Stanphyl Capital January 2024 Commentary

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

Friends and Fellow Investors:

For January 2024 and year to date the fund was up approximately 15.6% net of all fees and expenses. By way of comparison, the S&P 500 was up 1.7% and the Russell 2000 was down 3.9%. Since inception on June 1, 2011 the fund is up approximately 155.7% net while the S&P 500 is up 360.7% and the Russell 2000 is up 173.1%. Since inception the fund has compounded at approximately 7.7% net annually vs. 12.8% for the S&P 500 and 8.3% 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.)

Q4 2023 hedge fund letters, conferences and more

This month our large Tesla short position worked nicely as the stock finally began reflecting the fact that its growth story is as dead as its batteries in a Chicago winter. I believe there’s over 80% downside still to come in that stock and write plenty more about that later in this letter. Also this month, our largest long position, Volkswagen, was up nicely as the market finally seems to be recognizing its great value (discussed later in this letter); additionally, today it announced the founding of an AI lab. (Yes, this deep-value fund is apparently now long “an AI stock”!)

Meanwhile, the recession that I (and many leading indicators) predicted hasn’t yet arrived, and thus our large SPY short position continues to hurt us (despite today’s post-Fed meeting slide). However, 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 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. Meanwhile, the stock market has been rallying fiercely in response to the lessening inflation which is a natural predecessor of the hard landing I expect! So now 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.

Contrary to the belief of equity bulls with short memories, when an asset bubble unwinds, lower inflation and lower interest rates don’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 just 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 last partly into 2024), and consumers loading up on credit card debt, but a hard landing will soon arrive for the following reasons:

• Consumer credit card delinquencies are now rapidly increasing while personal savings have collapsed and the bills are coming due for “buy now, pay later” plans.
• Business lending data, shipping freight data and other leading indicators say that a nasty recession is imminent.
• Student loan repayments have resumed, and although many debtors aren’t yet paying they’ll soon have to.
• On the corporate earnings side, companies are losing their pricing power.

Keep in mind that even with the Fed now “on hold” with modest anticipated rate cuts in 2024, current stock market index valuations are unsustainable, as stocks are still expensive. According to Standard & Poor’s, Q4 2023 annualized run-rate operating earnings for the S&P 500 are currently estimated to be around $211. A 16x multiple on those earnings (generous for the current environment) would put that index at only around 3376 vs. its January close of 4845, while 15x would put it at around 3165. And those Q4 earnings occurred during a quarter of strong growth, so lower earnings in future quarters are quite possible. Also, just as in bull markets PE multiples usually overshoot to the upside, in bear markets they often overshoot to the downside. Thus, a bottom formed at a lower multiple of lower earnings is not unfathomable.

Meanwhile, although the high current year-over-year inflation rates of 3.9% core CPI and 2.9% core PCE are slowly trending down, 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 this Fed’s “dovish tendencies” despite those underlying inflation pressures, the fund now holds a modest 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 4x 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 €72 billion, thus making VW’s €54 billion stake alone worth only around €6 billion less than the entire €60 billion market cap of VW; in other words, at current prices you’re paying just €6 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 nearly 8% and VW has a wide range of electric cars available and in development as demand (or regulatory requirements) for them develops.

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 $1.07/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 (which announced promising test data in the Q3 earnings release) 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.

And now, Tesla…

In January Tesla reported Q4 2023 non-GAAP earnings of .71/share. The implications of this can be summarized in four simple Tweets plus a 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 will soon open 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 near the bottom of the 2023 JD Power survey and its Model 3 is the worst car (out of 111!) in Germany’s rigid safety inspection system!

And oh, the fraudulently promoted “Cybertruck” Tesla first previewed in 2019 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 kluge will enter 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 some 4680 cells of its own, other manufacturers will gladly make and sell them to anyone, and BMW has already 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.

Meanwhile, here is Tesla’s competition in cars…

(note: these links are updated regularly)

