The S&P 500 is now more than 200% higher than at its crisis-induced 2009 lows. But despite the powerful recovery in stocks, the rally has had few believers. All along the way, skeptics have pointed to threats in Europe, domestic debt issues, political stalemates, perceived asset bubbles — you name it. As it relates to stocks, they’ve all been dead wrong.
The truth is, global central banks are in control; they have been since coordinating in 2009 to save the worldwide economy from an apocalyptic spiral. And because the crisis was global, and the structural problems remain highly intertwined globally, the only hope toward achieving a return to sustainable growth is through continued coordination. The Federal Reserve has led the way on this front and continues to do so, now through forward guidance rather than outright quantitative easing.
How does this relate directly to the stock market? Simple: The Fed needs stocks to be higher. The Fed needs housing to be higher. Fed officials get their desired wealth effect through higher stocks. And from pinning mortgage rates at historical lows, they get wealth gains from rising housing prices.
The Fed can’t manufacture a sustainable recovery through monetary policy, but it can influence confidence. Members can assure the public that they stand ready to suppress any “shock risk” that might derail stock prices. And they, along with other major central banks, have proven they can do it. So with the elimination of a negative event that could tumble the stock market, why wouldn’t you own stocks? The Fed wants you to, and they are giving you no better alternative, with a 2.4% 10-year Treasury yield.
Still, there are plenty of naysayers that like to throw around words like bubble. They like to say the stock market is just a house of cards and that it’s completely manipulated by the Fed.
The truth is, the Fed does manipulate interest rates. That’s what they do. They set rates as a tool in an attempt to achieve their mandate of price stability and full employment. Stocks tend to be a byproduct of interest rate policy.
If core inflation runs hot, the Fed raises interest rates to curb it. When that happens, in normal times, stocks tend to soften. But these aren’t normal times. Core inflation is still under the Fed’s target of 2%. In the latest Fed minutes released Wednesday, officials noted inflation could stay low “for quite some time.”
Europe is fighting deflationary pressures, and so is Japan. So the Fed has no reason to raise rates. And even when they finally do, they are moving off of ZERO. When they move rates higher from such emergency, record-shattering low levels, it will not have the same effect as a normal rate-hiking cycle typically intended to cool down a hot economy. When they raise rates this time, it will be a celebration, as it will mean the economy and credit demand are both strong enough to deal with an increase in interest rates.
With this in mind, the economy, for the first time in a long time, will likely grow by about 3% into the end of this year and for next year. That means we have the underpinning for healthy earnings growth for stocks for the first time in a long time. And earnings growth drives stock prices.
For those who argue the economy is fragile, the bond market disagrees with you. The yield curve may be the best predictor of recessions historically. Yield curve inversions (where short rates move above longer-term rates) have preceded each of the last seven recessions. Based on this analysis, the below chart from the Cleveland Fed shows the current recession risk at 3.42% — virtually nil.
Given that central banks remain in control, rates are still exceptionally low and recession risk is nearly nil, any recent dip has been a huge buy opportunity. Still, several years into an economic recovery, fear continues to creep in for investors when there is any downtick in stocks. Perhaps it’s a form of post-traumatic stress disorder or simply a lack of perspective, but people seemingly have been conditioned to think another big crash is coming, despite the lack of evidence. The reality is, the U.S. economy is in a very different place than it was in 2008, and so is the global economy. Even if trouble were brewing, much of what might be an unknown in normal times is well-known now. We know how the central banks and governments will respond.
We’ve had seven declines of close to 5% or more in the S&P 500 since late 2012. In each case, the decline was fully recovered in less than two months. In most cases, the decline was recovered inside of one month. This is an amazing fact, yet many people have been focused on trying to pick a top rather than preparing to buy the dip.
You may have noticed I referenced the period from late 2012, in which stocks have been particularly resilient. This is not arbitrary. It coincides with the date Japan first telegraphed the massive policy effort to defeat deflation. The BOJ has since more than doubled its balance sheet, devalued the yen by nearly a third (vs. the U.S. dollar) and pushed up Japanese stocks by more than 100%. The massive BOJ experiment is a recipe for higher U.S. stocks. It pumps new money into the global economy and creates capital flows out of Japan and into U.S. stocks.
The above evidence supports the case for a continued rise in stocks. How high can they go?
If we applied the long-run annualized return for stocks (8%) to the pre-crisis highs of 1,576 on the S&P 500, we get 2,917 by the end of next year, when the Fed is expected to start a slow process toward normalizing rates. That’s 45% higher than current levels. Below you can see the table of the S&P 500, projecting this “normal” growth rate to stocks.
