Third Point, lead by Dan Loeb, recently published another very interesting quarterly letter. The fund has posted astounding returns since inception:
Until recently Loeb was one of the few value-minded investors I follow who remained quite optimistic with only a little bit of caution. He's been right while myself and many others were perhaps prematurely cautious. This latest letter signals a shift in his mindset and deserves highlighting just for that reason (emphasis mine):
"A shift in markets occurred in Q1. After a two”year period where growth surprised positively and inflation was benign, we began to see volatility in each of these areas. While earnings growth remains strong, investors now have to contend with increased uncertainty around appropriate multiples."
Loeb also dived in the primary reason for the multiple pressure, which precedes pressure on earnings (earnings are still strong):
"One cause of this uncertainty is that, after many years of very low rates, there is finally an alternative to equities in the form of relatively riskless two”year money. We have seen the impact of this new option in money market flows where $400 billion has flooded in so far this year versus a total $80 billion of inflows in 2017. Also, as manufacturing indices (PMI’s) cool from elevated levels, there is a real question about just which inning of the late cycle we are in. While we don’t believe a recession is close, there is definitely a concern that it is getting closer. Each of these considerations is weighing on multiples. For investors, this means the S&P is effectively range”bound and so, to generate profits, investors will need to adjust exposures more aggressively and successfully choose winners and losers across sectors."
Loeb also seems to imply this is an especially important time to have exposure to alpha instead of beta. This could give active managers who charge modest fees compared to their skill a good chance. It should also be a great opportunity for the knowledgeable DIY stockpicker.
Loeb described his portfolio management moves in more depth:
"We have responded to this regime shift in several ways. First, we have reduced net exposure by over 20% this year. We have taken about 15% exposure out of our long book and boosted shorts to about 25% of fund AUM. Last year’s focus on short selling after several years away from the strategy was a return to our early success as short sellers. We intend to further increase exposure to fundamental single names and quant”derived baskets in 2018 and rely less on market hedges to dampen volatility and reduce net exposure."
Third Point will take off some market hedges and pursue delivering alpha on the short side, which can be a very interesting strategy, especially if the fund is succesful on both sides of the book.
"Beyond a balanced approach to equities, we are spending more time evaluating opportunities in risk arbitrage. While credit strategies performed well in Q1, we find most corporate credit markets are too richly valued relative to equities and so we have modest exposure to the asset class. As we discuss below in our structured credit update, we have been finding fewer opportunities in RMBS after selling most of our portfolio at a profit and are currently focusing on marketplace lending deals instead."
Loeb is quite bearish on corporate bonds/credits as they don't yield enough compared to Treasuries or equities. The yield differentials are indeed near record level lows.
"On the eve of our twenty”third birthday, we believe our longevity is largely due to our ability to be flexible investors and to apply our framework to different economic and market environments. Of course, we don’t always get it right. Market shifts are inherently difficult to anticipate and when they happen, they do not ring a bell but they do blow a dog whistle, as we have said in the past. Our job is to listen carefully and to take decisive action when we suspect change is afoot. We believe that the increase in our short book and our reduced net and gross reflect what we are hearing."
This letter isn't a decisive call to sell everything. Instead it is a letter that emphasizes significant increased caution as we've seen from many of the greats like Howard Marks (Trades, Portfolio) and Seth Klarman (Trades, Portfolio). Although it has to be said perhaps the greatest of them all, Warren Buffett (Trades, Portfolio), remains one of the more optimistic investors but usually with the caveat that Treasuries are still only yielding very little. Something that could change rapidly.
Disclosure: No positions.
