We recently came across an Australian publicly traded investment fund’s investor letter. East 72 is one of the most bearish fund’s in the world at the moment with a net exposure greater than -100%. That means they are more than short the entire market. Obviously being short didn’t help with generating positive returns as the fund lost 23.4% in 2019. Its loses over the last 2.5 years is more than 50%. You can download a copy of their investor letter here.
Even though the fund’s investors are losing money hand over fist, we like to see more funds like East 72 that take bold positions and express their convictions publicly. S&P 500 companies announced 2019 Q3 total earnings of about $40 per share. This means the S&P 500 Index is trading at 80 times this amount. The year-over-year EPS growth rate is -2.8%. So, earnings are shrinking but earnings multiple is expanding. No wonder East 72 is frustrated. This is a result of Federal Reserve’s ultra accommodative interest rate policy. After Powell caved in to Trump’s bullying, long-term interest rates plunged and the equity markets rallied 30+% in 2019.
In its 2019 Q4 investor letter East 72 said the following about Apple Inc (NASDAQ:AAPL):
The best example of the impact of the “just buy equities” phenomenon was hinted at in the table above showing the 12% gain in NASDAQ composite over the final quarter; the second largest weighted stock in the index is Apple (AAPL) at around 8.5%. Its share price rating has exploded to the highest since smart phones were invented over the past year, notably with the 38% equity price rise in the past quarter. Notwithstanding the obvious financial strength (and engineering) of the company, does the “highest rating ever” (16.6x trailing EV/EBITDA) seem reasonable in the context of a low-growth company, with China market difficulties? We have no position, but think not.
East 72 doesn’t have any short positions in Apple Inc now, but they did in 2019. Luckily they covered it when Apple shares were trading at $250. One short position East 72 failed to cover was Tesla Inc (NASDAQ:TSLA) though. Here is what they said about the EV pioneer:
We discussed the Tesla phenomenon in detail at our AGM; suffice to say the unbridled enthusiasm for this intermediator of “green credits” from other auto manufacturers seems unbridled with a $30 BILLION addition to equity market value over the last quarter. It remains our largest stock position, as a short.
You can download a copy of their Tesla presentation here. Clearly the market isn’t valuing Tesla based on what it did in the past, it is valuing Tesla what it can do in the future. When investors and consumers hear the word “electric vehicle” which car brand do they think about next? I don’t own an Apple phone nor a Tesla car, but I understand how these companies are successful at extracting premium prices from luxury seeking consumers. The stocks I recommend in Insider Monkey’s monthly investor letter are usually undervalued value plays.
At Insider Monkey we leave no stone unturned when looking for the next great investment idea. For example Europe is set to become the world’s largest cannabis market, so we check out this European marijuana stock pitch. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. This December, we recommended Adams Energy as a one-way bet based on an under-the-radar fund manager’s investor letter and the stock is still extremely cheap despite already gaining 20 percent.
East 72 may be one of the world’s most bearish funds, but it likes a few US stocks. At the end of October East 72’s biggest long equity positions included AerCap Holdings (NYSE:AER), Alphabet Inc. (NASDAQ:GOOGL), Berkshire Hathaway (NYSE:BRK-B), and Goldman Sachs (NYSE:GS). These are the types of stocks that an old school fund manager like David Einhorn would buy, maybe except Alphabet Inc. I’d argue that Alphabet Inc. is a more value stock than AerCap because it has negative leverage and much cheaper than the rest of the market.
Alphabet is cheap because it is trading at 23 times forward earnings excluding cash, but it is growing its topline at a nearly 20% rate and it has hidden assets like its autonomous vehicle division that negatively contributes to the companies EPS figure. On the other hand S&P 500 Index’s earnings shrank 2.8% y-o-y, yet its PE ratio is more than 20 based on latest quarterly earnings figure. I’d rather own Alphabet than an index fund. Investors could have enjoyed 20% gains if they just bought Alphabet shares just a couple of months ago. By the way Alphabet is one of the top 5 stocks among hedge funds.
Another stock East 72 likes is the Italian holding company Exor which has Fiat Chrysler, Ferrari, and CNH Industrial N.V. (NYSE:CNHI) in its portfolio. Here is what they said about CNHI:
“EXOR is now moving to extract added value from CNH, through an intended spin-off of its US$13 billion “on-highway” bus and powertrain business, best known through its respective “Iveco” and “FPT Industrial” brands; this will leave behind the US$16 billion revenue “off-highway” business focused primarily on agricultural equipment (Case, New Holland) and specialty construction vehicles;
CNH has been placed on a path to far higher margins across the two businesses intended to double pro-forma earnings over four years; if achieved this would give scope for a significant $4-$8 billion uplift in the value of Exor’s holding”
CNHI shares currently trade at $11. If East 72 is right about this stock, it should return an average of 20% per year for the next 4 years. I would have taken a closer look at this stock but it has way too much leverage for my taste. Its market cap $15 billion, but its enterprise value is $36 billion. If I create an Alphabet position with 2.5 times leverage, I will probably achieve 20% annual returns or more.