In addition to the above, consider this: The P/E on next year’s S&P 500 earnings estimate is just 16.8, in line with the long-term average (16). But we are not just in a low-interest-rate environment, we are in the mother of all low-interest-rate environments (ZERO). With that, when the 10-year yield runs on the low side, historically, the P/E on the S&P 500 runs closer to 20, if not north of it. A P/E at 20 on next year’s earnings consensus estimate from Wall Street would put the S&P 500 at 2,600.
You have the best track record of any living investor: 27.5% annualized returns over the past 52 years.
You even made money in an extremely difficult period for stocks; between 2000 and 2014, you averaged a 22% annualized return, versus a 3.8% return in the S&P 500. That’s nearly 20 percentage points of outperformance, annualized, during a period that included one the worst stock markets in our lifetime. This is outstanding.
That said, while you’ve had great recent success with high-profile stocks, other areas of your portfolio, particularly in the energy sector, have been very poor performers. Today we are writing to respectfully challenge you to execute your game plan and create value in the uncharacteristically weak spots in your portfolio.
Carl, you’ve stated often that you are an advocate for the little guy. You’ve even gone so far to say small investors should follow your lead into the stocks you buy. You’ve laid out specific analysis to support the case, demonstrating how easy and powerful following your lead can be. According to your study, over the past five years, if any investor had bought an Icahn-owned stock the day that you (or your team) joined the board of the company, then sold it the day the board seat was exited, that investor would have made a 27% annualized return.
That means your “board seat effect” could have turned $30,000 into just over $100,000 for the average guy. Moreover, within your analysis, these stocks were winners nearly eight out of every 10 times, when this condition of a board seat was met.
We agree completely with your premise. As you’ve said, “The little guy should be allowed to follow good investors without having to pay a fortune.”
We founded our research business, BillionairesPortfolio.com, on the same fundamental beliefs. And today, Carl, we have co-invested with you, following your lead into four stocks – each of which either you or your team have a board seat: Navistar (NAV), Nuance (NUAN), Transocean (RIG) and Talisman (TLM).
Carl, you paid $49 for your 6% position in Transocean; it now trades at $27.11. You paid $11.60 for your 6% position in Talisman; it now trades at $5.71. We estimate your price on Navistar is just over $32; you’ve built a 15% stake and held it for three years. It now trades at just $36.46. We estimate your average cost on Nuance at just over $18, for a nearly 20% stake. It now trades at $15.01.
As shareholders, we support you in your effort to create change in these companies, to unlock value. To be frank, given your mission to fight for shareholder rights and your record of executing against that mission, we expect success. Just as you hold the companies that you invest in accountable for maximizing the value of your shares, we hold you accountable to work on behalf of all shareholders to do the same.
We are frustrated that you have not spoken publicly about these energy investments and have made little progress toward your goals. You have over $2 billion of your fund invested in energy stocks, including Talisman and Transocean. We believe that it is time for you to get to work and start creating value in these stocks.
Energy stocks are selling at the most undervalued levels since the great recession. Transocean is near a 10-year low, selling well below its Great Recession price of $37. Talisman is at a 10-year low, selling below its Great Recession price of $6. And, as you know, oil prices are almost 100% higher than they were during the Great Recession — even following the recent oil price sell-off.
This underperformance isn’t just in the stocks we’re discussing (RIG, TLM), but is sector wide. The ratio of oil prices to oil stocks is below 1. The last time the ratio was below 1 was March of 2009 — at the depths of the global financial and economic crisis. There is no fundamental reason why these stocks should be selling for less than they were during the Great Recession.
We are calling on you, and your team, to take action.
We’ve heard your public voice on Apple (AAPL) and Netflix (NFLX). But we haven’t heard or seen the same type of effort and passion in the deeply undervalued stocks we are discussing.
We know you have billions of dollars of inspiration to turn the ship around on these stocks. Let’s look at some numbers on what it will take to right the ship.
You purchased Transocean back in January of 2013, and you got a board seat in April of 2013. You usually hold a stock for two to three years. You bought Transocean at $49. Based on the board seat analysis you’ve presented, Transocean should return 27% annualized. Within your typical holding period, we should expect to see Transocean up 61% from the date you won a board seat. That would put the share price at $72.50. Transocean is currently less than $28 dollars a share. That projects a 150% return in Transocean over the next six to seven months. Let’s get to work!
