This weekend, we reported the thoughts of investment titan David Tepper of Appaloosa Management regarding where the market is heading given the revision of growth estimates on account of lagging economies, particularly China, and the downtrodden price of oil. To sum it up, he believed that there wasn’t much room for the S&P 500 to head higher, but wouldn’t want to be short either, owing to a couple of reasons, which included possible investor enthusiasm if the Fed decides to raise rates in its upcoming meeting. Meanwhile, another accomplished activist investor, Bill Ackman of Pershing Square, who was one of last year’s top performers in the hedge fund world with smashing 40% returns for the year, revealed in an interview with CNBC that he believes in quite the opposite: that current valuations are pretty cheap and the scenario that Tepper described as optimistic is in fact quite realistic.
Why do we pay attention to hedge fund sentiment? Most investors ignore hedge funds’ moves because as a group their average net returns trailed the market since 2008 by a large margin. Unfortunately, most investors don’t realize that hedge funds are hedged and they also charge an arm and a leg, so they are likely to underperform the market in a bull market. We ignore their short positions and by imitating hedge funds’ stock picks independently, we don’t have to pay them a dime. Our research have shown that hedge funds’ long stock picks generate strong risk adjusted returns. For instance the 15 most popular small-cap stocks outperformed the S&P 500 Index by an average of 95 basis points per month in our back-tests spanning the 1999-2012 period. We have been tracking the performance of these stocks in real-time since the end of August 2012. After all, things change and we need to verify that back-test results aren’t just a statistical fluke. We weren’t proven wrong. These 15 stocks managed to return 118% over the last 36 months and outperformed the S&P 500 Index by over 60 percentage points (see the details here).
$19 Billion Pershing Square’s Recent Performance
A background on this is necessary for readers to know where Ackman is coming from. Pershing Square was up by roughly 10% through July of this year until the market volatility rocked the fund’s portfolio. After losing 13.1% in August, through the 25th of that month, the fund found itself 4.3% in the hole for the year. Ackman’s top new picks heading into this quarter were Valeant Pharmaceuticals Intl Inc (NYSE:VRX), Air Products & Chemicals Inc. (NYSE:APD), Canadian Pacific Railway Limited (USA)(NYSE:CP), all of which down in August. Thus, it is not surprising that Ackman doesn’t see the market heading lower after such a severe downturn has already taken place.
Views On the Holy Trinity
Ackman addressed the three concerns that most investors are currently worried about, namely exchange rates, emerging economies headed by China, and the price of oil. Regarding the exchange rates, he believes that the market was already pricing in the future fluctuations. China he believes was obscure to everybody and the only fact that people were in agreement about seems to be that the real growth is lower than what the country’s official GDP figures suggest.
“Talk to anyone who knows anything about China [growth], they’ll tell you that 7 percent is fiction, 5 percent is probably a fiction, and real growth in China is something like 1 percent to 4 percent,” he said .
However, it can be debated how efficient the market really is in pricing all of these dynamics that could play out in the future, especially if China continues to dump US treasuries like it has been doing recently in order to keep the Renminbi’s exchange rate stable. There is a wide variety of scenarios that could take shape, which is causing investor nervousness.