David Tepper Interview Key Takeaways
September 12, 2015
QUICK 17M UPDATE
With the ongoing market volatility over the last several weeks, I have been more active in my daily writing in an attempt to monitor/tame my thinking; but to spare those who follow the blog or Twitter I have confined those writings to the Trading tab, which has temporarily turned into a quasi daily journal. I have put in an enormous amount of time/thinking/work into positioning not only the portfolio but my thinking as well for what I believe is a sea change in the market environment, and I am very close to a point where I can succinctly outline my thoughts in an interim investment letter. The market is too middling at this point to really update strategy and performance, so I am waiting for a break either way to provide an update. Though in quick summary, the portfolio is a bit less than 100% gross and approximately 0% net, excluding the FNMAS special situation; and in the event we break to new lows here in the upcoming weeks, I believe it would be a potentially highly attractive set-up for a year-end rally. But if we move higher without a move back to the 8/24 lows, upside is extremely limited, IMO, thus setting up a potentially attractive net short opportunity. And while my rule is to NOT go net short outside of recessionary economic conditions, the deterioration in market ‘health’ has been so pronounced, that if we rally back to highs without concurrent improvement in said health, a net short position will be a high probability set-up – too high to pass up. (Part of my need to document my thinking in real time is to hold back from buying into what I believe are rather compelling individual equity set-ups here. I am a stock-picker at heart, and I hate worrying about the broad market; but I believe the environment is such that patience is more undervalued here than some individual equities.)
On to Tepper…
Likely I am just slower than most, but I find it highly valuable to re-read/-watch things. The first go around can often be influenced by extraneous factors such as an obnoxious interviewer, talking/presentation style, etc; while the second time thru those factors fade to the background. (Yes, I need to train myself to do a better job of blocking these factors out the first time around.) All that to say – this morning I re-watched David Tepper’s 9/10 CNBC interview, and found that the second time thru solidified several hugely important points. Others scoff at paying attention to what other investors are saying…but A) I am a huge fan of the ‘sport’ of investing, thus I simply enjoy watching others highly skilled at their craft; and B) everyone thinks so differently – as investing is an intensely personal endeavor – that you can ALWAYS learn something from another investor. As such, I found the following key themes of the Tepper interview enormously beneficial to my current thinking and learning curve progression:
(1) Global Reserves Headed In Wrong Direction
After flowing in one direction for over 15 years into long-duration assets (i.e. long-dated Treasuries and equities), global reserves are now headed in the opposite direction. While the ECB and BOJ QE programs act as partial offsets to this ‘tide’ reversal, the fact of the matter is that the tide is now going out. Tepper believes that while it will not happen immediately, the tide could go out faster than it came in – the stairs up/elevator down phenomenon, in other words.
The key point I picked up on the second time around is that Tepper said those in close touch with the bond market began to see the tide reverse in the form of long-dated bond yields moving up. For years the general media has warned of the risk that China could drive Treasury yields up by moving out of its UST holdings; but when someone as in tune with the bond market as Tepper alerts you, you pay attention. These types of bond market moves are simply not on my radar, so this type of insight informs my thinking.
Tepper indicated that the 15-year flow of reserves into undervalued Emerging Markets currencies is what placed downward pressure on long-dated global bond yields over that time (think Jim Grant bemoaning uneconomically low Treasury yields for years…). I would have said the downward pressure on yields was the result of deflationary pressures due to high global debt load – and while that may be part of ‘it’, I am not nearly smart enough to connect those dots. What I do know is that when Tepper’s commentary is taken in conjunction with the dashboard of equity market indicators I monitor, the outlook for equity markets is less than robust.
(2) Equity Markets Lack a Valuation Cushion
No matter which way you slice the market, it is overvalued on an absolute basis; but nobody knows ‘when’ it will correct, which is why I try to incorporate economic, monetary and technical conditions into my market analysis. However, I believe Tepper touched on two key valuation components that could bring valuation back to the forefront of investors’ minds: growth and margins.
Growth. With a significant percentage of S&P 500 revenue coming from Emerging Markets, Tepper believes earnings estimates need to come down (i.e. projected growth rates need to fall) to account for the China-induced slowdown in Emerging Market economies. We can quibble about how growth should be factored into the broad market valuation equation – for example, John Hussman assumes a constant 6% nominal growth rate – but I believe Tepper likely utilizes an approach that appropriately accounts for how the majority of market participants view broad market valuation. As such, it is plausible that at 16.34 times 2016E EPS of $120 (Tepper’s rough estimate – the ‘Street’ is closer to $130…) that the S&P 500 (1961.05 at Friday’s close) is not appropriately accounting for reduced global growth, nor…
Margins. Simply, Tepper cited labor capacity pressures in the U.S. and falling capacity utilization in Emerging Markets as key reasons S&P 500 margins are likely to come under pressure going forward. As such, even a $120 2016 EPS estimate could be optimistic.
Valuation. Tepper cited a 2016 PE range of 14X to 16X, at which the S&P 500 would trade between 1680 and 1920 within the next six to twelve months, or 1800 at the mid-point, using said $120 2016E EPS.
(3) Long-Term Investor Positioning Has Not Yet Adjusted
Selfishly, my favorite part of the interview was Tepper’s citation of hedge fund ‘net’ positioning and mutual fund cash levels as evidence market positioning has not yet adjusted to the new STFR environment (i.e. the opposite of BTFD). I say selfishly because I have been harping on the fact that market sentiment remains far too complacent in the face of significant deterioration in market ‘health’. I have documented this thinking in real time via the Trading tab, as cited earlier, but have received push-back on this point…
The CNBC hosts questioned Tepper on his relatively cautious thinking, and whether or not his negative outlook was already reflected in investor sentiment. His response was (paraphrasing): show me hedge fund ‘net’ below levels of the last two years; show me mutual fund cash levels above levels of the last two years…before I get interested in the equity market again.
On this sentiment point, much has been made regarding ‘dumb money’ positioning in equity futures markets. Setting aside the fact that these data points are often inappropriately taken out of context (i.e. a -$6B net short position in 2015 is not a relevant comp to a -$6B net short position in 1996), because they are not confirmed by these longer-term sentiment indicators, at best I believe they indicate we may get a soft rally back up to ATHs.
It may appear I am simply cloning Tepper’s positioning here, but my well-documented thinking has been that we either move lower before a powerful move higher, or we move higher in a weak rally before heading down into a more problematic market environment. Based on the indicators I follow, this market is busted…and if we do not fully reset, then a move higher unfortunately may be akin to the final top as in 2007…
While Tepper did not get this specific, he indicated that if the market gets excited over a Fed move next week, it may provide an opportunity to get short. He said he does not like to short because of the market’s natural bias to rise over time, but indicated the set-up would be rather compelling.
I would agree.