Einhorn Vents his Frustrations about the Crazy Markets

by Wolf Richter, Wolf Street:

Why trying to bet against this madness is a widow-maker trade. Logic has nothing to do with it.

Investors who’ve approached this stock market and its ludicrous valuations over the past few years from a point of view of fundamentals and “value” – thus, often on the side of short-selling those stocks – have gotten clobbered, or were at least left in the dust by buy-buy-buy fundamentals-don’t-matter automatons.

This has become an exercise in frustration-management for many – including, apparently, David Einhorn, founder and president of Greenlight Capital, a $7 billion hedge fund that became successful by searching for overvalued and undervalued companies and betting one way or the other. This strategy has hit the rocks in recent years. So far this year, the fund is up 3.3% while the S&P 500 is up 14%.

In a letter to Greenlight’s clients, reported by Business Insider, he unloaded his frustrations about this crazy market.

“The market remains very challenging for value investing strategies, as growth stocks have continued to outperform value stocks. The persistence of this dynamic leads to questions regarding whether value investing is a viable strategy.

“The knee-jerk instinct is to respond that when a proven strategy is so exceedingly out of favor that its viability is questioned, the cycle must be about to turn around. Unfortunately, we lack such clarity. After years of running into the wind, we are left with no sense stronger than, ‘it will turn when it turns.’”

On the short side, he cited Amazon, Tesla, and Netflix, whose ludicrous valuations are glaring examples of what a good short-target looks like, but so far, most of those daring souls who tried to follow logic and profit from shorting these stocks over the past few years have gotten their head handed to them.

Here’s what Einhorn said about the three heroes that he considers “our three most well-known ‘bubble’ shorts”:

Amazon: “Our view is that just because Amazon can disrupt somebody else’s profit stream, it doesn’t mean that Amazon earns that profit stream. For the moment, the market doesn’t agree. Perhaps, simply being disruptive is enough.”

Tesla: “Tesla had an awful quarter both in its current results and future prospects. In response, its shares fell almost 6%. We believe it deserved much worse.”

Netflix: “On the second quarter conference call, the CEO stated, ‘In some senses the negative free cash flow will be an indicator of enormous success.’ To us, all it indicates is that Netflix is capable of dramatically changing the economics of stand-up comedy in favor of the comedians.”

Yet Amazon is up 30% this year, Tesla and Netflix 58%! This market simply doesn’t tolerate logic other than buy, buy, buy – until something changes.

Einhorn goes on to muse about the “alternative paradigm”:

“Given the performance of certain stocks, we wonder if the market has adopted an alternative paradigm for calculating equity value. What if equity value has nothing to do with current or future profits and instead is derived from a company’s ability to be disruptive, to provide social change, or to advance new beneficial technologies, even when doing so results in current and future economic loss?

“It’s clear that a number of companies provide products and services to customers that come with a subsidy from equity holders. And yet, on a mark-to-market basis, the equity holders are doing just fine.”

This “subsidy” from equity holders and creditors to customers has become a common theme on WOLF STREET, including earlier today concerning Netflix. How long are stockholders and bondholders willing to subsidize the prices that consumers pay for goods and services? Netflix thinks forever. Rational brains think not. But so far, rational brains have lost nearly every time.

These companies fight for market share with bleeding-edge pricing to “disrupt,” but equity holders and creditors, instead of punishing companies for it, fall all over them and bid up their shares and bonds, and thus encourage them to do this.

The most glaring example is Tesla, a tiny automaker that’s now bleeding billions of dollars a year in cash and whose vehicle production is so minuscule it’s not even a rounding error in total global production of 94.6 million vehicles. And yet, it has a market capitalization of $56 billion. This disconnect is inexplicable for rational minds – and makes Tesla a very juicy target for shorting the shares.

But shorting crazy stocks in a crazy market is a widow-maker trade; once shares have reached crazy heights, there is no longer a rational limit, by definition, to how much crazier the already crazy shares can get. Someday, those bets will be correct. But in the prevailing market insanity, it’s impossible to divine when exactly that will be.

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