Billionaire Dan Loeb is ‘closely watching’ these 4 key risks that can stop the market rally

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Daniel Loeb, founder and chief executive officer of Third Point LLC

The best hedge fund managers are always looking out for potential downside when they put together a portfolio. Third Point’s Dan Loeb, who nearly doubled the S&P 500’s return for more than two decades, shared his key concerns for the market in a note to clients Monday.

“While we remain optimistic about the trajectory of the economy and markets, we have weighed our positioning with an acute awareness of the risks,” Loeb wrote. “Although we do not fear a recession now, ‘event risks’ need to be considered.”

Unlike many of his well-known hedge fund peers, Loeb was able to generate strong returns last year.

Loeb’s hedge fund,Third Point Offshore, was up 18.1 percent in 2017 compared with the S&P 500’s 21.8 percent gain, according to an investor letter. From inception in 1995 to 2017, the fund generated annual returns of 15.8 percent versus the market’s 8.2 percent.

But the hedge fund manager said he is wary of four potential issues for the market he is “closely watching:”

1. Decelerating growth: “Since growth is already at a high level, further acceleration is less likely. That means that average returns will likely be lower and volatility higher this year.”
2. Rising inflation: “Low inflation has been a critical support for the market because it has allowed the Fed to be unhurried in its rate normalization. … We are watching closely to see how a tightening labor market and recently announced wage hikes will shape the future path of inflation.”
3. Less earnings growth: “The momentum of earnings growth is at a peak and its normalization could create greater volatility compared with the tranquility of 2017.”
4. Recession: “A recession would come as a surprise to investors and would likely lead to a substantial market decline given the expansion in valuations in recent years and the concern that the Fed would not have enough ammunition to sufficiently stimulate the economy.”

Loeb said his fund’s portfolio is “well-positioned” even under these risks due to its bets against stocks through short-selling and the “event-driven” nature of his investments.

In regard to the investor’s investment strategy
, Third Point materials describe its philosophy as “value-oriented” with an “emphasis on special situation equities.” The firm “seeks to identify situations where we anticipate a catalyst will unlock value.”