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GURU OUTLOOK: DAVID EINHORN IS VERY WORRIED ABOUT THE DEBTS

GURU OUTLOOK: DAVID EINHORN IS VERY WORRIED ABOUT THE DEBTS

WSOP No-Limit Texas Hold 'em World Championship

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 500 experienced last year.  He has since recouped all of the losses this year.  Einhorn is famous for his 2006 18th place finish in the World Series of Poker and has proven over the last 13 years to be one of the best risk managers on Wall Street.  So what does Einhorn like now?  Let’s take a look.

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.

 


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Sign up today for an exclusive discount along with our 30-day GUARANTEE — Love us or leave, with your money back! Click here to become a part of our growing community and learn how to stop gambling with your investments. We will teach you to BE THE HOUSE — Not the Gambler!

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