There’s no denying that US stock market had a difficult first quarter, especially following such an incredible 2013, and setbacks have been blamed on everything from Russian action in Ukraine to the weather. Leon G. Cooperman, Steven G. Einhorn, and Andrew Parlin of Omega Advisors Inc. argue in a letter to investors that the reality is simply that investors are becoming complacent and piling into overcrowded positions without regard to stock fundamentals. Even so, they think that the last quarter will prove to be a period of consolidation and that the bull market has much further to run, according to the hedge fund’s first quarter letter a copy of which was reviewed by ValueWalk.
Signs of complacency: Omega Advisors
At the beginning of the year, investors were mostly long US, European, and Japanese equities, short on EM and US fixed income, and long on the dollar. US social media companies, biotech, and small caps all became popular with momentum investors and were similarly overbought.
“This cooling-off of ‘hot’ sectors is constructive and supportive of a long-lasting bull market in U.S. equities. There is nothing better for the long-term health of the market than to keep greed at bay and to prevent speculative activity from spreading to the broader market,” they write. “The ‘wall of worry,’ which had displayed signs of decay going into this year, has been to a large extent, restored.”
The PE spread between sectors is still at its lowest point in more than ten years, a sign that many investors are looking for cheap exposure without much concern for fundamentals, and the percentage of IPOs from companies that are losing money is at the highest point since the tech bubble.
Yield curve inversion usually precedes a market top: Omega Advisors
Even if investors are investing irrationally, Omega Advisors says that they don’t see the telltale signs of a market top. They acknowledge that the duration of this bull market is well above average (it will soon be the second longest running bull run since the end of the Great Depression), but “bull markets don’t die of old age.”
Instead, what usually happens is that there is a lot of slack left in the economy from the previous recession which is gradually put to work during as the economy expands. When the Fed starts to worry about the amount of excess capacity in the product and labor markets it will increase interest rates to slow things down and keep inflation under control, with a slowdown usually following within the next year. Omega Advisors points out that an inverted yield curve almost always precedes a recession, and right now the yield curve looks fine.
US economy has a long way to go before returning to trend
And there should be an enormous amount of slack left in the economy. The Great Recession was so severe that American GDP was pushed entirely off its trend line, and Omega Advisors thinks it’s likely that the US will return to trend over the next couple of years, implying a very long bull market that occasionally gets ahead of itself and has to consolidate. And when you look at the last couple of years instead of just 2013, this bull market hasn’t even been as reliant on multiple expansion as average.
The big questions are how the end of QE will affect the economy and whether we are seeing a particularly drawn out recovery to trend or if the US economy has undergone a structural change. While unemployment is falling, many people are still underemployed and labor force participation is still below the thirty year average, and if long-term unemployed people can’t find work again then they don’t really represent slack in the system. The growth of the Fed’s balance sheet tracks the S&P 500 disturbingly well, so it’s natural to worry about what will happen when the cash injections end this fall.
Omega Advisors doesn’t weigh in on the unemployment rate, but points out that Federal Reserve chair Janet Yellen is committed to using her position to drive unemployment down, and that low inflation gives her room to act. They also think that while QE may have been necessary to prime the economy, it’s now growing on its own and investors are overly-concerned about tapering and next year’s possible rate hike.
Omega Advisors Performance
In terms of performance, Lee Cooperman’s Omega Advisors returned 1.14% in Q1. He states that the hedge fund suffered from its long Japanese equities and short yen position. The position in the yen short has now been closed, although some other big name hedge funds continue to favor the trade.
Just as our position in the TOPIX was the main driver behind macro adding 65 basis
points to our 4th quarter 2013 return, it was also a principal source of the 45 basis point detraction from our return in the 1st quarter of 2014.
Cooperman mentions some foreign equities which the hedge fund owns, including, Monitise, Kering (EPA:KER) (OTCMKTS:PPRUF). Cooperman notes that:
Kering has radically transformed itself from a conglomerate to a nearly pure-play luxury company with some of the world’s most coveted brands. Applying a multiple of slightly above 16x, a discount to the high-teens P/E at which the sector trades, yields a €200 price target, compared to the current price of approximately €150.
With regards to Monitise Plc(LON:MONI), Cooperman is bullish on the mobile banking technology, noting that Bank of America Corp (NYSE:BAC), among others, have spent a lot on the technology. Lee Cooperman states:
On our numbers, Monitise should be very profitable and rapidly growing within our holding period. Specifically, the company has guided to 30%+ EBITDA margins and 200mm+ users by June 2018. While those numbers provide a very attractive return profile from last sale, our numbers are higher than company guidance and as such we have continued to accumulate shares.
On the domestic front, Cooperman is not phased by recent bad news regarding Citigroup Inc (NYSE:C) quoting Ben Graham as stating, ‘“price is what you pay, value is what you get.” Cooperman believes that ‘Citi can trade to $60, the equivalent of tangible book value, by year-end 2014’
Lee Cooperman ends off the letter with a list of positions, and exposure, he states that gross equity exposure is “71% in U.S. equities and 16% in non-U.S. equities”.
The top 25 holdings, which account for approximately 47% of Omega portfolio