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Stanphyl Capital August 2024 Commentary

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Stanphyl Capital

Stanphyl Capital commentary for the month ended August 31, 2024.

Friends and Fellow Investors:

For August 2024 the fund was up approximately 10.0% net of all fees and expenses. By way of comparison, the S&P 500 was up 2.4% and the Russell 2000 was down 1.5%. Year to date the fund is down approximately 13.0% while the S&P 500 is up 19.5% and the Russell 2000 is up 10.4%. Since inception on June 1, 2011 the fund is up approximately 92.5% net while the S&P 500 is up 441.5% and the Russell 2000 is up 213.7%. Since inception the fund has compounded at approximately 5.1% net annually vs. 13.6% for the S&P 500 and 9.0% 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 a volatile month, as it started with a mini-crash during which I covered our large QQQ short near the lows (I couldn’t not cover it when the VIX soared into the 60s!) and then actually got long QQQ for a short, profitable trade for the same reason. (I couldn’t not get long when the VIX soared into the 60s!) I then took off the QQQ position entirely, let it run quite a bit higher, and then put on a smaller short position, which we currently hold. Thus…

We continue to run net short, as stock prices remain elevated despite an economy that’s beginning to crumble beneath them while the stock market continues its overconcentration in a small handful of Nasdaq 100 (the aforementioned QQQ) companies:

Five largest companies as share of the S&P 500 total market cap

We also remain short Tesla, which continues to be the biggest bubble-fraud in stock market history, as I discuss in detail later in this letter.

As noted above, this remains a very expensive market (the S&P 500 is at approximately 24x run-rate operating earnings and the Nasdaq 100 is at around 31x trailing earnings) while the U.S. consumer is finally cracking in this consumer-driven economy. Real (inflation-adjusted) retail sales comps are now negative (July sales reported in August were +2.7% year-over-year vs. 2.9% CPI) and scores of retailers have recently warned about a tough business environment. Most recently, Home Depot and Lowes warned in August and McDonald's warned in July about a weakening consumer, and also in August Target, Nordstrom, Dollar General and Foot Locker reported negative real (inflation-adjusted) same-store sales comps and guided to negative real comps going forward, while Macy’s , Kohl’s, Best Buy and Williams-Sonoma comps were negative in both nominal and real terms, and Wal-Mart reported same-store sales that outstripped inflation by a mere 1%, with that small gain likely due to middle-class consumers leaving pricier retailers.

Meanwhile, in August the stock market switched from "bad news is good news" to "bad news is bad news" as it finally began worrying that a recession may be on the way, and yet while the most recent Bank of America survey says 76% of investors anticipate a “soft” landing…

soft landing

… I expect a “hard” one, with sticky inflation (currently 3.2% core CPI and 2.6% core PCE) driven by massive federal budget deficits preventing the Fed from cutting enough to compensate for it. And inflation is now sticky:

Core PCE

As for precisely how expensive this market is, in the columns below from Standard & Poor’s are the last three years of quarterly operating earnings for the S&P 500 (using the latest estimate for Q2 2024). I then inflation-adjust those earnings to show that in real terms they’re lower now than they were in 2021! I then calculate run-rate PE ratios based on the “nominal” numbers to show that a lot of this bull market’s increase in the S&P 500’s price has been due to unwarranted PE multiple expansion, not real earnings growth. (As of August 31 the S&P 500 is at 5648, making its PE multiple approximately 24.)

Quarter S&P 500 Operating Earnings Earnings Annualized Inflation-Adjusted Earnings as of 6/30/24 S&P 500 Price PE Ratio
6/30/2024 (est.) $58.62 $234.48 $234.48 5468.40 24.0
3/31/2024 $54.63 $218.52 $219.81 5254.35 24.0
12/31/2023 $53.90 $215.60 $220.82 4769.83 22.1
9/30/2023 $52.25 $209.00 $213.34 4288.05 20.5
6/30/2023 $54.84 $219.36 $225.88 4450.38 20.3
3/31/2023 $52.54 $210.16 $218.75 4109.31 19.6
12/31/2022 $50.37 $201.48 $213.28 3839.50 19.1
9/30/2022 $50.35 $201.40 $213.18 3585.38 17.8
6/30/2022 $46.87 $187.48 $198.78 3785.38 20.2
3/31/2022 $49.36 $197.44 $215.76 4530.41 22.9
12/31/2021 $56.73 $226.92 $255.71 4766.18 21.0
9/30/2021 $52.02 $208.08 $238.32 4307.54 20.7
6/30/2021 $52.05 $208.20 $240.75 4297.50 20.6

 

