David Einhorn Is Winning Big By Being Bearish On Stocks And Bullish On Inflation
David Einhorn’s Greenlight Capital returned 4% net for the third quarter, bringing its year-to-date return to an impressive 17.7% at a time when most hedge funds are in the red—and some massively so. The S&P 500 declined 4.9% for the third quarter and 23.9% for the first nine months of 2022.
Additionally, while most long/ short equity hedge funds have gotten the majority of their returns from their short holdings, Greenlight Capital has enjoyed positive returns on the long side. The fund’s long portfolio contributed 5.9% to its third-quarter return, while shorts added another 0.1%, and macro subtracted 2% from the net return.
Bearish on stocks, bullish on inflation
In Greenlight’s third-quarter letter to investors, which was obtained by ValueWalk, David stated that he thinks the correct posture is to be bearish on stocks and bullish on inflation—a position that has served him and his hedge fund exceedingly well year to date.
He explained that the Federal Reserve appears to think inflation is caused by a supply/ demand imbalance, adding that there are two possible approaches to such an opinion. The first is to increase supply, which would require productive investment, and the second is to decrease demand, which would reduce income and wealth, lowering living standards.
Einhorn and his team remain quite critical of the Fed’s moves this year, emphasizing that the central bank is focused solely on decreasing demand over increasing supply. Of course, higher interest rates reduce investment and supply.
The Greenlight founder says that the most glaring area that brings evidence of this is in housing, where higher rates lead to reduced supply despite the widespread shortage that exists currently. He warned that the Fed’s policy could make inflation worse rather than better.
Einhorn believes supply and demand are only one piece of the inflation puzzle, with the creation of money — like the billions printed during the pandemic — being the other primary piece. He also questioned whether the Fed will succeed in reining in inflation, adding that the Fed itself questions its possibility of success as well and noting that nothing is being done about fiscal policy.
“As long as official policy is to make the stock market go down, so that people are less wealthy, so that they buy fewer things, so that prices stop going up, all while doing nothing about fiscal policy, we believe the correct posture is to be bearish on stocks and bullish on inflation,” the fund declared.
As a result, they have substantially slashed their gross long exposure year to date and clarified that their third-quarter purchase of Twitter
Einhorn notes that it’s clear that we’re in a bear market. Pivoting from “cautious” to “bearish” in January has served his firm quite well. Although the firm outperformed the S&P 500 for years, it has underperformed significantly over the last decade. This year’s returns have recovered Greenlight’s underperformance since the end of 2018, but the fund still has a lot further to go.
They added that it’s unclear whether we’re in a recession. GDP growth was negative in the first two quarters of the year, which typically marks a recession. However, politicians are debating the definition of a recession, which Einhorn’s team doesn’t find surprising, “as we appear to be in a post-factual world.” They pointed to a recent comment from a Fed governor who said he was “actually happy” about the stock market’s plunge.
Despite the plummeting prices across the entire stock market, which have plagued virtually every other hedge fund, Einhorn and his team were able to pick some winners.
During the third quarter, the big winners were long positions in Atlas Air Worldwide and CONSOL Energy, a short in Eurodollar derivatives, a long position in Green Brick Partners, a housing hedge for Green Brick, and Twitter.
Atlas Air generated significant returns after announcing its sale to a private equity consortium for $102.50 per share. Although that represented a low multiple and likely an extremely attractive deal for the buyers, David “happily” exited the position after the announcement, achieving an investment rate of return of almost 80%.
Green Brick announced second-quarter results that greatly surpassed expectations and was added to the S&P SmallCap 600 Index during the third quarter. The Greenlight team believes a significant slowdown in housing demand restrained the firm’s share price. Mortgage rates have skyrocketed, creating affordability issues. However, the fund not only won with its stake in Green Brick but also with its hedge of nearly half the position with a basket of stocks sensitive to the housing market.
During the third quarter, CONSOL Energy jumped from around $49 to about $64 a share amid continuing strength in the coal markets. The hedge fund expects the company to generate about $50 a share in after-tax free cash flow by the end of 2023. It paid its first dividend of $1 per share in August and announced a plan to distribute at least 35% of its free cash flow to shareholders. The fund chief emphasizes the “at least” part and sees room for that percentage to expand.
Greenlight started shorting Eurodollar futures in its macro book in January, predicting that the Fed would raise interest rates more than expected. Einhorn’s team believes current market expectations are roughly in line with their own, so they have all but exited this position.
The fund wrote about its position in Twitter in its last letter, even though it established that position during the third quarter. Twitter shares rose to around $44 per share during the quarter, but that’s still a sizable discount from Musk’s offer of $54.20 per share. Einhorn believes the case between Twitter and Musk, who tried to get out of the offer he made, is going well for Twitter and that the deal will close at or near that originally agreed-upon price.
Fund likes gold despite weakness
The fund’s two biggest losers were gold and two undisclosed shorts.
Gold plunged from $1,807 to $1,661 an ounce during the third quarter. Sometimes investors just want cash during a bear market and high short-term interest rates compete with gold. However, they remain concerned that the current inflation issue could evolve into a currency or sovereign debt crisis. As a result, Greenlight continues to hold gold even though it could remain weak in the near term.
New positions and exits
The fund’s only new material position during the third quarter was Twitter because management continues to believe we are in a bear market. The fund clarified that there hasn’t been a bear market since 2008 to 2009, and their strategy is to gradually stockpile dry powder as they remain in a bearish position.
In addition to exiting Atlas Air, the fund also sold all of its stakes in Change Healthcare, Chemours, International Seaways, Playboy, and Warner Brothers Discovery.
The fund enjoyed a 40% investment rate of return in Change Healthcare after it completed its sale to UnitedHealthcare. The Greenlight team exited Chemours due to their concern about the deteriorating economic cycle, capturing an investment rate of return in the mid-single digits.
Shortly after the fund established a position in International Seaways, a strategic investor purchased a large stake in the company. Greenlight exited the position with a nearly 40% gain in six months due to concerns about tumbling oil prices.
Playboy and Warner Brothers Discovery were unsuccessful investments. David had believed both companies were going through a significant transformation. However, Playboy failed to execute on its strategy, and Greenlight lost 50% on that position. The fund exited Warner Brothers Discovery with a roughly 40% loss due to concerns that it faces a more challenging path to execution than expected.