Hedge fund manager David Einhorn, who runs $8 billion Greenlight Capital, sent out his second-quarter letter to investors.
In it, the famed fund manager gives his observation of what he thinks is going on in the stock market.
“The market’s rapid advance in the face of a challenging earnings backdrop may be creating an unstable condition. This could resolve itself in a few ways: the market could melt-up, melt-down, or even do the former followed by the latter,” Einhorn writes.
In his letter, Einhorn discusses the Fed and Chairman Ben Bernanke. He even gives Wall Street Journal reporter Jon Hilsenrath a shout out even though it’s not by name.
Here’s an excerpt [via ValueWalk’s Jacob Wolinsky]: (emphasis ours)
After Wall Street’s knee-jerk sell-off following President Obama’s re-election, the market proceeded to march upward at a steady pace until first quarter earnings season, when the rate of appreciation accelerated. Between mid-April and mid-May, the S&P 500 gained 8.5%, the Russell 2000 advanced 11% and the Japanese Nikkei 225 advanced 18%.
During the first few years of the market recovery, the formula for higher stock prices was “beat estimates and raise guidance.” Not anymore. Now it’s enough to beat the current quarter, and make it easier to beat the next one too by simultaneously lowering forward expectations. “Beat and Raise” has become “Beat and Lower” and seems just as effective at driving stocks higher. Indeed, in the recent quarter, 70% of companies in the S&P 500 “beat” the official street estimates, while forward estimates fell for roughly the same percentage of companies. At this point in the cycle, lowering the bar seems to be treated as bullish because it increases the likelihood of future earnings beats.
So if lackluster annual earnings growth in the low single-digits does not explain the rising market, what does? The consensus view is that the Federal Reserve’s easy money policy is driving the growth. It is now undeniable that the market is watching the Fed, perhaps more closely than ever. At a press conference in mid-June, Federal Reserve Chairman Ben Bernanke raised the possibility that the Fed might reduce its quantitative easing program in September, and end it by the middle of 2014, triggering the first notable stock sell-off in months.
What is equally obvious is that Chairman Bernanke is watching the market just as closely. It didn’t even take two days of negative reaction from the financial markets before a plugged-in journalist (who is widely believed to be the Fed’s unofficial spokesperson) reported that – oops! – it was all a big misunderstanding. That the Fed can’t stand a couple of bad days in the market without reversing course suggests that the Fed will follow the path of least resistance and continue with its counterproductive policy rather than accept the transitory market effects of ending it. The Fed’s pain tolerance for market declines (even on the heels of large gains) appears to be strikingly low.
The market’s rapid advance in the face of a challenging earnings backdrop may be creating an unstable condition. This could resolve itself in a few ways: the market could melt-up, melt-down, or even do the former followed by the latter. By the middle of May, the postelection run-up helped raise the Partnerships’ gross exposure to record levels. Accordingly, we made considerable reductions in both our long and short portfolios, positioning us to ride out future volatility and to take advantage of new opportunities. During the sell-off in late June, we found a few new opportunities which slightly increased our net long exposure.
Read the full letter below:
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