Stanphyl Capital June 2024 Commentary

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Arquitos Capital Management

Stanphyl Capital's commentary for the month ended June 30, 2024.

Friends and Fellow Investors:

For June 2024 the fund was down approximately 19.9% net of all fees and expenses. By way of comparison, the S&P 500 was up 3.6% and the Russell 2000 was down 0.9%. Year to date the fund is down approximately 9.1% while the S&P 500 is up 15.3% and the Russell 2000 is up 1.7%. Since inception on June 1, 2011 the fund is up approximately 101.0% net while the S&P 500 is up 422.3% and the Russell 2000 is up 189.1%. Since inception the fund has compounded at approximately 5.5% net annually vs. 13.5% for the S&P 500 and 8.5% for the Russell 2000.  (The S&P and Russell performances are based on their “Total Returns” indices which include reinvested dividends. Investors will receive exact performance figures from the outside administrator within a week or two. Please note that individual partners’ returns will vary in accordance with their high-water marks.)

This was our second-worst month ever, and the reason why is twofold: we’re running very net short in a stock market that keeps climbing almost entirely on PE multiple expansion despite an economy that’s beginning to crumble beneath it, and our large Volkswagen long position was pounded due to the threat of an EU tariff war with China that I believe will be resolved with minimal impact for Volkswagen AG (OTCMKTS:VWAPY).

The vast majority of investors currently believe that a long-short fund willing to run net short is a dinosaur. Even Jim Chanos, one of the all-time great fundamental short analysts, recently closed his fund and reverted to a family office because he couldn’t find enough investors willing to join him, and just today Bloomberg reported that Jim is far from alone.  Yet throughout financial history, it has been when most investors abandoned all interest in short selling (as they have now) that it soon turned out to be needed the most.

Short Interest on the SPY and QQQ US ETF

As Stanphyl’s largest investor, I’m as frustrated as you are with our recent performance and perhaps more so, as the majority of my personal wealth is in the fund. And yet when I’ve been as out-of-sync as I am right now with the market, the market usually cracked soon thereafter. This happened in my personal portfolio (pre-Stanphyl) when I was very net short through most of 2007 as stocks blithely climbed during the housing crash, and then in this fund in late 2019 when stocks soared despite Covid clearly being on its way from China to the U.S., and again in late 2021 when it was obvious that the Fed would soon raise rates beyond anything we’d seen in decades, yet stocks obliviously continued climbing nearly every day (much as they are now) before crashing heavily. For reasons I clearly lay out below, I think stocks are now in the same situation that they were in early 2000, late-summer 2007, late 2019 and late 2021, and regardless of whether the current imbalance is resolved via a “crash” or a “long, grinding bear market,” the direction of the resolution will be the same: down, a lot.

The fund is extremely liquid and if you notify me by July 29th I will redeem any of you either partially or fully as of July 31 (waiving our normal “three-month notice” and giving you a chance to see how things go over the next few weeks). You’re a terrific group of LPs and those of you who are also personal friends shall remain so regardless of what you decide to do regarding your investment here! But as Stanphyl (by design) constitutes only a relatively small percentage of the net worth of any of you, I hope you’ll remain in the fund and think of it as a hedge against your current (possibly extremely stretched!) long positions. To understand why we continue to be positioned the way we are, please read on…

The S&P 500 (which we’re short via the SPY ETF) has only reached its current level of market-cap concentration two other times in modern financial history. What were those other times? Have a look:

Top 10 percent of stocks by size ve the entire US stock market

Yes, it was 1929 and early 2000. And yet here we are with that same concentration in 2024 with a very expensive market (approximately 25x run-rate operating earnings!) and a U.S. consumer who's finally cracking in a consumer-driven economy. Retail sales comps are now negative on an inflation-adjusted basis and scores of retailers have recently warned about a tough business environment. (Even heretofore fairly strong Walmart warned in June about a weakening consumer.)

Meanwhile, Q1 GDP growth came in at just 1.4% while home sales are plunging. At some imminent point in time, this stock market will switch from "bad news is good news" to "bad news is bad news" as it suddenly realizes that there's a HARD economic landing coming which, according to a recent Bank of America survey, only 5% (!) of investors expect…

Expectations for soft landing up

…while sticky inflation (3.4% core CPI and 2.6% core PCE) driven by massive federal budget deficits prevents the Fed from cutting enough to compensate for that. That's what we remain positioned for.

In the far-right column below from Standard & Poor’s are the 12 most recent quarterly operating earnings for the S&P 500 and, in the middle column, the price of the S&P 500 as of that date. (The S&P 500 is now at 5460.)

most recent quarterly S&P 500 operating earnings

As you can see, nominal earnings have barely grown in the last three years, and although Q1 2024 earnings were up 4% year-over-year, that was only around 0.5% CPI-adjusted. Additionally, those latest earnings are lower “nominally” and much lower “inflation-adjusted” than they were way back in Q4 2021 (when stock prices were much lower). In fact, adjusting for inflation, Q1 2024 earnings came in lower than every quarter of 2021! Annualizing those Q1 2024 earnings to $218.48 ($54.62 x 4) and putting a long-term market average 16x multiple on them would bring the S&P 500 all the way down to just 3496 vs. June’s close of 5460. Even an 18x multiple would bring the S&P down to just 3933 vs. the current 5460. And then what happens to those earnings when we get a recession?