Next, your team received a board seat on Talisman Energy in December of 2013, when Talisman was $10.50. Using the same math from your board seat analysis, applying a 27% annualized return for every year you, or your team, has a board seat on a company, Talisman should be selling at $16.90 by next month. The stock currently trades for $5.00 and change. Carl, you have a lot of work to do in a very short time. This projects a nearly 200% return on Talisman by next month.
Obviously that target is highly unlikely. But over the next few months, we want to see progress toward the changes we know you can force, to begin the revaluing process of this stock. By December of 2015, your influence, based on history, should give shareholders a 340% return on Talisman, or $21.50 a share.
Carl, we think there is a simple formula for these stocks: You! We challenge you to get back to your activist ways. You and your team have seats on the boards of all four of these underperforming companies. Start creating value for us today. Force the CEO out. Force Nuance to sell itself to the highest bidder. Force Talisman to sell off its assets, piece by piece, to the highest bidder. Force Transocean to do the same.
You are the best investor on the planet because you have a simple playbook of buying stocks at deeply depressed prices, reforming troubled companies and selling for a huge profit. You don’t have a board seat on Apple. You didn’t have a board seat at Netflix. While those investments were successful, they represent a clear drift from your style.
By any standards, you have lost a significant amount of money on these stocks we’ve discussed. So get angry and fight. Fight for the little guy, just like you said you would do this summer. Shareholders are counting on you. And we know you are one of the few investors in the world that can do it.
Respectfully,
William Meade and Bryan Rich
Billionairesportfolio.com
The annual Invest For Kids Hedge Fund Conference was in Chicago this past week and featured many of the best hedge fund managers in the world. Below are some of the managers who spoke, and their favorite stocks:
1) Billionaire Larry Robbins of Glenview Capital likes Ebay (EBAY), Tenet Healthcare (THC), Teradyne (TER) and Cadence Design Systems (CDNS).
2) Steve Kuhn of Pine River Capital Management likes Japan (NKY), especially the 400 Japanese stocks that the nation’s Government Pension Investment Fund can trade. For more on Japan and the best stocks to buy, please click here.
3) Billionaire Bill Ackman of Pershing Square Capital Management, who is up an incredible 42% year-to-date, likes Valeant Pharmaceuticals (VRX) and Canadian Pacific Railway (CP).
First, let me say this: Most people lose money trading options.
It’s a very difficult game. But if you can find an edge, the returns can be huge. One of the best option-trading hedge funds in the business, Cornwall Capital, has averaged 51% annualized over the past 10 years. That turns a mere $20,000 investment into $1.2 million, in less than 10 years.
Two of the best option strategists that have ever worked on Wall Street are Keith Miller, formerly of Citigroup, and John Marshall, of Goldman Sachs. Both Miller and Marshall happen to be Blue Jays (i.e., Johns Hopkins University grads), like me. If you can ever find any of their research studies, print them out and examine them closely. They are excellent — and will give you an edge.
Below are the rules the best hedge funds use when trading options:
Rule #1
Options are like a coin toss; you’ll be lucky if half your option trades are profitable. That is why you have to make sure you get paid for the risk you take.
Only trade an option if your projected return is a triple or better. To do this you will have to buy an out-of-the-money option. And you should go out at least two months, preferably longer. Now, here’s the math:
Let’s say you make 40 option trades a year. Odds are at best you will only make money on 50% or half of these trades. Therefore, if you had 40 options trades and 20 of those trades expired as worthless, and the other 20 option trades averaged a triple or more, you would still make 50% a year. For example, on a $40,000 account taking 40 trades a year, if 20 option trades lose everything and the other 20 trades give you an average return of 200%, your account would be worth $60,000, giving you a 50% return.
So $20,000 would go to zero on the option trades that expired worthless. The other $20,000 would go to $60,000 on a 200% return.
Rule #2
Price predicts a stock’s earnings and fundamentals 90% of the time. According to Keith Miller of Citigroup, a stock will start to move one to two months ahead of its earnings date, in the direction of the earnings report. This means if a stock starts trending higher or breaks out higher before the company reports earnings, the earnings report will be positive 90% of the time.
Rule #3
When you are buying options on a stock, make sure the stock is owned by an influential investor or activist. These investors, such Carl Icahn, Barry Rosenstein of Jana Partners and the rest, are always working behind the scenes to push the companies to unlock value; this can come in the form of incremental positive change or big one-time catalysts. This positive announcement or catalyst usually emerges after the stock has moved up in price. So when you see an activist-owned stock breaking out, or trending higher, there is usually a good chance change is coming. Thus, you’ll want to buy calls on this stock immediately.
Rule #4
Only trade an option if there is an event or catalyst that will reprice the stock. This could be an earnings announcement, a company’s Investor Day or an annual meeting.
