In recent months we have seen one after another hedge fund mogul and asset manager turn decidedly bearish: first it was Carl Icahn warning that the market will crash when central bank credibility finally runs out, then David Tepper suggested two months ago that a proper multiple for this market is 16x instead of the current 19x, and then most recently, Sam Zell bet the peak of the housing bubble has arrived when a week ago he dumped 23,000 apartment units to Starwood [15], in a deal that was a carbon copy of what he did just before the 2007 bubble burst.
Then over the weekend, we found that Dan Loeb is the latest who, after getting hit by the market and losing 8.9% in Q3 and 4.5% YTD according to this October 30 letter, has decided the central bank liquidity-driven rally may have overstayed its welcome and not only derisked by one third but added so materially to the short side that his short bets now outnumber his long ones.
First, some top level perspective from Loeb on the two biggest variables for the global economy: China and the Fed.
- A weakening China, where the new question is not whether but how severe the slowdown of the world’s foremost growth machine will be. In August, we saw for the first time the limits of the Chinese government’s ability to manipulate the economy as animal spirits triumphed over central planning. While the situation has stabilized somewhat since, the downside scenario for China seems more intimidating than ever before;
- Janet Yellen may have inadvertently checked herself and the Fed into the Hotel California. It is increasingly difficult to see how the Fed can justify raising rates in 2015, particularly considering recent employment weakness in the U.S. (an unwelcome surprise) and similar softness in manufacturing figures. Unlike the concerns that weighed on the Committee earlier in the year – that a rate hike might damage the fragile environment outside of the U.S. – recent data undermining consensus U.S. growth assumptions requires different analysis. If the U.S. consumer is weaker than had previously been believed, the Fed needs to be careful not to push the world into a recession. Ms. Yellen cannot afford to get this wrong;
So in addition to the previously reported new holdings by Third Point in Baxter and Japan's Seven & i, how is Loeb's booked positioned at this moment:
Despite a difficult quarter for our portfolio, we are optimistic about what we own: a mostly U.S.-centric, concentrated portfolio of event-driven names and structured credit. We understand the macro and market challenges to the overall investment environment. We do not see indicators of a looming U.S. recession and so, while volatility is likely here to stay and multiples may be capped, we are seeing some compelling value opportunities in stocks. The environment for short selling is also attractive and we have more single short names than long positions in our book today. We have reduced our net exposure by nearly a third through sales and new shorts over the past few months while maintaining significant positions in our highest conviction, event-rich names. The conviction to keep and add to our core healthcare names during the selloff enabled us to re-establish ourselves on positive footing this month.
So "more single name shorts than longs." Why?
Investors feel there is no longer a monetary safety net, as a tidal shift in fund flows from central banks has removed the “Fed put”, creating headwinds instead of tailwinds.
That may be but not quite yet: consider the recent barrage of "all in" central bank easing, which has seen the PBoC cut, the ECB preview QE2, Sweden add to QE, and the BoJ promising to add easing "if necessary" in just the past two weeks, and even the Fed is now mostly expected to do nothing until well into 2016. Ironically, it will be the ongoing squeeze of the shorts - both Loeb's and everyone else's - that is the primary driver of the historic meltup in the S&P over the past month, which got its green light with the terrible September jobs report.
