Oct 02/15 – The market has left Einhorn for dead

2015-10-02 9am EDT  |  #Einhorn #GLRE #Greenlight #hedge funds #stocks #SUNE #unemployment #Yellen

August was bad, and it doesn’t look like September was any better. Hedge funds continued to get hammered, with renowned managers like Daniel Loeb from Third Point and Barry Rosenstein from Jana Partners, having another down month. Both funds have now slipped into the red for the year. Loeb’s Third Point is down 3.7% year to date, while Rosenstein’s Jana Partners is down 6.6%. And they are by no means alone.

The HFR Global Hedge Fund index is also down for the year with the index slipping below unchanged during August, and hitting new lows into the end of the quarter.

Some of the biggest supposed “superstar” hedge fund managers are having troubles navigating the Federal Reserve induced liquidity withdrawal:

After starting off the year with an AUM of $18.3 billion following a solid 2014 in which Pershing Square returned 40% mostly on the back of Ackman’s aggressive – and questionably illegal – activism involving Valeant, payback arrived with a levered vengeance, and after rising 10.1% through the end of July, pushing Ackman’s AUM to $20.2 billion, the past two months have been absolutely brutal for the last remaining “prominent” hedge fund manager.

Ackman may have hoped the pain would end in August when the fund lost nearly $2 billion in AUM, sliding 9.2% net, but September was a total bloodbath, and saw Pershing Square report one of its worst quarters in history outside of the financial crisis, tumbling by 12.5%, bringing the total loss over the past two months to a whopping -22%, the YTD drop to -12.6%, and the firm’s AUM to $16.5 billion, a loss of nearly $4 billion in just the past two months, and the lowest it has been since early 2014.

I have long held the view too many hedge funds are simply beta masquerading as alpha. It is no surprise the recent risk off environment has shown most of these hedge funds have not engaged in that much “hedging.”

Yet there are funds whose managers are truly exceptional. Usually they are not the ones you see regularly on CNBC – they are too busy taking care of their clients money to worry about having their mugs up on the screen. My favourite hedge fund manager of all time – Stanley Druckenmiller gave something like one interview during the whole time he was actively managing client money. Since his retirement Druck has become more willing to appear on TV, but he was virtually unknown to the general public in his heyday.

Another one of my favourite hedge fund managers also had a terrible 3rd quarter. Actually, it was worse than terrible. In what can only be described as a disastrous performance, Greenlight Capital’s David Einhorn lost 3.6% percent in September, which put him down a whopping 17% for the year.

Einhhorn has all the wrong positions. He owns too much gold. His number one holding is Apple. And one of his biggest bets has been beaten like a red headed step child.

Greenlight Capital is the largest holder of solar company SunEdison. I won’t bother going through the merits of the investment, but needless to say, the market’s confidence in the company’s business model has collapsed over the past quarter.

There is no doubt SUNE was a little bit of a hedge fund hotel. Too many hedgies were trying to coattail Einhorn’s position. When things started to turn south, the crowded nature of the trade made the scramble for the exits all the worse. Given Einhorn’s massive position he wouldn’t have been able to sell, even if he wanted to, without making things way worse.

But is the market correctly pricing Einhorn’s big solar bet? Or did they sense he was in trouble, and start selling ahead of him? During the Long Term Capital Management crisis Meriwether bitterly complained Goldman Sachs was hired to help the fund navigate their liquidity crunch, but all they did was use that information to sell their positions out ahead of LTCM. Wall Street has a long history of front running weak members of the herd.

The question that needs to be answered is whether Wall Street might have overestimated Einhorn’s weakness. Did they push his positions down too far? Is Einhorn going to continue to bleed, or is this a buying opportunity?