Why do I believe so strongly that we face a “hard landing”? For the same reasons I’ve been stating since the Fed started raising rates in 2022:

There’s no way an “everything bubble” built on over a decade of 0% interest rates and trillions of dollars of worldwide “quantitative easing” can not implode when confronted with 5% U.S. rates and quantitative tightening plus tighter money from the ECB (even with the tiny June cut), BOJ and other central banks.

And contrary to the belief of equity bulls with short memories, when an asset bubble unwinds, lower inflation and lower interest rates won’t immediately ride to the rescue. When the 2000 bubble burst and the Nasdaq was down 83% through its 2002 low and the S&P 500 was down 50%, the rates of CPI inflation were 3.4% in 2000, 2.8% in 2001 and 1.6% in 2002, and the Fed was cutting rates almost the entire time.

Yet despite myriad lurking dangers—both economic and geopolitical—the stock market (even the non-AI stocks) is disconnected from a scenario involving any landing. Here are a few exhibits that perfectly capture this decoupling…

Credit growth vs delinquencies

Citi US economic surprise index

Truck tonnage index vs. S&P 500 index

LEI fell again in May

Share of equity market capitalization

So for now, at least, we’ll remain net short and I hope you’ll stay with us for the journey. Here is some commentary on some of our other positions; please note that we may modify them at any time…

We continue to own Volkswagen AG (via its VWAPY ADR, which represent “preference shares” that are identical to “ordinary” shares except they lack voting rights and thus sell at a discount). Under CEO Oliver Blume VW is doing all the right things to position itself for the future (including a June deal obtaining instant access to Rivian’s excellent EV software- here’s a good explanation of the rationale behind it). VW currently sells for only around 3.5x its 2024 earnings estimate while controlling a massive number of terrific brands including separately listed Porsche, of which it owns 75% at a current market cap (for Porsche) of €63 billion and Traton, of which it owns 89.7% at a current market cap (for Traton) of €15 billion, thus making VW’s €47 billion Porsche stake and €13 billion Traton stake combined worth around €5 billion more than the entire €55 billion market cap of VW; in other words, at current prices you’re getting paid €5 billion to own all these other brands:

I believe Audi alone is worth around €40 billion and the entire company is worth around €170 billion; additionally, the stock yields around 8% and VW has a wide range of electric cars available and in development (including one for €20,000) as demand (or regulatory requirements) for them develops, as well as a newly revamped China strategy and even a robotaxi.

We remain short Tesla, which this year reported disastrous Q1 deliveries & earnings and Q2 will also be awful—better than Q1 but significantly worse than the year-ago quarter. In response, the company suffered massive layoffs, the sudden departure of its chief engineer who immediately dumped almost all his stock, the firings of multiple other key executives and most of the Supercharger team, the indefinite postponement of a $25,000 mass-market car (perhaps to be replaced by an only slightly cheaper, de-contented version of the existing platform), the forced licensing in China of Baidu’s driver assistance mapping & lane-keeping navigation (somehow misinterpreted by the market as being bullish for Tesla, in a country where its aging product line already faces at least 10 competing driver assistance systems), and yet another NHTSA investigation of its deadly and fraudulently marketed so-called “Full Self Driving” while lawsuits against that product continue to pile up.

This year Tesla will sell fewer cars than last year and at considerably lower prices, and will be lucky to earn $2/share (less than half of 2023’s $4.30) with an industry-average (or worse) operating margin. In other words, Tesla is now just another cyclical car company (only around 7% of its revenue comes from its low-margin energy business), and similar car companies sell for 4x to 8x earnings, which makes Tesla worth less than $20/share vs. June’s closing price of $197.88. No wonder Musk is trying to nonsensically claim that Tesla is “really a robot company”!

