A Frustrated David Einhorn Asks "Will The Market Cycle Never Turn?"

Just days after Third Point's Dan Loeb took a victory lap in his latest letter to investors, boasting a 14.5% YTD performance, outperforming the S&P and virtually all of his peers, a decidedly more downcast letter was released today by Greenlight's David Einhorn, who also had a good quarter, generating 6.2% in Q3, which brought his YTD return to 3.3% after a subpar first half. Yet despite the solid Q3 performance, Einhorn admits that "the market remains very challenging for value investing strategies, as growth stocks have continued to outperform value stocks. The persistence of this dynamic leads to questions regarding whether value investing is a viable strategy. The knee-jerk instinct is to respond that when a proven strategy is so exceedingly out of favor that its viability is questioned, the cycle must be about to turn around. Unfortunately, we lack such clarity. After years of running into the wind, we are left with no sense stronger than, “it will turn when it turns.

Such an open-ended answer, however, is a problem for a fund which famously opened a basket of "internet shorts" several years prior, and which have continued to rip ever higher, detracting from Greenlight's overall performance.

This, in turn, has prompted Einhorn to consider the unthinkable alternative: "Might the cycle never turn?" In other words, is the market now permanently broken.

Einhorn goes on to explain that his strategy "relies on the assumption that the equity value of a company equals the market’s best assessment of the current and future profits discounted at the company’s cost of capital. Our ability to outperform often comes from our skill in finding opportunities where the market has misestimated current or future profitability or miscalculated the cost of capital by over- or underestimating the risks."

It is here than an unexpectedly exasperated Einhorn emerges:

Given the performance of certain stocks, we wonder if the market has adopted an alternative paradigm for calculating equity value. What if equity value has nothing to do with current or future profits and instead is derived from a company’s ability to be disruptive, to provide social change, or to advance new beneficial technologies, even when doing so results in current and future economic loss? It’s clear that a number of companies provide products and services to customers that come with a subsidy from equity holders. And yet, on a mark-to-market basis, the equity holders are doing just fine.

Ah yes, the Fed-funded "deflation trade" which lowers prices for goods and services courtesy of ravenous investors who will throw money at any "growth" idea, without considerations for return or profit, because - well - more such investors will emerge tomorrow.  After all, in this day and age of ZIRP, what else will they do with their money.

Here Einhorn took aim at his favorite "bubble" shorts: Amazon, Tesla and Netflix. This is what he said:

When we consider the business performance of our three most well-known “bubble” shorts, we wonder if this alternative paradigm is in play. Last quarter, we noted Amazon.com’s (AMZN) earnings estimates had fallen over the prior few quarters. This quarter, AMZN revealed a much lower level of long-term structural profitability, causing consensus estimates for the next five years to drop by 40%, 22%, 18%, 14% and 8%, respectively. Ordinarily, stocks trading at nosebleed multiples fall sharply when such a dramatic reassessment happens. Instead, AMZN fell less than 1% during the quarter. Our view is that just because AMZN can disrupt somebody else’s profit stream, it doesn’t mean that AMZN earns that profit stream. For the moment, the market doesn’t agree. Perhaps, simply being disruptive is enough.

 

Tesla (TSLA) had an awful quarter both in its current results and future prospects. In response, its shares fell almost 6%. We believe it deserved much worse. So much went wrong for TSLA in the quarter that it is hard to only provide a brief summary. The main near-term problems are poor demand for its legacy vehicles and manufacturing challenges for the new Model 3. Notably, TSLA dramatically reduced its gross margin assumption for the September quarter and publicly blamed ramp-up costs for the new Model 3 sedan. More quietly, the company used the lower gross margin hurdle to offer incentives and to lower the cost of options on the Model S and Model X vehicles, and even offered significant markdowns on showroom models. Given the depth of the price cuts, we were surprised that demand for the Model S and Model X only improved modestly.

 

Meanwhile, it is becoming clear that scale manufacturing is actually a skill. While the CEO makes bold claims about TSLA’s superior prowess, continued production shortfalls, defects and product recalls disprove him. TSLA faces competition from established OEMs that have decades of scale manufacturing experience. Some of TSLA’s presumed market lead in areas like autonomous driving may more likely reflect TSLA’s willingness to put inadequately  tested and dangerous products on the road rather than a true technological advantage.

 

Finally, there is Netflix (NFLX), where the quarterly results beat expectations and the shares advanced 21%. Competition is heating up and media companies such as Disney will be removing their content from NFLX to compete directly (bulls used to believe that Disney would pull a Time Warner/AOL and pay-up for the highly promoted but profitless business). NFLX continues to accelerate its cash burn as it desperately tries to compensate for its inability to rely longer-term on licensed content. On the second quarter conference call, the CEO stated, “In some senses the negative free cash flow will be an indicator of enormous success.” To us, all it indicates is that NFLX is capable of dramatically changing the economics of stand-up comedy in favor of the comedians. Perhaps, there really is a new paradigm for valuing equities and the joke is on us. Time will tell.

