you hat if you followed the Soros plan to the letter.

Instead of trying to take predictive/protective positions in the market, focus on the long-term approach of investing. Find companies with stable operations, good management, and staying power. If you hold on to these types of investments through a downturn, their value will likely return to normal in time.

Jessica Alling has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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