Stanphyl Capital’s commentary for the month ended February 29, 2024.
Friends and Fellow Investors:
For February 2024 the fund was down approximately 10.1% net of all fees and expenses. By way of comparison, the S&P 500 was up 5.3% and the Russell 2000 was up 5.7%. Year to date the fund is up approximately 4.0% while the S&P 500 is up 7.1% and the Russell 2000 is up 1.5%. Since inception on June 1, 2011 the fund is up approximately 130.0% net while the S&P 500 is up 385.3% and the Russell 2000 is up 188.6%. Since inception the fund has compounded at approximately 6.8% net annually vs. 13.2% for the S&P 500 and 8.7% 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 month’s reversal of much of last month’s gain was entirely due to our large S&P 500 (SPY) short position continuing to levitate against us into very thin air and a (dead-cat) bounce in our Tesla short position on (what I believe to be) its way to oblivion. I discuss Tesla in the back half of this letter, so let’s open with SPY…
In the far-right column below from Standard & Poor’s itself are the 11 most recent quarterly operating earnings for the S&P 500 (with Q4 2023 estimated with >90% of companies having reported) and, in the middle column, the price of the S&P 500 as of that date. (Keep in mind that the S&P 500 is now at 5096.)
Notice anything interesting?
Even with strong GDP growth earnings aren’t growing and in fact were higher for most of 2021 when stock prices were much lower. Annualizing Q4 2023 earnings to $206.08 ($51.52 x 4) and putting a 16x multiple on them would bring the S&P 500 all the way down to just 3297 vs. February’s close of 5096. And then what happens to those earnings when we get a recession???
Yes, the recession that I (and many leading indicators) predicted hasn’t yet arrived, but not yet arriving isn’t the same as not arriving, and I strongly believe that a recession will appear in the first half of this year and the expensive stock market will suffer severely from it.
The consensus is now for either “no landing” or a “soft landing,” yet before even the worst recessions the consensus is nearly always for a “soft landing”; for example, here’s just one headline of many from August 2007:
In fact, for reasons I clearly lay out below, I still strongly believe that the U.S. economy is headed for a hard landing, yet despite myriad lurking dangers—both economic and geopolitical—the market is now extremely overbought and investor sentiment is quite bullish.
Here’s a chart that perfectly captures the stock market’s current decoupling from “reality”…
And here are a couple that reflect how oblivious the bulls are to that reality…
Why do I believe so strongly that we face a “hard landing”? For the same reasons I’ve been stating for a while:
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% rates and $95 billion/month in U.S. quantitative tightening plus tighter money from the ECB, 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.
Yes, a nasty recession has been delayed due to a combination of “interest rate lag effects,” leftover “Covid cash” (which the San Francisco Fed now believes will run out in the first half of this year), and consumers loading up on credit card debt, but a hard landing will soon arrive for the following reasons:
- Consumer debt delinquencies are now rapidly increasing while personal savings have collapsed.
- Business lending data, shipping freight data and other leading indicators indicate that a recession is imminent.
- Student loan repayments have resumed, and although many debtors aren’t yet paying they’ll soon have to.
Meanwhile, the high current year-over-year inflation rates of 3.9% core CPI and 2.8% core PCE recently ticked back up again, and thus I believe we’re in for a new core “inflation floor” of around 3% as the U.S. government racks up massive deficits while substantial wage increases continue. In fact, because of the Fed’s “dovish tendencies” despite those underlying inflation pressures, the fund now holds a small amount of gold (via the GLD ETF).
Here then is some commentary on some of our additional positions; please note that we may add to or reduce 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). In January VW reported solid 2023 delivery results (+12% vs. 2022), and currently sells for only around 4.2x its 2024 earnings estimate while controlling a massive number of terrific brands including Porsche, of which it owns 75% at a current market cap (for Porsche) of €79 billion, thus making VW’s €59 billion stake alone worth only around €9 billion less than the entire €68 billion market cap of VW; in other words, at current prices you’re paying just €9 billion to own all these other brands:
I believe Audi alone is worth around €40 billion and the entire company is worth around €150 billion; additionally, the stock yields over 7% and VW has a wide range of electric cars available and in development as demand (or regulatory requirements) for them develops, as well as a newly revamped strategy for its important market in China. In February VW announced a deal to supply Indian automaker Mahindra with one of its EV platforms, as well as January deliveries that were +13.3% year-over-year.
We continue to own a small position in Fuel Tech Inc. (FTEK), a seller of air and water pollution control technologies, which in November reported a decent Q3, with revenue, gross margin and operating income all roughly flat year-over-year, at $8 million, 45% and $133,000 respectively. Management reiterated that 2023 revenue will be up slightly vs. 2022, at around $27 million. Meanwhile, at a current price of $1.09/share with 30.4 million shares outstanding and $33.2 million in cash and Treasuries (and no debt), Fuel Tech is selling for an enterprise value of approximately zero. This is the kind of company that will either ignite growth and its stock will climb higher (as its core fossil-fuel pollution treatment business is in a long-term, government-mandated decline, its new “Dissolved Gas Infusion” water treatment is the potential medium-term catalyst for that), or it’s cheap enough to make a good strategic acquisition target, as removing the costs of being an independent public company could make it instantly earnings-accretive while allowing the buyer to acquire a nice chunk of revenue cheaply. The risk here is that if there’s no acquisition and the water treatment business doesn’t pan out, Fuel Tech will become what Buffett might have called “a cigar butt business with just a few puffs left in it” (albeit pollution-controlled puffs). Thus, this should be a very small position in anyone’s portfolio, as it is in ours.
We remain short Tesla, which in January reported Q4 2023 non-GAAP earnings of .71/share. The implications of this can be summarized in the following Tweets and slide from Bernstein:
And on top of Tesla’s rapidly declining business model it also has a massive “fraud kicker”…
In 2019 Elon 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. Yet here we are in 2024 and 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, 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 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, in 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 2024 10-K 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:
As for Tesla’s latest hype story, “AI,” the three top leaders of that team left the company in October… I’m sure things there are going great!
Meanwhile, Tesla is now opening its U.S. charging stations to cars from most 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 buy 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 fifth from the bottom in the 2024 JD Power dependability survey and its Model 3 is the worst car (out of 111!) in Germany’s rigid safety inspection system!
And oh, the fraudulently promoted 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 make itself are a manufacturing disaster with no meaningful advantage in energy density vs. the older “2170s” at the pack level), and the real-world range of its cars is now just average vs. its competitors. And even if Tesla does wind up successfully making its own 4680 cells, other manufacturers will gladly make and sell them to anyone; for instance, BMW announced it will buy them from CATL and EVE.
As for January’s court ruling rescinding Musk’s massive pay package, I consider that to be no more than “a sideshow” unless it angers him so much that he leaves the company and dumps his remaining stock (admittedly, a possibility), in which case TSLA shares would plunge.
Thanks,
Mark B. Spiegel
Stanphyl Capital
