David Einhorn’s Greenlight Capital was up 4.4% for the first quarter, outperforming the S&P 500’s -4.6% return. The fund’s management noted that a lot happened during the quarter, “culminating in an unexpected bout of violence.”
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In his first-quarter letter to investors, Einhorn says that he sees a “decent risk” that the 13-year bull market and the long-running period of relative peace and stability throughout the American sphere of influence since the end of World War II are over. He pointed to the oft-repeated sentiment that COVID accelerated trends and changes already underway, adding that he believes the same is true of the war.
Einhorn notes that the war has accelerated inflation, the ongoing supply chain issues, and energy, food, materials, and labor shortages and that stock prices had already started to fall as well. He sees evidence that inflation is destroying demand, slowing the economy in the process. Einhorn adds that if the Federal Reserve were serious about halting inflation, it “would be as aggressive and creative in tightening as it was when it was easing.”
He also questions whether the Fed is doing whatever it takes to deal with inflation or is merely talking tough, emphasizing that he thinks the central bank is doing the latter.
Greenlight’s long portfolio lost 7% during the first quarter, but gains in its short book and index hedges almost totally offset that loss. The fund reports that macro, led by inflation swaps and gold, generated a little more than all the return.
He segmented the fund’s long portfolio attribution into Green Brick Partners, which plunged sharply and contributed much more than all the loss, and “pretty much everything else, which did quite well.”
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Green Brick Partners and homebuilding stocks
Einhorn believes that even though there wasn’t anything wrong with Green Brick’s corporate performance, its stock plunged from about $30 to around $20 during the first quarter. Analysts slashed their estimates for this year and next by about 2%, although Einhorn says that the problem was with the entire sector, as most homebuilders plunged by similar percentages.
He explained that homebuilding stocks de-rated amid a new consensus view of a collapsing housing market. Analysts circulated the narrative that house prices have risen and noted that mortgage rates are rising. They’re also saying that sales and housing starts are slowing, and inventories and cancellations are rising.
David explains that this narrative supposedly implies a collapse in house prices, leaving homebuilders in a precarious position. He noted that everyone remembers when the last housing bubble popped and that the market appears to be suggesting that it’s about to happen again, meaning the sector is now un-investable at any valuation.
However, the Greenlight team disagrees with the new consensus view, and Einhorn describes the comparisons between today’s housing market and that of 2006 as “strained.”
Why Greenlight thinks the market is wrong about homebuilding stocks
Overbuilding was widespread in 2006, with an average of 3.5 million existing homes for sale, and the 30-year mortgage rate averaged 6.4%. Homebuilders were also highly leveraged, and homes were financed with very loose underwriting standards.
Today’s market comes amid a nationwide underinvestment in housing, which has resulted in a shortage of about 2 million units. Only about 870,000 existing homes are for sale, and mortgage rates sit at around 5%. Underwriting standards are tight amid minimal speculation and low financial leverage among homebuilders.
In Green Brick’s largest market, existing homes for sale have declined 21% over the last year and are down 77% versus three years ago. Most of the indicators the bears are pointing to as evidence of a housing slowdown don’t actually reflect a traditional slowdown.
Instead, he said they reflect the industry’s inability to build houses due to factors like labor and material shortages, which have lengthened construction times. Mortgage rates might at some point impact demand, but for now, homebuilders are constrained more by supply than demand.
Further, any slight decrease in demand probably won’t pose a serious risk to earnings or balance sheets. House prices aren’t the only prices that are rising, as rents are up too. Additionally, homebuilding stocks and home prices did well during the inflationary period in the mid-to-late 1970s.
Changes to Greenlight’s portfolio
Greenlight’s short portfolio posted broad-based returns for the first quarter, led by plunging prices in its basket of bubble stocks and a significant decline in the price of a medical device company that posted disappointing earnings results.
In mid-January, Einhorn adjusted the fund’s positioning to reflect better his view of the weakening economy and the possibility of the end of the bull market. The Greenlight team added more index hedges and increased their macro positions in corporate credit default swaps and inflation swaps.
They focused their research efforts on short ideas, so they didn’t make any large additions to the fund’s long portfolio. However, they did add new small positions in International Seaways, Ryanair Holdings, TD SYNNEX Corporation, Southwestern Energy
Greenlight also exited its long position in EchoStar during the first quarter after holding it for a year with a 22% investment rate of return. Fund management started to worry about the company’s ability to grow its subscribers. Greenlight also dumped Jack in the Box after nearly two years with a 55% investment rate of return.
At the end of the first quarter, the fund’s largest disclosed long positions were Brighthouse Financial, Change Healthcare, Global Payments
Details on new positions
International Seaways owns and operates oil tankers and product carriers. The Greenlight team noted that demand for oil tumbled during the pandemic, resulting in an extended period of low charter rates for tankers. The fund acquired its shares at less than 60% of the company’s liquidation value.
Greenlight expects a tighter market now that demand has recovered to pre-pandemic levels with no shipyard slots available for the construction of new tankers for several years. Amid the tighter market, they expect International Seaways’ discount to its net asset value to close.
Ryanair is the largest low-price airline in Europe. It expanded during the pandemic by upgrading and improving the fuel efficiency of its fleet and reducing its airport costs. Ryanair has secured a competitive advantage by hedging near-term fuel prices, so the hedge fund expects its earnings to beat expectations as demand for air travel continues to recover.
The Greenlight team reinitiated a position in TD SYNNEX as they believe its recent merger with Tech Data
Southwestern Energy is the second-largest natural gas producer in the U.S., and the Greenlight team feels it is well-situated to satisfy growing domestic and export demand. They explained that Europe now plans to cut back on its reliance on Russian energy and depend more on LN
Weatherford offers drilling tools and other products and services needed to produce oil and gas. The company filed for bankruptcy in 2019 due to poor execution and a high debt load, but the Greenlight team believes it has emerged as a “less levered, better managed and cashflow generating business.”
They expect Weatherford to benefit from the many years of underinvestment in exploration and production, which have resulted in severe oil shortages. Greenlight also expects the company to benefit from the significant increase in capital expenditures on exploration and production that’s underway.
Michelle Jones contributed to this report.