The headline’s from yesterday’s Elliott Management investor letter centered on Paul Singer’s call for an end to “financial lawlessness.” The twenty-five page letter, however, included additional insight regarding the activist hedge fund’s performance and market outlook.
The fund returned near 12% in 2014, closely tracking its benchmark compounded annual return of 12.8% since 1994, according to an investor letter reviewed by ValueWalk. Positive sectors included distressed securities, performing debt, equity oriented traded, commodities trading and portfolio protection trades related to interest rates and currencies, key areas of concern for fund managers who track the international debt crisis.
Paul Singer: QE boosting equity prices
Weighing in on the hot topic of the day, the impact of Federal Reserve stimulative measures to support the economy, the letter said “There is no question that the massive purchases of bonds (as well as some equities) by global central banks were highly influential in boosting the prices of equities, but the extent of such influence is unknown. We think equity investors ought to have a high degree of uncertainty about what will happen to stock prices as and when the Federal Reserve diminishes or ceases QE (quantitative easing) and ZIRP (zero interest rate policy).”
There has been a growing behind-the-scenes discussion among fund managers as to where the vulnerabilities of the markets exist relative to the impact of quantitative easing, and Paul Singer weighed in. “It is hard to know which markets (fixed income or equity) are more vulnerable to the twists and turns of government policy. The Fed’s balance sheet expanded by more than $1 trillion in 2013 to close the year at more than $4 trillion for the first time, while rates on 10-year U.S. Treasuries rose from 1.88% to 3.07%,” a historical abnormality noted with alarm by many professional traders along the yield curve.
“This odd result could be due to a growing belief among investors that an accelerating economic recovery is around the corner. Alternatively, it could mark the first signs of avoidance behavior on the part of investors, reflecting their concerns about the ultimately inflationary effects of central banks’ radically expansionary monetary policies.” Professional investors have expressed concern that the yield in the ten-year Treasury note is too low relative to the growing risk.
Primary support for current economic system is easy money
Paul Singer notes the primary support for both the economic and financial systems in the U.S., Europe and Japan is “extremely easy monetary policy, characterized by bond-buying on an unprecedented scale, essentially zero percent short-term interest rates, and a fanatical focus on boosting the inflation rate to combat the specter of deflation lurking behind every bush.”
When considering the economic debate hedge fund professionals typically engage in, Paul Singer writes, “It is not productive to debate whether QE is really money-printing. Rather, the appropriate question is whether the developed economies are taking all reasonable steps to create the conditions for faster growth. In our view, the answer is an emphatic ‘No!’ Instead, lawmakers are relying on the untested and risky notion that the major central banks can hold things together while they dither and hide their heads in the sand.”
Economic numbers sending mixed messages
Like many market strategists Paul Singer finds economic numbers, particularly the employment data, to be sending mixed messages. “Five years after the crisis, there has been no meaningful restoration of normal employment conditions. Although the headline unemployment rate fell during the year from 7.9% to 6.7%, it was a statistical illusion caused by the fact that millions of discouraged jobless Americans have stopped looking for work, so the percentage of Americans in the labor force remains mired at multi-decade lows.”
When looking to the culprit of unusual employment situation, the acknowledged Republican Paul Singer says, “the poor public policy choices made by governments in both the U.S. and Europe are largely responsible for this lousy performance. Policies discouraging employment and encouraging dependency, widespread tax increases (and the promise of more), crushing regulation (interpreted and enforced by unaccountable regulators), laws that are growth suppressive (Obamacare being the worst) and punitive policies toward the financial system that are not making the system safer (and in certain ways have made it less safe) have combined to suppress employment, normal lending and borrowing, and robust economic growth.”
Projecting the upcoming economic and political debate, where income inequality is likely to be a campaign theme in upcoming elections, Paul Singer took exception to what he considers “dangerous appeals to class divisions” and “blaming the lopsided recovery on the beneficiaries of distortionary government policies” such as quantitative easing. Paul Singer also took aim at Obamacare and an increase in the minimum wage as potentially damaging to the economy.
On a macro level, Paul Singer notes that “QE has created asset price booms” and that “last spring we witnessed the first tangible sign that the Fed may be trapped in its current posture. The Fed cannot retreat due to excessive debt in the system, the fragility of major financial institutions (still opaque and overleveraged) and the prospect that a collapse of bond prices could lead to a quick, deep recession.”
When he looks at gold, Paul Singer considers the larger debt crisis picture. “The explanation for why gold is out of fashion and drifting down is not compelling to us. The economy seems stuck in a quagmire, but most so-called “experts” have been changing their minds almost weekly about when they think the economy will finally begin a long-term acceleration to the upside. The mood is populist and hostile to making money, but nobody is fleeing London or New York, and people are treating the nonsense in Washington D.C., Tokyo, Paris and Brussels as just business as usual. In contrast, we are quite concerned about the current environment – and we are determined not to let down our guard. Governments around the world have not given serious thought to their long-term debt and statutory obligations or to the dangers of running an aggressively expansionary monetary policy. The leverage in the system has not really come down post-crisis, and policymakers do not have any more understanding of the financial institutions within their borders than they did six years ago.”
Hope is typically treated as a four letter word in investing, and hope is often accompanied by wishful thinking. When considering the lot of traditional investors, Paul Singer notes the “delusions” that sometimes occur in history. “We sympathize with traditional stock and bond investors, who are faced with extremely poor choices today. QE has distorted the prices of all traditional asset classes to such an extent that none currently promises a fair return with modest risk.
Mass delusions sometimes occur in history, which is why we are not too concerned about being alone in thinking certain things about markets and the world.”
When considering the Elliott Management portfolio going forward, the focus is on risk management,