Einhorn also highlights the biggest winners and losers in the quarter including CONSOL Energy (CNX), General Motors (GM) and Uniper (Germany: UN01) which were the largest contributors, while Caterpillar (CAT) short and Mylan (MYL) were detractors.

Some more details: Greenlight added long positions in Hewlett Packard Enterprise, Micron and Tempur Sealy; exited a short position on Best Buy and a long position on PVH. The fund's largest disclosed long positions at quarter end were unchanged from the end of 2Q: AerCap, Bayer, Consol Energy, General Motors and gold. The parternships had an average exposure of 118% long and 73% short.

The full letter is below:

Comments

spastic_colon Dame Ednas Possum Tue, 10/24/2017 - 12:53 Permalink

using his CAT short as an example; it has become obvious that the dislocations have come from torching any short positions by allowing and likely encouraging VERY creative accounting especially if you are a weighted index component security; this is the major hazard of the politically motivated FED and board rooms across the spectrum; until these bastions of fraud are infiltrated nothing may change.

In reply to by Dame Ednas Possum

asteroids Dame Ednas Possum Tue, 10/24/2017 - 13:42 Permalink

Dear David: We can do some rough figuring. The FED with QE has printed up Trillions and given it to its member banks. Those banks burn billions on unproductive assets like hookers, blow and bonus's. The FED says it will take back a paltry 20billion/mo. Calculate how many months it will take to evaporate those trillions and you'll get in the ball park.

In reply to by Dame Ednas Possum

LawsofPhysics Tue, 10/24/2017 - 12:55 Permalink

Not in anyone's lifetime - Ben BernankeHow has this fucker escaped execution for treason?  Simple, all animals are created equal, but some animals are "more equal" than others..."Full Faith and Credit"

Badself Tue, 10/24/2017 - 13:00 Permalink

How can so many intelligent people not see how this will end.  Look at Venezuela not Spain and you will see our future.  The market will never cycle again until the collapse of the current govt occurs.

Quivering Lip Wed, 10/25/2017 - 14:15 Permalink

I'll ask this question again. Why is it that these intelligent people can't figure out that there is no market. Only counterfeiting done by the major Central Banks for the benefit of their owners. If you can conjure up fiat at the press of a keystroke and continually purchase assets with fiat created out of thin air you have no market. You have no real value in anything.When Non GAAP and mark to fantasy became the norm all reality vanished from the financial world. Fraud is the new norm.When yeild on sovereign debt went zirp/nirp reality disappeared. I mean who the fuck buys negative yielding bonds when Central Banks have been debasing their currencies for decades? Trying to make sense of anything financially is like trying to reason with an Alzheimer's patient who has profound cognitive and memory loss.At some point I'm sure the bottom will fall out and the owners of the CB'S will do it all over again. Until then party like its September of 1929.Centralized Confiscation and Consolidation through Counterfeiting.

Phillyguy Tue, 10/24/2017 - 13:21 Permalink

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The new "paradigm" for the markets is to continue inflating stock prices using share buybacks and cash MA deals which has been fueled by the continuous infusion of >  $4 trillion of ultra-cheap money from the US FED. No doubt, the financial windfall from Trump’s $trillion + tax cut for the wealthy will be used to further elevate share price and further line the pockets of greedy corporate CEOs. The dire financial conditions facing the average American can be summed up in one statistic- 60% of US adults do not have $500 in savings (see: money.cnn.com/2017/01/12/pf/americans-lack-of-savings/index.html). This is going to end in a financial explosion which will make 2008 look like a Sunday picnic.

GreatUncle Tue, 10/24/2017 - 13:51 Permalink

Reckon it is possible now, they learned it in 2008 ... a bull or bear market, price corrections are all relative.Consider a normal rate of 7% YOY increasing profits.Now everyobdy reckons 0% or less is the correction.The correction could be anything less than some arbitrary figure but the minimum must satisfy Keynes and that can never be negative for sure.How to compare it ... just know that the +2% YOY Keynesian value is the new 0%, they no longer have the ability to put it much less than that now there is no slack in the system to put lower it past that.Only by people cashing out of markets in a big way can send it to a < 2% now and even that does not stop the CB's propping it up because if the Keynsian limit is breeched goodbye CB's. 

khakuda Tue, 10/24/2017 - 14:39 Permalink

You can't be short yet. Unprecedented CB money printing. The late 90s was very similar, but this is much worse. High stock prices allowed companies to lose money and not be punished back then. Now, Switzerland and Japan print money and buy stocks at any price.

CBsdecided after 2008 to create an inflated stock market anyway possible and they don't have a target price. Sky is the limit and no one can stop them.

Barney08 Tue, 10/24/2017 - 18:03 Permalink

The market would have to rewind to 2012 to make him whole. He is totally fuk'd! I don't think he's as bad off as Ackman but he's gotta be close.