Rule #5
Only buy options when both implied volatility and historical volatility are cheap. Be a value buyer of options. Watch volatility. Buy volatility only when it’s cheap.
A perfect example of an option trade that fits all of the above criteria is Walgreens ($WAG).
> Jana Partners, run by billionaire Barry Rosenstein — one of the top 5 activist hedge funds on the planet — owns more than $1 billion of Walgreen’s stock. That’s more than 10% of the fund’s overall assets invested in Walgreen’s (Jana has $10 billion under management). Even better, they just added to their position last week, buying $77 million more during the market correction.
> Walgreen (WAG) just broke out of a consolidation pattern, and it looks like it is ready to make a big run (see chart below).
> Walgreen reports earnings on December 22nd. So whichever way the stock moves over the next month or two will predict whether the company’s earnings are positive or negative. Based on the stock’s current price momentum, the report will be positive.
> The Walgreen $65 calls are cheap, especially since they expire only two days before the company reports earnings. You can buy the Walgreen December $65 calls for just $1.10. That means, at $66.10 or higher, you will make money on this option. My price target for Walgreen, based on its recent breakout, is $69. That also happens to be where Walgreen gapped previously.
> If Walgreen stock trades just 10% higher to $69 by December 20th, you will more than triple your money on this option in less than two months. This is the risk-reward profile you want when trading options. Your goal should be to make 50% a year.
Momentum investing, or buying stocks with the largest six-month and one-year price gains, works well when volatility is low, with the VIX below 25. But when the VIX closes above 25, all bets are off. This is when mean reversion kicks in, and the sectors and asset classes that have performed the worst tend to turn into the market leaders.
What would that shift mean today? It would mean: Go long energy, long small caps, and short momentum-driven tech stocks (YELP, TSLA, FB, NFLX, TWTR), while trimming healthcare and scaling into retail.
The simplest play would be to buy energy stocks and small-cap stocks (or the Russell ETF), and short momentum tech stocks or the QQQ’s.
If Carl Icahn is going to push Apple to buy one of his holdings, it has to be Nuance (NUAN). Here’s why:
Icahn owns 19.2% of Nuance, or $1.14 billion worth, and his son Brett is on the board. That’s big.
Also, Nuance has a market cap of $4.7 billion and an enterprise value of $6.2 billion; Apple has around $37.7 billion in cash, so they could easily buy the company for a significant premium.
In Netflix (NFLX), not only has Icahn reduced his stake and sold some of his shares this year, but he only owns $777 million and does not have the same type of board representation as he does at Nuance. Netflix also has a $28 billion market cap, so it would cost Apple $30 billion-plus (with a buyout premium) to buy Netflix. That’s too rich.
William Meade
President of The Billionaire’s Portfolio
Yesterday GT Advanced Technologies (GTAT) declared bankruptcy, sending the stock down more than 90% in one day. It’s likely that 99% of everyone who read this news went on with their day thinking to themselves, “Thank goodness I didn’t own this stock.”
But the 1%, the smartest hedge funds, were getting ready to pull the trigger on one of the oldest and most powerful quantitative trading strategies around: buying a stock the day after it declares bankruptcy, then selling it at the close.
This strategy has been known by almost every hedge fund on the Street, including the billion-dollar-plus hedge fund I worked for back in 2002, when WorldCom filed one of the largest bankruptcies in history. The next day our fund loaded up on WorldCom stock, which was selling for pennies on the dollar, and we made over 120% in one day.
This bankruptcy trade works for two main reasons:
1) Short sellers buy their stock back (or cover immediately after a bankruptcy filing)
2) Distressed traders-hedge funds will buy bankrupt stocks because there is a possibility they can squeeze some money out of them during the bankruptcy process, especially if they own 5% or more (a controlling stake).
This powerful combination of huge buying with virtually little selling (because no one really sells a stock after it has declared bankruptcy and dropped 90%) usually pops the stock more than 100% the day after a company declares bankruptcy.
That is why GT Advanced Technologies is up 150% today on huge volume, and why many hedge fund traders are smiling while the rest of the public is left scratching their heads.
To find out more about what hedge funds are buying and the sophisticated strategies they use to make 100% or more returns go to Billionairesportfolio.com
When I first heard about this, I thought it was a joke: There is a start-up company, of course in San Francisco, that connects maids with people who need their home cleaned. Ok, I considered Merry Maids, which a lot of people use. But when I found out the company had received $38 million in venture capital financing and that the founder was in her 20s, with zero experience in the house-cleaning industry, I knew the apocalypse had come and the tech bubble had burst.
