Hedge fund manager John Paulson used to have a legend-like status as one of the world's savviest investors – a guy who spotted the U.S. housing mess long before others and profited handsomely from it. Now, with investments in Sino-Forest Corp. and Bank of America Corp. sapping the performance of this funds – his two biggest funds have fallen 23 per cent and 33 per cent per cent, respectively, in 2011 – Mr. Paulson's reputation has taken a hit.
However, according to an article in the Wall Street Journal, the setbacks haven't changed his outlook: "Donning a dark sports jacket, the founder of giant hedge-fund firm Paulson & Co. apologized for the unusual volatility of his funds and vowed to recover recent losses. He acknowledged mistakes and said he was making adjustments. But there's one thing Mr. Paulson said hadn't changed – his bullishness."
There are essentially five reasons behind his commitment to stocks, despite the rattling backdrop of a stumbling economic recovery, political paralysis in Washington and the ongoing European debt crisis:
- The discrepancy between equity earnings yields (the inverse of the price-to-earnings ratio) and Treasury yields is at a record high, making stocks look cheap.
- The dividend yield of the S&P 500, currently 2.2 per cent, is higher than the yield on the 10-year U.S. Treasury bond – even though dividend yields rise while bond yields are fixed.
- Recent stock declines have been buying opportunities for savvy investors.
- Dour macroeconomic events, including the European debt crisis, is overshadowing strong corporate performance for stocks within his portfolio.
- U.S. banks are compelling: Their strong balance sheets will make them compelling long-term bets no matter what happens in Europe.
Convinced? There's certainly something here for everyone. Those who stand by Mr. Paulson as an exceptionally savvy investor will no doubt like the fact that he still has confidence in his outlook. The setbacks merely indicate that cheap stocks have become even cheaper.
However, those who entertain suspicions that Mr. Paulson is a one-bet wonder might be scratching their heads over this bullish outlook. Looking at dividend yields and earnings yields, while shrugging off the macroeconomic outlook, might be interesting but it is hardly legend-building stuff.
David Berman