Third Point Reinsurance (TPRE) was added to the Pivotal Point portfolio in the middle of last month, and has struggled a bit since. No worries.

The Bermuda company is the public investment vehicle of Dan Loeb, the billionaire activist hedge fund manager. The business prospects, and share price are nearing an inflection point.

Reinsurance might not be the first thing investors think of when they consider the high stakes world of professional hedge funds. Insurance seems staid. However, reinsurance markets can be extremely lucrative. Essentially, reinsurance companies are insuring the policies written by insurance companies. If the policies are rated wisely, collected premiums might not ever be paid out. In the interim, reinsurance companies are able to invest the premiums.

The appeal to investment managers is the longer-term use of the capital, free of worry about skittish investors asking for redemptions. Warren Buffet, and a who’s who of hedge fund managers have utilized the reinsurance structure.

Third Point is even more clever. Since inception, it has never rated losses in excess of treaty. This means the company always has a very good idea how much money it will get to keep. This was especially prudent in 2017 as hurricanes, earthquakes and wild fires pushed insurance industry losses to $100 billion, for only the third time in history.

Related losses at Third Point were $5.3 million.

Meanwhile, Dan Loeb and his team of investment managers have been on fire. The equity portfolio returned 5.2% in the third quarter, and 24.3% for the first nine months. The fund has made large bets in Baxter International Inc (BAX) and Alibaba Group Holding Ltd (BABA). It is still trimming its massive position in DowDuPont Inc (DWDP).

It also holds a massive $3.5 billion stake investment in Nestle. The position is considered an activist position, and not subject to 13F regulatory filings.

Third Point Reinsurance shareholders saw gains of 3.4% for the quarter, and 14.2% for the first nine months. The smaller returns are based on the available float of the reinsurance business. Investment income was $89 million, versus $88 million a year ago. For the first nine months, income rose to $325 million, versus $135 million, a year ago.

More impressive, in the first nine months of the year, fully diluted book value has increased $2.08, to $15.24. The company has authorized a share buyback for up to 51.8 million shares if the stock trades below 90% of book value. This provides a terrific backstop.

The business appeal of Third Point is clear: It is a low risk way to participate in the performance of a proven hedge fund manager. On average, the hedge fund has returned 15.6% annually since inception in 1995. Risk is minimal, due to the share repurchase program.

The share price has been mired just below the $17 level. A rally through that point would clearly be an important upside breakout. It should jumpstart a rally toward the $21 level. There is support at $14.50.

TAX PACKS

Wondering why investors care about the tax overhaul bill winding its way through Congress? UBS Wealth Management argued in a research piece that cutting the corporate tax rate to 20% would result in earnings for Standard & Poor’s 500 companies some $10 per share higher, to $151 instead of $141, in 2018, according to a report in Barron’s.

But a major risk for the market is the potential rise in U.S. inflation, says Mark Haefele, the giant Swiss bank’s global chief investment officer, also in Barron’s. That concern, which could push the Federal Reserve to tighten more aggressively, is shared by Deutsche Bank’s strategists, along with the impact of the European Central Bank’s tapering of its massive bond purchases.

Deutsche last week joined the small but growing list of major banks that think the Fed could raise its interest-rate target four times in 2018, in addition to the quarter-point hike that seems to be a lock at the Dec. 12-13 meeting of the Federal Open Market Committee.

So, who are the potential winners and losers of the tax plan?

The market is telling us that bank stocks are lined up to be big winners due to three factors …

First, new leadership at the Federal Reserve is willing to back off on costly regulations put in place after the great financial crisis of 2008-2009.

Second, higher interest rate targets at the Fed will lead to fatter profit margins for lenders.

And third, their charts look splendid, as major money-center banks and investment banks like Goldman Sachs Inc (GS) as well as the major regional banks like Fifth Third Bancorp (FITB) and Zions Bancorporation (ZION) are breaking out of multi-year bases on solid volume.

