GURU OUTLOOK: DAVID EINHORN IS VERY WORRIED ABOUT THE DEBTS
Courtesy of The Pragmatic Capitalist
David Einhorn became a household name last year when he attacked Lehman Brothers (among other companies) for their poor financial condition. He very publicly shorted the stock ahead of the firm’s implosion. This didn’t help Einhorn from losing money for the first time in his career, however. His firm’s flagship fund finished the year down 22.7% in 2008. It looks bad at first glance, but this was just half of the losses the S&P
Einhorn is increasingly concerned about the debts in the financial system. Einhorn had some very interesting comments earlier this year regarding gold, which has become one of Greenlight’s favorite positions. He isn’t a goldbug, but Einhorn is growing increasingly concerned about the future of fiat currencies due to irresponsible monetary and fiscal policies. Einhorn has very little faith in the Fed to print us back to prosperity. The following is an excerpt from his 2008 year-end letter:
We never thought we would ever buy gold or gold stocks. David’s grandfather Benjamin was a goldbug. From the time David was ten, Grandpa Ben took every opportunity to tell David about the problems with fiat currencies and the coming inflation and advised that the only sensible thing to do was to buy gold and gold stocks. And, for the last thirty years of his life, that is what Grandpa Ben did. And it was a lousy investment. Being a patient investor is one thing. Being “wrong” for three decades is quite another. To everyone’s dismay, we believe that some of Grandpa Ben’s predictions are playing out. Our current chairman of the Federal Reserve, Ben Bernanke, is an “inflationist.” When times were good, he supported an easy money policy. Even when the Fed raised rates, Bernanke took great pains to give the markets many warnings to insure that the higher rates wouldn’t break up the credit party, i.e. bubble formation. Now that the cycle has turned, the Fed has promised to resort to “all means necessary” to head off the effects of the collapsed bubble. Rates have effectively been lowered to zero. The Fed is making loans collateralized by toxic waste and has now begun a policy called “quantitative easing” – a fancy term for “printing money.” The size of the Fed’s balance sheet is exploding and the currency is being debased. Combined with an aggressive fiscal policy, it is clear that the authorities are going “all-in” to try to mitigate the near-term effects of the economic collapse. Our guess is that if the chairman of the Fed is determined to debase the currency, he will succeed. Our instinct is that gold will do well either way: deflation will lead to further steps to debase the currency, while inflation speaks for itself. We have bought gold, calls on gold, an index of gold mining stocks (GDX) and calls on higher long-term U.S. interest rates. We have also moved some of our cash into foreign currencies, particularly the Japanese Yen.
When I watch Chairman Bernanke, Secretary Geithner and Mr. Summers on TV, read speeches written by the Fed Governors, observe the “stimulus” black hole, and think about our short-termism and lack of fiscal discipline and political will, my instinct is to want to short the dollar. But then I look at the other major currencies. The Euro, the Yen, and the British Pound might be worse. So, I conclude that picking one these currencies is like choosing my favorite dental procedure. And I decide holding gold is better than holding cash, especially now, where both earn no yield.
Einhorn has been very vocal about his physical gold holdings, which he prefers over the gold ETF’s or miners.
Although he is concerned about the debts at home, Einhorn believes Japan might be past the point of no return. In essence, he argues that Japan is 10 years in advance of the U.S. in terms of their debt problems:
Japan appears even more vulnerable, because it is even more indebted and its poor demographics are a decade ahead of ours. Japan may already be past the point of no return. When a country cannot reduce its ratio of debt to GDP over any time horizon, it means it can only refinance, but can never repay its debts. Japan has about 190% debt-to-GDP financed at an average cost of less than 2%. Even with the benefit of cheap financing the Japanese deficit is expected to be 10% of GDP this year. At some point, as American homeowners with teaser interest rates have learned, when the market refuses to refinance at cheap rates, problems quickly emerge. Imagine the fiscal impact of the market resetting Japanese borrowing costs to 5%.
Along these same lines, we have bought long-dated options on much higher U.S. and Japanese interest rates. The options in Japan are particularly cheap because the historical volatility is so low. I prefer options to simply shorting government bonds, because there remains a possibility of a further government bond rally in response to the economy rolling over again. With options, I can clearly limit how much I am willing to lose, while creating a lot of leverage to a possible rate spiral.
As of the end of last summer, Einhorn had turned neutral on the equity markets. His bottom up approach was finding very few opportunities and Einhorn spent much of the summer taking profits and selling into the rally. As of the end of September Einhorn’s largest followings are as follows:
- Pfizer (PFE): 7.64%
- CareFusion (CFN): 7.32%
- Cardinal Health (CAH): 6.86%
- Teradata (TDC): 6.56%
- URS (URS): 5.78%
- Gold Miners ETF (GDX): 5.58%
- Wyeth (WYE): 5.35%
- Einstein Noah Restaurant (BAGL): 4.97%
- EMC (EMC): 4.75%
- Aspen Insurance (AHL): 4.22%
- Travelers (TRV): 4.04%
- Microsoft (MSFT): 3.39%
- Everest Re (RE): 3.22%
- McDermott (MDR): 3.17%
- MI Developments (MIM): 2.93%
Einhorn has been vocal about shorting the ratings agencies McGraw Hill (MHP) and Moodys (MCO) as well.
It’s not the brightest of outlooks, but count on Einhorn to continue generating superb risk adjusted returns regardless of the market environment.