When I pulled up the SUNE holders list on Bloomberg, I notice that Dan Loeb has recently bought 2.4 million shares of SUNE. Loeb is a shark, there is no denying that. But he is a lean mean killing machine that is exceptionally savvy when it comes to trading opportunities. When Ackman got in his pissing match with Carl Icahn and overextended himself on the short side of Herbalife, Loeb had no gumption about squeezing him. In a Piccasso-eque fit of brillance, Loeb bought a big chunk of Herbalife and rode it higher for a great trade as Icahn squeezed Ackman. If Loeb thought SUNE was headed lower, he wouldn’t think twice about leaning on Einhorn’s long position. But my suspicion is Loeb realizes SUNE has been unfairly punished.

And Loeb is not alone. Have a look at this great piece by Brone Capital’s John Hempton about why he is buying SUNE (click here for link).

John does a great job outlining the issues and making the case for why the worst might be already baked in.

Obviously Einhorn’s poor performance is not solely attributable to SUNE’s collapse. Yet I think the over reaction might be indicative of much of his portfolio. Great managers have ups and downs. Only fools think it is all straight up. My suspicion is that Wall Street has pushed Einhorn’s names down too far, and this is a buying opportunity. I wouldn’t sell Einhorn short with my worst enemy’s margin, and given the fact that smart guys like Loeb and Hempton are picking away at Einhorn’s names, I think Greenlight’s portfolio will quickly rebound.

But how do you play that? One way would be to buy SUNE, or the other names in Einhorn’s portfolio. And I might be do that, but if you just want to bet on David Einhorn, there is an even better way.

A lot of these hedge fund managers own insurance companies. They like to emulate Buffett who uses the float from his insurance company’s operation to make his investments. David Einhorn is no exception. Greenlight Capital Re (ticker GLRE) is a property and casualty reinsurance company whose float’s main asset is holdings of the Greenlight hedge fund.

The company therefore has two main inputs into its performance. The first is the performance of the insurance operation, while the second is the return from the investments in Greenlight’s hedge fund. My understanding is the insurance part of the operation is relatively stable. You could therefore argue GLRE trades as tracking tool for Greenlight’s hedge fund. But depending on the market’s attitude towards Einhorn’s performance, GLRE trades at a premium or discount to book value.

It is obviously not this easy, but this chart of Price to Book Value gives a big picture view of the market’s expectation of Einhorn’s future performance.

Given the extreme pessimism about Greenlight’s recent returns, they have priced GLRE at the cheapest price to book value since the 2008 credit crisis.

I, for one, am confident David Einhorn will bounce. His recent slump is something all great investors experience. A year from now we will have forgotten about this ugly quarter. If that happens, his hedge fund returns will rise. This will drive the book value of GLRE higher. But I think the discount to book value will also normalize. I could easily envision the discount to book value rising from 0.80 to 1 in a blink of an eye.

The mere normalization of the price to book value would cause a $5 gain in GLRE.

I am buying GLRE with the idea Einhorn’s hedge fund portfolio returns will stabilize and head higher, and at the same time the price to book of his insurance company will return to a more normal level of 1 times book value. The market has left Einhorn for dead, but I think they are selling the wrong guy short.

Good job Janet, you have pushed the economy into a slump

The unemployment numbers were released this morning, and much to the Fed’s surprise, they were terrible. Contrary to their wishful thinking, the Phillips curve did not kick in and cause wage inflation. In fact, all aspects of the report were abysmal.

Economists are surprised, but they shouldn’t be. It is quite simple. The US economy can’t handle higher rates (or even talk about higher rates) and everything that comes along with that (higher US dollar for example).

Too many market forecasters are using old play books to navigate this new environment. This morning on Bloomberg news I heard market pundit Michael Holland blame the crummy employment numbers on the uncertainty created by the Fed failing to raise rates. Holy crap. What a load of horse shit. Do you know how ugly it would be if the Fed had raised rates last month and then we got this employment number? Remember – “Sep 2815 – Repeat after me – rate hikes are not positive for risk assets.”

Thanks for reading and have a great wk-end,

Kevin Muir

the MacroTourist