Annualizing the Q2 2024 earnings estimate to $234.48 ($58.62 x 4) and using the traditional “rule of 20” (which says that the S&P 500’s PE ratio should be 20 minus the current 2.9% nominal rate of CPI inflation) would put a 17.1x multiple on those Q2 earnings and bring the S&P down to just 4009 vs. the current 5648. And 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 still disconnected from a scenario involving any landing. Here are a few exhibits that perfectly capture this decoupling…

Change of rates

Surge in Credit Cards

Cass Freight Index

Truck Tonnage Index

Equities

Corporate buybacks

Thus, we remain net short. 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 joint venture obtaining instant access to Rivian’s excellent EV software- here’s a good explanation of the rationale behind it) and one in China with Xpeng. VW currently sells for only around 3.3x 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 €65 billion and Traton, of which it owns 89.7% at a current market cap (for Traton) of €15 billion, thus making VW’s €49 billion Porsche stake and €13 billion Traton stake combined worth around €12 billion more than the entire €50 billion market cap of VW; in other words, at current prices you’re getting paid €12 billion to own all these other brands:

Volkswagen Market Cap

I believe Audi alone is worth around €30 billion and the entire company is worth around €150 billion; additionally, the stock yields over 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 battery energy storage business and a robotaxi.

We remain short Tesla, which in July reported yet another horrendous quarter (Q2 2024), with year-over-year revenue up a mere 2% while earnings were down 46% (!) to just .42/share, and approximately half of those earnings came from the sale of emission credits, not the business itself! (For the full first half of 2024 Tesla earnings were down 50%!) Additionally, Tesla’s Q2 operating margin of 6.3% was among the worst in the industry, and comparable auto companies sell for 4x to 5x earnings which, annualizing Tesla’s Q2 number, would make it worth only around $8 a share vs. August’s insane closing price of $214.11

For all of 2024 Tesla will sell fewer cars than last year and at considerably lower prices, and may earn less than $2/share (less than half of 2023’s $4.30) with the aforementioned industry-average (or worse) operating margin. In other words, Tesla is now just another cyclical car company (less than 12% of its Q2 revenue came from its low-margin energy business). No wonder Musk is trying to nonsensically claim that Tesla is “really a robot and robotaxi company”! (More on that below.)

And oh, about those emission & battery production credits that comprised half of Tesla’s Q2 earnings, and the $7500 consumer tax credit that’s responsible for a huge chunk of its U.S. sales: why is Musk alienating most of Tesla’s customer base by blatantly campaigning for the presidential candidate who will eliminate those EV subsidies, thus putting Tesla in even bigger trouble?

EV policy

EV Push

I believe Musk is supporting Trump in the hope that Trump will kill the DOJ’s extensive and ongoing criminal investigation into Musk, and is willing to sacrifice Tesla’s business (by helping elect a “subsidy killer” and alienating Tesla’s customer base) in an attempt to stay out of prison.

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. 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 (lawsuits against it continue to pile up) and may be a basis for millions of people to sue Tesla for hundreds of billions of dollars (more on that below), 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 and in July 2024’s Q2 conference call he said “I recommend anyone who doesn't believe that Tesla would solve vehicle autonomy should not hold Tesla stock.” Needless to say, I agree with him!

In July Musk’s suddenly announced (in April) August debut of a Tesla robotaxi “prototype” was postponed until at least October. Safe robotaxis (already available from multiple competitors in both the U.S. and China, as are humanoid robots more advanced than Tesla’s) need LiDAR sensors, yet if Tesla’s prototype does have LiDAR, Tesla may face the most massive lawsuit in history, as it has sold around six million LiDAR-less cars claiming they had all the hardware needed to be autonomous, and thus anyone can claim “future autonomy” is the sole reason they spent $40,000 to $100,000 to buy their Tesla, and then sue for a refund. Thus. Musk is damned if he does include necessary LiDAR in future cars and damned if he doesn’t; it’s a real “fraudster’s dilemma”! In April 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 Tweet

Meanwhile, multiple competitors in China already offer the equivalent of Tesla’s current so-called “Full Self Driving,” and some of them even offer it for free!

Last year 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, and in August 2024 the VP of Finance left. This may be tied into the aforementioned DOJ criminal investigation of Musk, which may go beyond “autonomy fraud” and cover additional 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, in December it was revealed that Teslas crash more than any other brand of car.)

Indeed, 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:

Musk Tweet

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?

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.

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 both JD Power's initial quality survey and Consumer Reports’ used car reliability 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 demand is already collapsing despite extremely limited production.

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 Tesla may be about to give up on them. And meanwhile, the real-world range of Tesla’s cars is now just average vs. its competitors.

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!

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.

Thanks,

Mark Spiegel

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The post above is drafted by the collaboration of the Hedge Fund Alpha Team.