Soros, Watsa, Icahn Divided on Shorting or Going Long Trump Rally

Three top investors see drastically different markets ahead

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Mar 31, 2017
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As the Trump rally plods along, investors dispute whether the market is heading for a plunge or toward more blue skies – no less for investors who have billions to put down on their divergent views, like Carl Icahn (Trades, Portfolio), George Soros (Trades, Portfolio) and Prem Watsa (Trades, Portfolio).

Carl Icahn (Trades, Portfolio) and George Soros (Trades, Portfolio) both expect a market meltdown and have lost big on their short positions against the market over the past months and years and maintain them out of continued apprehension. Prem Watsa (Trades, Portfolio) also lost money on his market short for years but has dropped the hedges on faith that President Donald Trump will spur the economy to prosperity.

Activist investor Carl Icahn (Trades, Portfolio) stepped in to serve as Trump’s special advisor on regulatory reform in December after his hedge fund began hemorrhaging money. Shares of Icahn’s hedge fund and business conglomerate Icahn Enterprises (IEP, Financial) jumped 8% on the day of the announcement, but his stock was down 26% for 2016 through the Nov. 8 election as results suffered.

Icahn Enterprises reported a net loss of $2.2 billion in 2016 and $2.13 billion in 2015 due primarily to investment losses. In 2015, Icahn’s long positions lost 18.1% as several core holdings including oil companies sank; short positions added 0.8%, for a decline of 18.0% for the year.

In 2016, it was short exposure and broad market hedges that lost 34.1% in value, while long positions rose 16.3%, that caused Icahn to deliver a 20.3% loss for the year.

Icahn was apparently ebullient about Trump’s immediate effect on the market – implosion – that he left an election event early to buy stocks, according to several news outlets. But at the end of the year, he still had his hedges in place. In March, he reported a net short position of 128% at the end of 2016, five times larger than in 2015, based on dim expectations for the market.

“I don’t want to publicly call them out but there are certain industries we think are especially susceptible to potential border adjusted tax plans and other dynamics related to the retail space and certain industries that we continue to have strong views on valuation,” Icahn Enterprises Director, President and CEO Keith Cozza said on a conference call.

“Other than that, the majority of our short exposure has just been general macro emphasis. Just it’s more of a – obviously, it's a directional bet at this point, besides hedging all of our long exposure. Just at you know, very high market multiples. Market does seem priced for perfection [indiscernible] even further today. But we continue to have a fairly bearish view. I think net short exposure is down a little bit from third quarter but still a very large number," he said.

George Soros (Trades, Portfolio), whose famous short of the British pound netted him $1 billion in the ‘90s, appeared to have made a misstep with a bet against the stock market leading to the 2016 election.

The family fund where Soros is still involved, Soros Fund Management, doubled his puts on the S&P 500 SPDR (SPY, Financial) to 4 million in the second quarter, and quadrupled his weighting in puts of the small-cap iShares Russell 2000 (IWM) in the first quarter. The market’s subsequent surge cost the strong Hillary Clinton supporter almost $1 billion, according to Wall Street Journal estimates.

Since the election, Soros has backed off his short of the S&P 500 index. He cut the position by 3.3 million puts in the third quarter and by 182,000 puts in the fourth quarter, reducing his total position to 493,000 puts by year-end. It remained his fourth-largest position at 3.61% of the portfolio.

The macro investor increased his short against the small-cap index iShares Russell 2000, buying 638,300 puts in the fourth quarter, for a total position of 2.5 million puts by year-end, making it his second biggest holding at 10.8% of the portfolio. The iShares Russell index has gained 16% since the election.

Soros also boosted a smaller bet against the SPDR Select Sector Fund – Industrial (XLI, Financial), buying 1,040,000 puts in the fourth quarter, bringing his holding to 1.25 million at year-end at 2.55% of his portfolio. His bet against emerging markets, however, ended after two years. Soros bought 22.4 million puts of the iShares MSCI Emerging Index Fund (EEM, Financial) and chopped 20.7 million in the fourth quarter.

Prem Watsa (Trades, Portfolio)

On his own island is Prem Watsa (Trades, Portfolio), leader of the insurance-focused conglomerate in Canada, Fairfax Financial Holdings (TSX:FFH, Financial). Nothing short of the election of Trump convinced the investor to drop five years of return-depleting market hedges that contributed to reducing his cumulative five-year gain of $4.1 billion by $2.9 billion to $1.2 billion as of year-end 2016.

But Watsa expected to make up for the losses when what he called the “grand disconnect” between market prices and economic fundamentals to reverse, warning in 2015 that it may happen “sooner than you think!”

“In a declining market, like 2008 – 2009, we expect our common stock portfolio to come down much less than the indices, thus reversing most of the net losses resulting from our hedges,” he wrote in 2015. “As I said last year, we are focused on protecting our company on the downside against permanent capital loss from the many potential unintended consequences that abound in the world economy.”

Among fear factors that induced his defensive stance, Watsa in 2014 named the Cyclically Adjusted Price Earnings Ratio for the S&P 500, which stood at 28 times. It had gone higher only twice before, he said, at the start of the Great Depression in 1929 and the dot-com bubble of 1999 to 2002. Since his time of writing, the CAPE ratio edged up even higher, to 29.06 as of March 31. It was around 30 on Black Tuesday in 1929 and at 44.19 in 1999.

His worry about record after-tax profit margins, however, eased slightly as they declined from 8.72% in the first quarter 2014 to 8.5% in October, while the rising U.S. dollar index, which he also listed, rose from 97.49 at the first quarter 2015 to 100.39 on March 31.

High profit margins and a rising dollar, combined with deflation, would result in “significant declines” in the earnings of S&P 500 companies, Watsa said. But S&P 500 companies’ earnings per share grew 8.0% in 2016 and for the first quarter of 2017 are expected to rise 9.1%, the highest year-over-year growth rate since fourth quarter 2011, according to Factset. Further, of the 11 companies that have given earnings guidance for the quarter, 79 have projected negative guidance and 32 expect positive guidance. The 71% of companies issuing negative EPS guidance also falls below the five-year average of 74%.

Despite economic changes, the Nov. 8 election was the key to Watsa’s profound shift to bullishness. He “quickly reacted” to Trump’s surprise win by removing all of his index hedges and some individual short positions, as well trimming his fixed income portfolio’s durations to around one year. Together, the moves gave him a net loss of $1.2 billion on his investments, which translated to a $512 million dent in earnings.

Watsa’s enthusiasm for the new administration sprang from its pledge to reduce corporate taxes from 35% to 15-20%, roll back regulations and increase infrastructure spending, which Watsa believed would stimulate economic growth.

Corporate tax cuts are expected to be passed by the end of the year or early next year. Trump had previously promised in February to deliver details of a tax plan in two to three weeks though investors are still waiting. The new president has been more aggressive in slashing regulations, including those regarding climate change, education, the environment, land use and workplace safety and wages.

“Higher economic growth would result, we think, in higher profits for many companies, so that even though the indices may not go up significantly, we think a value investor like us can ply our trade again with less of a concern of economic collapse,” Watsa wrote in his annual letter for 2016.

See Prem Watsa (Trades, Portfolio)'s portfolio here, George Soros (Trades, Portfolio)' portfolio here and Carl Icahn (Trades, Portfolio)'s portfolio here.