In April Musk suddenly announced the August debut of a Tesla robotaxi, something he’s been lying about for years and—unless it’s equipped with absolutely necessary LiDAR—is undoubtedly lying about again. And yet if it does have LiDAR Tesla may face the most massive lawsuit in history (perhaps over $100 billion), as it has sold millions of LiDAR-less cars claiming they had all the hardware needed to be robotaxis. So Musk is damned if he does include LiDAR in future cars and damned if he doesn’t; it’s a real “fraudster’s dilemma”! I summed up on Twitter why Tesla’s LiDAR-less so-called “Full Self Driving” is so bad, based on numerous anecdotal (as Tesla refuses to publish “official”) reports of “intervention frequency”:

Stanphyl Capital Tweet

As I just mentioned, in 2019 Musk claimed that the hardware in then-current Teslas (and every subsequent Tesla) would soon receive software to make them hugely profitable "robotaxis.” As far back as January 2016 he claimed that every new Tesla had all the hardware needed to be completely self-driving and would receive the necessary software by 2018, and he “demonstrated” this with a completely fraudulent promotional video about which the DOJ is reportedly conducting a serious criminal investigation. Meanwhile, here we are in 2024 and, because Tesla’s “autonomy” system has been linked to hundreds of crashes and dozens of deaths, the NHTSA recently forced Tesla to make its cars less self-driving via an upgrade of its driver monitoring system, an action safety experts say was highly inadequate, thus making more severe restrictions likely. This has been a huge consumer fraud and may be a basis for millions of people to sue Tesla for tens of billions of dollars, while negatively impacting Tesla’s current and future sales via negative publicity that has turned its so called “Autopilot” and “Full Self Driving” into laughingstocks. In 2022 Musk said that without self-driving, Tesla stock is basically worthless; needless to say, I agree with him.

On top of Tesla’s massive “self-driving” fraud, in December Reuters published a huge exposé of Tesla’s deadly and financially fraudulent multi-year cover-up of defective suspensions (providing yet more evidence of both Musk’s sociopathology and Tesla’s fraudulently low warranty reserve), thereby causing two U.S. Senators to demand a massive recall and, possibly related to those defective suspensions, in December it was revealed that Teslas crash more than any other brand of car.

Now let’s put these massive safety deceptions and cover-ups into context: as bad as Tesla’s public financials are lately, how much worse might they be “in reality”? I mean, why would anyone trust financial statements from a guy who’s been caught lying and covering-up deadly safety defects multiple times over the years and cycles through CFOs the way McDonald’s cycles through Gen Z fast-food workers?

In fact, last August Tesla’s most-recent CFO suddenly quit (or was fired) on no notice, the latest in a series of sudden and unexplained Tesla CFO departures. This may be tied into the possibility that the DOJ is close to criminally indicting Elon Musk following the revelation of a massive & systemic Musk-directed consumer fraud regarding the range of Tesla’s cars, his alleged attempted theft of company assets to build himself a house, and, in addition to the above-mentioned Reuters story, Handelsblatt’s story about a massive & systemic Tesla safety cover-up while people continue to die in (or because of) Teslas at an astounding pace. In fact, Tesla’s most recent 10-Q confirmed that the company has received multiple subpoenas regarding many transgressions. Whether from these crimes or something else, Musk will go down because fraudsters like him always do… even if he thinks he has an “airtight strategy” (blackmail?) to combat these regulators:

Elon Musk Tweet

As for Tesla’s “AI” hype story, the three top leaders of that team left the company in October, and in May Musk raised $6 billion for a competing company he controls!

Meanwhile, Tesla is now opening its U.S. charging stations to cars from all other manufacturers which, in turn, will adopt Tesla’s connector and charging protocol. (Those competitors are building their own networks, too.) Seeing as many people only bought a Tesla instead of a competing EV in order to access those chargers, and seeing as all the competing charging networks will also adopt this protocol while paying Tesla nothing (Tesla open-sourced it), this will cost Tesla far more in lost auto sale profits than the pennies per share it may gain from charging profits.

And Tesla has objectively lost its “product edge,” with many competing cars now offering comparable or better real-world range, better interiors, faster charging speeds and much better quality. In fact, Tesla ranks third from the bottom in the 2024 JD Power initial quality survey and its Model 3 is the worst car (out of 111!) in Germany’s rigid safety inspection system!

And oh, the fraudulently promoted and multiple-recalled Tesla “Cybertruck” won’t be much of a “growth engine” either, as by the time it might be in meaningful mass-production in late-2024 that grotesque-looking, impractical kluge will be in a dogfight of a market vs. Ford’s F-150 Lightning, GM’s electric Silverado, the Dodge Ram REV and Rivian’s R1T.

Another favorite Tesla hype story has been built around so-called “proprietary battery technology.” In fact though, Tesla has nothing proprietary there—it buys the vast majority of its cells from Panasonic, CATL and LG, while the “4680s” it’s trying to make itself are a manufacturing disaster with no meaningful advantage in energy density (and, as noted in that linked article, even if Tesla does wind up successfully making its own 4680s, other manufacturers will gladly make and sell them to anyone). And meanwhile, the real-world range of Tesla’s cars is now just average vs. its competitors.

As for June’s vote to reinstate Musk’s massive pay package, I both welcome the dilution and consider it to be no more than “a sideshow” unless the judge invalidates the vote and Musk leaves Tesla and dumps his remaining stock, in which case TSLA shares would plunge instantly rather than gradually. Meanwhile, despite promises to the contrary, he still spends far more time on Twitter than he does at Tesla.


Mark Spiegel,

Stanphyl Capital

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