David Einhorn: Inflation Is Here To Stay, And Powell Hasn’t Lifted A Finger
It’s been another quarter to forget for David Einhorn’s Greenlight, which lost -2.6% in Q3, underperforming the S&P’s 0.6% gain as “longs detracted 4.5% in the quarter while shorts added 1.2% and macro added 1.0%.” In his latest quarterly letter published earlier today, Einhorn writes that at quarter-end, the largest disclosed long positions in the Partnerships were Atlas Air Worldwide, Brighthouse Financial, Change Healthcare, Green Brick Partners and Teck Resources; the fund had an average exposure of 127% long and 70% short.
Housekeeping matters aside, we jump right into the meat of Einhorn’s letter which, not surprisingly, was all about inflation. Below we excerpt the key sections, highlighting several sections.
Over the summer, the Federal Reserve characterized inflation as “transitory.” As inflation has refused to resolve itself quickly and on its own, Fed Chair Powell revised his description to “frustrating.” But why should he feel frustrated? It’s not like he has done his best to fight inflation without success; he hasn’t lifted a finger to fight inflation. Instead, he has maintained a policy designed to create inflation. As a result, inflation is here and it appears poised to worsen.
So, why complain?
We think the reason is that if the Fed were to actually fight inflation, it would harm the financial markets and trigger a fresh recession that our fiscal and monetary policies aren’t capable of addressing. We don’t think our leaders are prepared to take responsibility for doing so. As a result, the Fed is left with a strategy of obfuscating inflation, claiming it’s transitory and just hoping that it goes away on its own. Or, at worst, it can be dealt with over time by gradually reducing bond purchases and ultimately gradually increasing interest rates.
Unfortunately, this seems increasingly unlikely.
As we discussed last quarter, some price spikes due to bottlenecks are likely to reverse at some point. Others, however, are likely to persist. Last quarter we discussed how the lack of cheap equity capital for capital-intensive companies is likely to suppress investment and prevent high prices from becoming the cure for high prices.
Another factor that we overlooked is the impact of ESG investing. ESG stands for Environmental, Social and Governance. However, in practice, social and governance are mostly overlooked.
Environmental is mostly about climate change. Climate change is mostly about carbon emissions. Carbon emissions are mostly about fossil fuels. The result is that ESG investing has led to an aversion to investing in fossil fuels. Now, energy prices are soaring, contributing to inflation. Given the ESG concerns, huge shortages and higher prices are not stimulating expansion of, say, coal supply. In this political climate, who is going to invest in a new mine that won’t come online for a few years?
The structural problem around the current global energy crisis – which is why it isn’t going away anytime soon – is that politicians have decarbonized supply faster than they can decarbonize demand. In order for prices to fall, demand needs to be destroyed, which leads to a growth problem well before anyone gets a chance to raise rates.
It should go without saying that demand destruction means less use by those least able to afford it. So, it will be the poorer countries and citizens that go without. Inflation, in general, disproportionately affects those with the lowest incomes. The unpleasant truth is that often the goals of ESG run counter to the goals of reducing or eliminating poverty and wealth inequality.
Furthermore, two of the most important drivers of inflation – housing rents and labor – are likely to continue to drive the U.S. Consumer Price Index (CPI) higher. Housing rents (both rentals and owners’ equivalent rent) are the largest component of CPI and they flow through with a lag.
When rents go up, not everyone has to renew their lease immediately. The price increases happen at renewal. Currently, rents on renewed leases are up 9.2% year-over-year through July according to Zillow; it will take a full year for that impact to roll through CPI.
And we unquestionably have a labor shortage. In the most recent employment report, wage inflation is now up 4.6% year-over-year and accelerating. The labor participation rate has fallen by a few percent. While many believed that extended unemployment benefits and the need to take care of children out of school were suppressing labor supply, the termination of those benefits and the return to school have come and gone and the labor shortage persists.
We have heard a number of theories including that the COVID shutdown sent many undocumented workers back to their countries of origin, as there was no work here; that older workers are reluctant to return to work for fear of getting sick; and that those receiving benefits were working the whole time, but for cash off the books. We have no way to refute or substantiate any of these, and they may all have a kernel of truth.
However, one theory that resonates with us based on our own anecdotes is that some are not joining or returning to the workforce because they don’t need to. Homeowners have seen the values of their houses go up by an average of 20% in the last year. Those near retirement have seen their 401(k) retirement plans swell with the stock market. These older citizens are choosing not to return to the workforce. And some younger people have made so much money in cryptocurrencies, non-fungible tokens (NFTs) and meme stocks that they can sit at home rather than enter the workforce. More power to them.
However, this means that as the economy reopens, the labor shortage is likely to persist. Employers need to compete for labor, which means rising wages. Rising wages means rising costs. And rising wages combined with the benefits of fiscal stimulus and rising asset prices means healthy demand.
It’s a recipe for demand-pull and cost-push inflation at the same time.
For a Fed that is desperate to avoid taking measures to fight inflation, it’s a tough predicament. No wonder Chair Powell finds inflation “frustrating.” The risk is that the capital markets lose confidence in the Fed policy and develop a view that the Fed is “behind the curve” in dealing with sustained inflation.
What we (and we assume you) find frustrating is our inability to achieve satisfactory investment results. We believe we were correct in our top-down view, long-short positioning and individual company performance and we still had a down quarter. This one-step forward- two-steps-back result is…well, pick your own adjective.
As noted above, we had a positive quarter in short selling and in macro. The problem this time was in the long portfolio. It is easier to explain when we can highlight an analysis that we missed, developments that went against us, or just a difficult macro environment. However, none of that was evident last quarter. We simply lost money in the face of what we thought was excellent performance by our companies. In fact, many of our longs not only exceeded consensus expectations, they exceeded our internal (even more optimistic) expectations.
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The rest of the note focuses on the fund’s longs such as GRBK, BHF, SONO and shorts such as CSP. Much more in the full letter below.
Wed, 10/20/2021 – 15:45