This note was originally published
at 8am on May 03, 2011.
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“I feel dirty making money on the long side in this market”
-A Hedgeye Client that has been successfully making money on the long side
This quote comes from a client of hedgeye, who just happens to work for one of the largest “long only” money managers on the planet. Why does he feel dirty? He’s probably shares many of the same views that David Einhorn has had as he’s been covering his shorts. The music is playing and the kids are Dirty Dancing. The Chuck Prince of 2007 would approve. The grownups, however, do not.
David Einhorn had this to say, in the Greenlight capital Q1 Shareholder Letter: “The broad market, which shrugged off the continued escalation of commodity prices, unrest in the Middle East, a catastrophe in Japan, tightening monetary policy outside the United States and a deceleration of domestic economic growth...this quarter we were repeatedly confuzzled when we read company news announcements that we expected to cause falling stock prices, only to see them rise instead – and sometimes sharply at that. Nonetheless, we believe that this environment is cyclical, and that it will continue this way... until it doesn’t.”
Einhorn likens the market today to Charlie Sheen, believing that “all publicity is good publicity”. Einhorn’s past record and thorough thought process that comes through in his writing are both impressive. He is no Bud Fox; he understands the danger of investor psychology and groupthink. Nevertheless, he is not confident that his firm can call the turn so he has been covering.
Both Einhorn and the Hedgeye Client quoted at the beginning of this Early Look are thoughtful market operators that have generated alpha in different market cycles across sectors and geographies. Clearly by the sentiments they are expressing, they are alerting us to a real problem that exists in money management at this point in equity markets. Capital has been pumped into the system through two rounds of quantitative easing and PM’s that want to get paid will chase yield with that capital. The stock market rally has been self-sustaining in that regard; a rising stock market does improve consumer confidence among higher income brackets. However, the reception of all news as good news is disturbing to say the least. As the multitude of interconnected global macro factors continue to change in real-time, the government is handcuffed with sky-high debt, zero percent interest rates, and slowing economic growth.
The pension fund community, too, has been dragged into this game of pass-the-grenade. “Assumed” rates of return are to be hit lest the funds face a significant shortfall on their obligations. Given the fear of inflation that has rightly taken hold, pension funds cannot look to bonds for the required 7-8% returns with interest rates at 0%. Rather, pension fund managers are chasing yield right at the top of the cycle. In fact, I would argue – although Keith may not agree (so this is not the official Hedgeye view) – that the cycle has already topped.
Jobless claims have given back all of the progress that was made from January 2010 onward. GDP slowed sequentially and sell-side expectations for GDP growth are coming back down to earth. What’s more, Fed-sponsored inflation and price instability is the ultimate kryptonite for the economy as we head into 2H11.
Osama bin Laden’s death is a great victory for the U.S. Military and the American people, but it is important to keep that in context from a market perspective. Many market pendants are trying to spin this as a positive for the consumer and thus the overall market. While it may have been yesterday, for a time, consider the day-to-day realities facing Americans. Sky high gas prices, food costs, clothing costs, healthcare costs and declining purchasing power are a constant reminder to consumers of the fragility of the economy.
Even if Bin Laden’s death is to have a long-lasting impact on markets, it may be a negative one if any retaliation or escalation of extremist terrorist activity causes an increase in the global risk premium and the cost of oil. In fact, a CNBC.com poll conducted yesterday indicated that, of just under 10,000 respondents, 72% of people responded “No” when asked if they felt safer now that U.S. forces have killed Bin Laden.
The Dirty Dancers out there are counting their blessings that the market, perched on a precipice, is still on two feet thanks to the maintenance of the status quo. Quantitative Easing sponsors bubbles and I believe that while earnings have been strong of late, many markets are taking on more and more of the characteristics of a bubble. Dr. Rich Peterson uses three main parameters to describe a bubble. First, it’s a great story. Secondly, it has unlimited upside and finally, it is confirmed by higher prices. An asset class that is exhibiting these characteristics is difficult to resist. Pension fund managers and hedge fund managers alike are following market momentum as their performance targets require them to.
All the while, great stories are being told as to why the market should keep going up. Inflation is “transitory”. Japan’s catastrophe is not a big deal. Oil prices are still not high enough to impact the consumer, according to some. At the end of the day, all of these stories are supportive of higher equity prices.
How will it end? This debate begins on the topic of debt and deficits. Hedgeye believes that a country’s currency is a prescient indicator of its underlying economic health and we view the USD crashing as a bearish indicator, just as it was in 2008. Warren Buffett’s recent quote on the impossibility of a U.S. debt crisis of any kind “as long as we keep issuing our notes in our own currency” is based on several obvious assumptions that neither Mr. Buffett nor anyone in the investment or bureaucratic community can be certain of. The unexpected is unexpected for a reason. That the political make-up of Washington D.C. will allow the federal government to continue on this road or to involve itself with the States’ debt issues remains to be seen.
Part of the timeline of the USD Currency Crash call we’ve been making has been this literal moving target on the debt ceiling limit. It was only three weeks ago that Secretary Geithner was doing some Dirty Dancing of his own, drawing a firm line in the sand that May 16th was the debt ceiling debate’s date with destiny. Now, after 1Q11 GDP growth sequentially slowed and the dollar maintained its downward trajectory, Geithner has decided to join the festivities by pushing out the deadline to July 8th as of a few weeks back and now to August 2nd as of yesterday. “Extend and pretend” is a phrase that comes to mind.
In my view, the bottom line is this; there are some terrific story-tellers out there. Whether it’s today on Osama bin Laden’s death being bullish for confidence but not for oil, that the global currency market will tolerate this crashing of the global reserve currency, or Secretary Geithner procrastinating in the hope that the market will give the dollar a bid, story-tellers abound.
Lastly, this weekend I went shopping with my daughter for her prom dress. After trying on at least thirty different dresses, the first twenty-nine were not good enough, she found the right one. She has assured me that there will be no Dirty Dancing at the prom.
Function in Disaster; finish in style,