Two months ago, a downbeat David Einhorn mused rhetorically "will this market cycle never turn?"
Despite solid Q3 performance, Einhorn admitted 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.
While the Greenlight founder did not explicitly answer the question, in a recent speech at The Oxford Union in England, Einhorn made it clear how farcical he believes this market has become, pointing out that the problems that caused the global financial crisis a decade ago still haven’t been resolved.
"Do I think we've learned a lesson from the global financial crisis? It depends on what one thinks that the lesson was, unfortunately" Einhorn says 9'40" into the speech.
Famous for his value investing style and bet against Lehman Brothers that paid off in the crisis, Einhorn said he identified several issues at the time of the crisis, including the fact that institutions that could have gone under were deemed too big to fail. The scarcity of major credit-rating agencies was and remains a factor, Einhorn said, while problems in the derivatives market “could have been dealt with differently," and in the “so-called structured-credit market, risk was transferred, but not really being transferred, and not properly valued.”
"if you look at all the obvious problems from the financial crisis, we really kind of solved none of them. And we went on a different way, and we basically, went the bailout route. And said we are going to create a whole lot of moral hazard, and we're going to sweep as much of this stuff as in the rough under the rug as we can, and we are going to move on as quickly as we can. And so, that solved some things in some ways, but I think it is left the basic structure, more or less, as it was. And I think that it is susceptible to the same type of events or series of events sometime in the future."
Einhorn didn’t avoid discussing his underperformance, citing several failed bets that companies’ stocks would decline. He didn’t name the stocks he was shorting, but insisted that none of the companies are “viable businesses.”
"What I was basically saying was look value investing over time has worked, we think this is the best and right way to invest, it's not going to be true every day, in every environment, but we are in an environment right now, where it doesn't seem to be working at all, and in fact the opposite seems to be working, because people are looking at things and saying, the ownership of a company is something other than the risk adjusted future profits of the company, maybe it's the social disruption, maybe it's the social desirability, maybe is the charismatic value of the CEO."
Einhorn, an avid poker player, also shared the following insight into the similarities between gambling and investing:
Host: You are an avid poker player and say what is your approach to risk, both when dealing with cards and chips and then dealing with stocks.
David: Yeah. Investing in a poker game, and investing in stocks at least the way I do it, it's a very similar skillset. You have certain facts that you know, and in stock investing, it is whatever objective information you know about a company or a situation, you know, what is the stock price is a good one. But also, what the company does, what their sales are, so forth. These objective things that you know. And then, there are things that you can surmise, but you don't really know, you are making an implication, so that would be, you know, what is the motivation of the CEO, what is the strategy, what are the various interests that are there, what does the competition looks like. These are not objective, these are things that through work, you can make an educated guess about, but you don't really know. And then you have a range of things that you don't know that are going to come in the future, which are future events, that are fundamentally unpredictable, but they live within a range of possible future events. So, you combine what you know, with what you think you can surmise, combined with understanding the range of outcomes related to the uncertain things, and say is this a good place to commit a fraction of my capital.
And then you could translate that to poker, what is it that you know, you know how many chips you have, you know what cards you are holding in your hand, if there are cards that are displayed face up on the table, you can what those are, right? And there are things you can surmise, what are my opponent’s cards likely to be, how he is betting the hand, I can get information that way or by sitting in a table and playing with him for a while, I can see what his personality is, what his style is, what his skills and I can make inferences about the present hand based on upon his past behavior. So those are things you are trying to deduce.
And then there is the uncertainty which is the range of future cards that are concealed in the deck that is yet to be displayed, that is important, right, and there is a range of those possible outcomes. And you take a look at all of those things, what you know and what you can surmise, and the range of outcomes and say do I want to, you know, play this hand? Do I want to bet chips into this hand and so forth?
Finally, in the context of Einhorn's generally downbeat mood, we remind us of his exasperated conclusion from the latest Greenlight letter to investors:
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?
Finally, here is the timestamped breakdown of Einhorn's full talk and Q&A from his November Oxford Union speech (h/t ValueWalk):
- 00:21 Introduction
- 02:47 If he ever considered another career path.
- 03:40 How he got started in the business.
- 05:16 Reason for success
- 08:00 Is the culture of the industry changing?
- 09:40 About the 10 years of the global financial crisis, have we learned our lessons?
- 12:32 New perspectives
- 15:06 About disruption and new firms coming along - new technologies
- 15:45 Approach to risks
- 18:15 Charity
- 20:41 Empathy
- 22:45 What next in the philanthropic area
- 24:04 Future of the fund
- 24:47 Start of QA.
- 25:00 Market entry environment
- 32:25 Contrarian investments
- 33:44 Vulture funds and social issues
- 36:53 About future investments and evaluations
- 38:55 Risk and intuition
- 40:19 Financial Crisis
- 42:03 Risk and intuition
- 42:49 Analysis and machine learning
- 45:05 Investment view
- 45:27 Analysis and machine learning
- 46:06 Gap between investor and companies - Corporations have a longer horizon than investors do.
- 49:48 Billions TV Show
Video below (transcript can be found here):