David Einhorn and the Deflationary Value of Cloud
For months, Greenlight Capital CEO David Einhorn has been mourning his “luck,” in preferring value stocks over growth.
The Greenlight Capital fund is down about 19% so far in 2018 and it suffered its worst performance in June, down 7.7% while the S&P 500 was up 1.7%.
Of course, Einhorn didn’t just buy value. He literally bet against growth stocks like Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX) and Tesla (NASDAQ:TSLA), calling them his “bubble basket.”
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Einhorn is not wrong here. Stocks like Amazon are getting a bubble valuation. But timing their fall is a fool’s errand, because such stocks rise fastest just before they crash. That’s the way bubbles operate.
Value Delivered
What few noticed in the carnage was that Einhorn’s “long” bets paid off. The sale of Time Warner to AT&T (NYSE:T) delivered a nice gain. Einhorn made enough in Continental Resources (NYSE:CLR), an oil and gas company, to offset his losses in Tesla.
What most perplexes Einhorn is why General Motors (NYSE:GM) remains moribund while Tesla keeps rising, to the point where Tesla CEO Elon Musk personally trolled Einhorn, saying he would buy him a box of short shorts.
Einhorn wonders why GM, which earned $2.4 billion for the quarter and has a market cap of $53 billion, is worth only slightly more than Tesla, which continues to lose money but has a market cap of $50 billion.
The answer is that GM is a good dividend investment, with a yield of 3.8%, while Tesla is a stock for gamblers. Gamblers will eventually lose, but expecting it, and betting against them, is silly. Better to play the house and buy Intercontinental Exchange (NYSE:ICE), the owner of the New York Stock Exchange, up 32% over the last year, while the S&P 500 is up just 29%. When the gamblers trade out, the house always wins.
The fact is that value stocks are not designed to grow quickly, only in line with the growth of the U.S. economy, its value. The economy is growing at an average rate of 3% this year, with the second quarter’s 4.1% set against the first quarter’s 2.2%.
Value won’t deliver much better returns than that, although handing Wall Street $1.5 trillion, as the tax cut did, will make it appear that way. Instead, what investors who won with the tax cut did was double-down on growth, on what works. Apple (NASDAQ:AAPL) works. Microsoft (NASDAQ:MSFT) works. This remains the cloud decade, and the efficiency of cloud continues to drive deflation into the economy, and profits into those whose businesses run on cloud.
Bubbles Do Burst
It’s not a sign of courage to buy big iron over cloud. It’s a sign of stupidity.
The cloud stocks are rolling over because they are the economy, and the economy will roll over as the fuel of the tax cuts is spent, as the trade war looms and as the bill for those tax cuts approaches. But you can’t time it, and it’s foolish to bet money on naming the day.
“We have been accused of being stubborn, but one person’s stubbornness is another person’s discipline,” Einhorn writes. What’s stupid is not recognizing fundamental changes in the economy made possible by the cloud, understanding the deflationary nature of cloud, and plugging that into the value portfolio thesis.
Value can’t shine in a deflationary environment. Cloud has produced that environment. When the cloud boost to deflation fades, so will the economy. Its fall won’t be signaling a return to value. It will be signaling a recession.
Dana Blankenhorn is a financial and technology journalist. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in T, AMZN and MSFT.
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