If economic activity continues to pick up, the building of single-family and multi-family dwellings will continue to advance. Seattle, where I live, is astride an astounding boom of apartment buildings – much of it is oriented toward the expectation that Amazon.com is still growing at a mind-blowing rate. My son is an analyst for a big apartment developer in Seattle and devoted much of his first podcast to the expectation that Amazon intends to lease up to 12 million square feet of commercial
space in downtown Seattle by 2022, up more than triple from its current space.

We’ve been expecting a business boom to follow the stock market boom. And it appears to be coming. Indeed, the country seems to be at the stage of the economic cycle where jobs are available, wages are starting to rise and mortgages are still affordable. The banks have credit to lend, and rising rates from a low base will go straight to profits after years of consolidating head count.

Stocks have been discounting this possibility, but the idea is not yet fully realized. I continue to think that defense stocks will also be beneficiaries of the next turn of the wheel as the White House puts its weight into an arms build-up to blunt potential threats from China and North Korea. And thee new leadership in Saudi Arabia seems to be leaning toward a military conflict with Iran that would drag in other countries like Qatar and Egypt.

Some of the top stocks in the group that have pulled back a bit lately are large caps like Northrop Grumman Corp (NOC), General Dynamics Corp (GD), TransDigm Group Inc(TDG), Huntington Ingalls Industries Inc (HII), and Boeing Co (BA). We already own NOC in the portfolio. I’m not adding the others, but you can look at them on your own.

NOTES ON MY SCORECARD

– The S&P 500 is in its second longest bull market: 3,188 days and +284% since starting at the end of the last bear market on March 9, 2009.

– The longest bull market in history ran another 1,306 days, or 3.7 years for a gain of 528% from 12/4/87 to 3/24/2000.

– This is the longest rally of 3% or more without a 3%-plus correction, at 391 days, from 11/4/16 to 11/30/17.

– Not too long after this bull market started in 2009, I forecast that the S&P 500 had a shot at rising 5x to the 3,330 level. With the S&P 500 closing at 2,629 on Tuesday, that’s now just a 25% move away.

– The rally has had a firm underpinning, as the U.S. and global economies are healthy and growing, central banks are still accommodative, earnings growth has surprised with upside and regulations are easing. But the hidden super-factor is that inflation is still low, allowing price/earnings multiples to levitate.

– The Dow Jones Industrial Average closed over 24,000 or the first time on Thursday That was the sixth 1,000-point threshold since last November’s election. Prior thousand-point levels in the 1985-2014 stretch have been crisscrossed, or back-tracked over, 20 to 85 times. But in the past year, no thousand-point threshold has been crossed more than five times and three were not crossed back over again at all.

– The S&P 500 is quite extended above the upper edge of its uptrend channel, which is where tops happen. I don’t expect a complete flop; more like a negatively biased sideways crab walk.

– Sectors moving to the top of the favored list are ones that were on the skids over the summer: Financials (XLF), Telecom (IYZ), Energy (XLE) and Industrials (XLI). However, all sector funds are overbought at this time. Again, that doesn’t mean they will reverse and go down, but it takes a lot of buying power to get them to overbought, so expect some consolidation – i.e., the crabwalk.

– Bespoke Investment Group analysts showed in a report Friday how much lane-swerving was at play in the past two weeks: Through Thanksgiving, the stocks that had done best in 2017 were growth names with low or no dividend yields. Stocks with heavy international revenue exposure as well as low short interest had also outperformed. Value stocks with high dividend yields and low P/E ratios had been the year’s worst performers. … The script completely shifted in the past week. The 50 stocks that were up the most YTD through last Friday were down an average of 2.05% from Friday through Wednesday. The 50 stocks that were down the most YTD through last Friday were up huge from Friday through Wednesday, averaging a gain of 4.01%. Their conclusion: “The theme is rotation, rotation, rotation.”

Best wishes,

Jon Markman