David Einhorn: The Pequod Returns Home
Has the bubble whale been slain? And is it really time to celebrate?
All men live enveloped in whale-lines. All are born with halters round their necks; but it is only when caught in the swift, sudden turn of death, that mortals realize the silent, subtle, ever-present perils of life. — Herman Melville, Moby-Dick
One key difference among investors and traders is their perspective on the market price. Does it contain valuable information?
Value investors have their metaphor of the emotional Mr. Market who, as Buffett will remind you, is there to serve and not to instruct.
What others are doing means nothing. It’s what Graham writes in Chapter 8 of “The Intelligent Investor,” that the market is there to serve you and not to instruct you. That’s of enormous importance. — Warren Buffett
A value investor may simply compare their estimate of intrinsic value to the market price and pick up a bargain if offered. Traders on the other hand may consider price an input into their decision making. Simple trend following is the most extreme example; nothing but price matters.
This can lead to opposite reactions when a position goes south. A trend follower simply stops out and protects their capital.
My job is to get with the flow. I will make a forecast, but my job is simply to trade the range. — Paul Tudor Jones
A value investor has to decide who is wrong: is the market getting more irrational (in which case keep buying as prices fall) or has the investor made a mistake?
While contradictory, both mindsets can work in their respective games. Typically, the value investor judges an individual security while the trader may traffic in the market as a whole. Tragedy, or comedy depending on your perspective, ensues when you mix the two as happens occasionally when a fundamental investor starts making macro bets. Sebastian Mallaby put it eloquently in More Money Than God:
Value investors pride themselves on rock-solid convictions. They have torn apart a company balance sheet and figured out what it is worth; they know they have found value. Macro investors have no method of generating comparable conviction.
I’ve written about the difference in style in the past, for example in the case of Paul Tudor Jones’s short of the Japanese bubble. Jones saw the bubble clearly, as did many others. But he could not predict the timing and regularly stopped out, waiting for the right moment to pounce.
Every time it breaks 5%, I will sell it. I will probably try to market-time it, and risk 2-3% of my portfolio. And it will probably cost me another 4-6%. But it is going to break. I will catch it, and I will get paid 25% or 30% or 35%. That is my function, to try to get with it.
Julian Robertson on the other hand took his value mindset into macro bets as his fund grew in size. The conviction that had served him well became dangerous.
Julian always doubled up. When a short was going down, he pressed it, and when a long was going up, he pressed it. — Mark Yusko
Tiger ended up with a monstrous short Yen position that cost him dearly during the 1998 market turmoil:
During the course of October, Robertson managed to lose $3.1 billion in currencies, primarily from his bet against the yen; and his excuses were not persuasive. “The yen, which was as liquid as water, suddenly dried up like the Sahara,” he pleaded to his investors, failing to add that liquidity had evaporated not least because of Tiger’s recklessness. Tiger had been short an astonishing $18 billion worth of the currency—a position almost twice as large as Druckenmiller’s famous bet against sterling.” — More Money Than God
What about bets that are somewhere in between, that combine a macro thesis with the value mindset on individual stocks?
David Einhorn occasionally sets out on that kind of thematic whale hunt. In 2008, he harpooned high profile targets like Lehman Brothers. The financial crisis was also the culmination of his pursuit of Allied Capital.
Einhorn had been shorting frauds since he started Greenlight in 1996. And he had the scars to show for being a short seller during the dotcom bubble:
We also lost money shorting Chemdex, a publicly traded start-up setting up a business-to-business (B2B) network for companies to sell chemicals to one another.
Chemdex had almost no chance to generate enough commissions to cover its enormous up-front investments or its operating expenses … We invested 0.5 percent of our capital to short Chemdex at $26 in September 1999, which was up substantially from its $15 IPO price in July.
I got a clue and gave up. We covered at $164 per share on February 22. This made Chemdex/Ventro our biggest short loser of all time, costing us 4 percent of capital.
Did I feel smart when the shares hit $243 on February 25? No. That was not ten times as silly as $26. Both were stupidly silly. Of course, after the bubble popped, the shares touched $2 later that year … on their way lower. — Fooling Some of the People All of the Time
Only a few years later in 2014, he spotted what he believed to be a repeat of that bubble and again sharpened his spear and set sail.
The current bubble is an echo of the previous tech bubble with fewer larger capitalization stocks and much less public enthusiasm. … Once again, certain ‘cool kid’ companies and the cheerleading analysts are pretending that compensation paid in equity isn’t an expense because it is ‘non-cash’,” Greenlight wrote. Einhorn Bets Against Tech as ‘Cool Kid’ Stocks Show Bubble
In his most recent letter he explained why:
Historically, we have avoided so-called valuation shorts, because valuation by itself is rarely a catalyst. After all, twice a silly price isn’t twice as silly.
However, during the 1998-2000 bubble, we recognized that shorting bubbles can be quite profitable when they burst. Though we didn’t expect to ever see another bubble like that one again, we were wrong. When we saw a second mega-bubble forming, we wanted to participate in the subsequent decline.
His eyes transfixed on the target, Einhorn was almost lost at sea.
After years in rough water, investors asked What Exactly Happened to David Einhorn? Specifically, they wondered about his short basket that included some marquee growth names:
“Bubbles do pop, you know. Or at least they used to,” Einhorn noted somewhat wryly at Sohn.
But Einhorn’s shorts on Amazon and Netflix — part of what he calls his “bubble basket” of some 20 to 40 stocks — are head-scratchers to those who think those companies are growth machines that are here to stay.
He has returned triumphantly, or so it seems.
The Greenlight Capital funds (the “Partnerships”) returned 36.6% in 2022, net of fees and expenses, compared to an 18.1% loss for the S&P 500 index.
2022 was an exceptionally good year. In many ways it was our best ever and is most comparable to 2001, the year after the last technology bubble popped. — Greenlight Q4 2022 letter
Has he really been vindicated? In his letter Einhorn laid out the history of his bubble short. Let’s take a look.