The company is called Homejoy, and it was founded by Adora Cheung, who has an undergraduate degree from Clemson University and a Masters from The University of Rochester; she started Homejoy right after graduate school.
Even more amazing, it seems Adora Cheung had no previous experience in the industry before she started Homejoy. However, in today’s world, where venture capitalists will throw money at any and every idea, this is not a huge surprise. Yet when a woman in her 20s without any real experience in her industry gets 38 million, you have to wonder what they are smoking in the Valley.
Even more bizarre, Adora admits she didn’t know how to clean a house before she started the company, so she went to a “maid boot camp.” And it gets even stranger: According to recent articles in The Washington Post, New York Magazine and International Business Times, Homejoy has used homeless people to clean houses. Imagine you come back from a hard day at work, and the poor guy whom you’ve been giving money to on the corner of your street is not only in your house, but he is cleaning your house. Wow!
But perhaps I am too cynical and should really be moving out to San Francisco to pitch venture capitalists on an online pest control company. I mean, if a 20something woman with zero experience in her industry can get $38 million from venture capitalists to hire homeless people to clean houses, maybe I am the fool for not grabbing the money while it’s hot.
But in reality, this is Pets.com, this is the end — sayonara, Silicon Valley. I only wish you could short privately held firms.
Will Meade
President of The Billionaires Portfolio
When high-quality stocks sell off for non-fundamental reasons, billionaire investors lick their chops.
As you probably know, Warren Buffett has made his fortune being “greedy when others are fearful.” Billionaire Jeffrey Ubben, of ValueAct Capital Management, has been quoted as saying, “As soon as a company falls out of bed, for whatever reason, we can go right to our old notes.” Ubben bought a $1 billion stake in 21st Century Fox when the stock fell last July, in reaction to Fox’s bid for Time Warner (TWX).
Billionaire Bill Ackman recently said in an investment letter that “minority stakes in high-quality businesses can be purchased in the public markets at a discount. These discounts principally arise because of two factors: shareholder disaffection with management, and the short-term nature of large amounts of retail and institutional investor capital which can overreact to negative short-term corporate or macro factors.”
Legendary billionaire activist Carl Icahn is another investor who likes to add to his positions after a correction or dip. He has added to his positions in both Nuance Communications and Navistar International over the past year.
Some investors take macro and news-driven dips as an opportunity to take companies private.
Jeff Smith’s $2.5 billion Starboard Value fund owns RealD (RLD) at an average cost of around $10.50. After this week’s broad market decline, he offered to take the company private at $12, a 28% premium for shareholders from yesterday’s share price.
Given the recent slide in broader stocks, I think we’ll find that the world’s best billionaire investors and hedge funds are using this opportunity to add to their losers. Here are four stocks that would fit the bill:
Hertz (HTZ) – Carl Icahn owns almost 9% of Hertz at an average cost of $28.50. The stock is selling at $24.00 today. That’s a 17% discount to what Icahn paid for his shares.
MeadWestvaco (MWV) – Starboard Value’s average cost in Mead is $43.50 a share. The stock is currently selling for around $40. According to their 13D filing, Starboard believes the stock could be worth $69 a share if MeadWestvaco management follows through with their restructuring plan. That would be a 72% return from Mead’s share price today.
Armstrong World Industries, Inc. (AWI): ValueAct Capital owns nearly 17% of this stock, though it’s down 10% in the past month. According to Barron’s, ValueAct has averaged a 59% return on stocks when they own a controlling stake. That compares to 9% for the S&P 500 over the same time period.
Apache Corp (APA) – Billionaire Barry Rosenstein of the activist hedge fund Jana Partners reported a $1 billion stake in Apache in July. The stock has dropped from $104 to under $90.
To learn more about the stocks owned by the world’s best billionaire investors, follow me at BillionairesPortfolio.com.
When the news broke on Friday that activist hedge fund Starboard Value had taken a position in Yahoo (YHOO) and was pushing for a Yahoo-AOL merger, many people were probably asking, “Who is Starboard Value?”
As I told Bloomberg on Friday, Starboard Value has one of the best track records of any hedge fund out there; they have been profitable on 85% of their activist campaigns since 2002.
Starboard also has produced some of the best risk-adjusted returns of any hedge fund in the industry, and they do the most exhaustive and comprehensive research of any activist investor I have ever followed.
Here is the entire Bloomberg article on Starboard Value, including my quotes about Starboard to Bloomberg’s top activist-investing reporter, Beth Jinks.
Will Meade
President of The Billionaires Portfolio
