Here’s What David Einhorn Bought In Q4 As He Prepped Greenlight For A Recession
We’ve all seen the headlines about inflation. The December U.S. inflation reading hit 7%, the highest level in almost 40 years, and consumers are extremely concerned about where it goes from here. A recent Gallup poll found that 79% of Americans expect inflation to keep rising, and half expect it to increase “a lot.”
So what’s the Federal Reserve to do? On one hand, it needs to keep inflation from destroying the economy, but on the other, it has historically shown a preference for propping up the financial markets. It’s looking increasingly likely that the Federal Reserve can’t do both.
Fed Chair Jerome Powell on inflation
David Einhorn has prepared Greenlight Capital for a recession, explaining in his fourth-quarter letter that central banks’ never-ending easy-money policies and global ESG initiatives are starving the poor and causing them to freeze. Meanwhile, the Fed has signaled plans to raise interest rates at its March meeting, but Einhorn is skeptical that it will do more than talk.
Fed Chair Jerome Powell said toward the end of November that the word “transitory” should no longer be used to talk about the current round of inflation. As a result, the market stopped seeing the rapid inflation pace as being short-lived. However, for many market watchers, it was clear that this round of inflation wasn’t transitory long before the Fed admitted it.
At this week’s Fed meeting, Powell warned of prolonged upside risk to inflation and the possibility that price increases could accelerate. He added that it will take a while for the Fed to unwind its massive balance sheet because it is “substantially larger than it needs to be.” Powell also signaled that the first rate hike could come as early as March, setting the stage for a series of rate hikes this year.
In their January 26 letter to investors, the Greenlight team said the Fed often talks about taking “away the punch bowl when the party gets wild… only to return with even more punch when the first partier asks for his overcoat.” They noted that when Powell was asked about whether the Fed would continue to print money by buying bonds, he expressed concern about tapering, saying that the “markets can be sensitive to it.”
The Greenlight team pointed out that this statement suggests the Fed wants to fight inflation without disrupting markets, adding, “Does Chairman Powell think that inflation will go away, simply by noticing it?” They called attention to the Fed’s history of supporting the market at the expense of the economy.
The Greenlight team explained that the market had been conditioned to expect the central bank to keep supporting the market. As a result, many are now concerned that it will make a grave policy error by tightening into potentially decelerating inflation. Some market watchers believe even a single tightening would be an error.
Inflation is “embedded”
Einhorn’s team uses the word “embedded” to describe the current inflation, adding that the Fed will have to give up its protection of the financial markets in order to fight it successfully. They added that they don’t know whether the Fed will tolerate inflation by staying behind the curve or allow financial conditions to tighten so much that the economy slows, and it is blamed for the slowdown.
Edward Moya of OANDA used a similar word in an email on Wednesday, saying that “Powell signaled they will use their tools to make sure inflation does not become entrenched.” He agrees with Greenlight assessment, adding that the Fed will have to “choose between fighting inflation or avoiding a deterioration in financial conditions.”
While the Fed has said that the labor market is in good shape, the Greenlight team believes that the economy and especially the labor market are overheating. They pointed out that the commodity markets are getting tighter and tighter, with oil prices over $80 a barrel and corn at $6. The Greenlight team also warned that these prices could go significantly higher.
They believe it’s unlikely that stopping the money printing and gradually raising interest rates while continuing to prop up the stock market will pull inflation back below 2%. The Greenlight team sees the “paper gains of young speculators” as one of the drivers of the labor shortage, adding that these speculators “would prefer to ‘trade from home’ than take a job.” They believe a “serious bear market” could be needed to get these younger workers to rethink their position.
Not serious about addressing real problems
Einhorn’s team at Greenlight Capital emphasized their view that U.S. leaders are not serious about addressing real problems. They said the nation’s leaders are willing to hold a big event to “celebrate facing the challenge” but not willing to “make hard decisions — that come with real costs — to actually meet the challenge.”
The Greenlight team pointed out that, unlike a comet, inflation won’t destroy the planet, but they believe the world’s poor are “at risk of freezing and starving from central bank easy monetary policies combined with global ESG initiatives. They also pointed out that this combination is creating “political unrest” in some places.
Einhorn’s team believes that inflation will eventually cause a recession, no matter what the Fed ends up doing. They noted that as prices rise, low-income consumers will have to cut back on things due to the higher prices of necessities, adding that there are signs that this is already happening.
As a result, Greenlight has begun to position for that scenario with several new positions in the fourth quarter.
New inflation play: Global Payments
Among those new positions is Global Payments, a payment technology and software solutions provider that enables small and midsized merchants to accept electronic payments. The company also offers ancillary services like payroll. The Greenlight team explained that Global Payments benefits from inflation because it charges a percentage of merchant dollar volume.
They report that the company enjoys 40% sustainable operating margins from taking small fees on billions of transactions, adding that they “rarely find such a high-quality business at a valuation that we find attractive.” Global Payments largely traded far above a market multiple in early 2021, but its stock plunged 46% between April and December as investors started to worry about fintech disruption.
The Greenlight team believes the market is overstating the threat. They also think it’s more likely that a disruptor will acquire Global Payments for its scale, salesforce and relationships rather than outcompete Global Payments. Greenlight bought the stock at an average price of $126.67, or 13 times the consensus expected 2022 earnings per share, and the shares ended 2021 at $135.18 per share.
Other new positions
In February, Greenlight reestablished a position in Capri Holdings, formerly known as Michael Kors Holdings. The fund’s management expects the market to re-rate the company as a diversified luxury brand owner after its acquisitions of the Versace and Jimmy Choo brands and slashing almost 30% of its wholesale business and more than 10% of its North American retail locations. Greenlight added to its position in May and December.
During the fourth quarter, the fund bought shares of Dutch biotech company Galapagos, which develops small molecule medicines. The shares plunged 48% during the first 11 months of 2021 after a series of disappointments in the company’s late-stage drug trials. The Greenlight team noted that Galapagos has €73 per share in net cash, the inflammatory disorder drug Jyseleca, and a pipeline of other early-stage drugs. They believe Jyseleca and the pipeline are worth much more than their implied -€2 billion valuation.
Greenlight bought shares of ODP Corporation, a holding company that operates retail brands like Office Depot and OfficeMax and provides business services and products. The fund’s management explained that ODP is transforming itself by separating its retail and business solutions businesses and that it has a strong cash position and an undemanding valuation. ODP is also in the process of buying back 20% of its shares by mid-2022.
The fund also established a position in Rheinmetall AG, which produces land-based military vehicles. The shares sold off over concerns that the results of Germany’s elections could reduce German defense spending and that the semiconductor shortage could reduce demand for the company’s automotive components. However, Greenlight believes the replacement cycle for military vehicles for NATO and its allies will drive 8% to 10% annual revenue and operating profit growth at Rheinmetall.
Greenlight exited AerCap Holdings, Countryside Properties and fuboTV during the fourth quarter.