• Porsche Taycan
• Porsche Macan Electric Coming in 2024
• Volkswagen ID.3
• Volkswagen ID.4 Electric SUV
• Volkswagen ID.6 SUV EV in China
• Volkswagen ID.Buzz Electric Van
• Volkswagen ID.7
• VW’s ID.2all compact EV will cost under €25,000 when it arrives in 2025
• VW’s Cupra Born
• Volkswagen Group Will Spend $200 Billion To Boost Its EV Business
• Audi Q8 e-tron electric SUV
• Audi e-tron GT
• Audi Q4 e-tron
• Audi Q6 e-tron electric SUV
• Audi A6 E-tron due in early 2024 with saloon, estate and hot RS6
• Hyundai Ioniq 5
• Hyundai Ioniq 6
• Hyundai Kona Electric
• Genesis GV60
• Genesis GV70
• Kia Niro
• Kia EV6
• Kia EV9
• Kia EV5
• Kia EV4
• Jaguar’s All-Electric i-Pace
• Mercedes EQS
• Mercedes EQS SUV
• Mercedes EQE
• Mercedes EQE SUV
• Mercedes EQC electric SUV available in Europe & China
• Mercedes EQV Electric Passenger Van
• Mercedes EQB
• Mercedes EQA SUV
• Mercedes CLA (2025 model)
• Ford Mustang Mach-E
• Ford F-150 Lightning
• Ford to launch 7 EVs in Europe in big electric push
• Ford unveils Lincoln Star electric SUV concept as it readies to add four new EVs by 2026
• Chevrolet Blazer EV
• Chevrolet Equinox EV
• Chevrolet Bolt
• Cadillac Lyriq
• Cadillac Vistiq
• GMC Electric Hummer Pick-Up and SUV
• GM electric Silverado pickup truck
• GMC Sierra EV Denali
• Honda Prologue
• Honda’s new EVs will launch in 2026 under the Honda 0 Series name
• BMW iX1
• BMW iX3
• BMW iX
• BMW i4
• BMW i5
• BMW i7
• BMW Neue Klasse (2025 model)
• Nissan Ariya: All-Electric Crossover SUV
• Nissan LEAF e+
• Polestar 2 sedan
• Polestar 3 electric SUV
• Volvo EX30
• Volvo XC40 Recharge electric SUV
• Volvo C40 Recharge electric crossover
• Volvo EX90 electric SUV
• Acura ZDX
• Stellantis to launch up to 8 EVs on new STLA Large platform in 2024-26
• Jeep Wagoneer S Electric
• Jeep will launch 4 all-electric SUVs by 2025, including Wagoneer and ‘Wrangler’ EVs
• Renault Scenic E-Tech
• Renault Zoe electric
• Renault to boost low-volume Alpine brand with 3 EVs
• Renault’s Megane E-Tech
• How Renault’s Ampere aims to be Europe’s leader in EVs, software-defined cars
• Dodge Ram 1500 REV
• Peugeot e-208
• Peugeot E-2008
• Peugeot E-308
• Peugeot’s full-electric 3008 and 5008 SUVs will have up to 700 km range
• Citroen E-C3
• Toyota bZ4X
• Toyota plans to expand battery EV line-up in Europe to 6 models by 2026
• Subaru Solterra
• Subaru accelerates U.S. electric plans with local production and 8-model EV lineup
• Honda, Sony to start premium EV deliveries in 2026
• Honda pours $40 billion into electrification, targets 2 million EV production by 2030
• Rivian electric pickup trucks & SUVs
• Maserati Grecale Folgore
• Mini Cooper SE Electric
• Opel Corsa-e
• Opel Astra electric
• Vauxhall Mokka electric
• Skoda Enyaq iV electric SUV
• Skoda Enyaq electric coupe
• BYD presents three BEVs for European market
• Nio expands into Europe and beyond
• Lucid Motors: Electric Luxury Cars
• Range Rover Electric
• Alfa Romeo Milano Electric
• Fisker Ocean
• Rolls-Royce Electric Spectre
• Bentley will start output of first full EV in 2025
• Aston Martin will build electric vehicles in UK from 2025

And in China…

• BYD is #1 in Chinese EVs, selling FAR more than Tesla
• Volkswagen Group Accelerates Electrification Drive to Boost Presence in Chinese Market
• Audi, SAIC EV Tie-Up a ‘Coming of Age’ for Chinese Automaking
• Audi-FAW’s $3.3 billion electric vehicle venture
• Nio
• Xpeng Motors
• Hozon/Neta
• Li Auto
• GAC Aion
• Leap Motors
• GM plans to launch over 15 EV models in China by 2025
• Ford Mustang Mach-E Rolls Off Assembly Line in China
• Cheaper than Tesla: Honda takes aim at China’s middle class
• BMW i3 Debuts As All-Electric 3 Series Only For China
• Hongqi
• Geely
• Zeekr Premium EVs by Geely
• Baidu and Geely put nearly $400 million more into their electric car venture
• China-made Mercedes-Benz EQE hits market
• BAIC
• Hyundai, BAIC Motor to inject $942 mn in China JV for EVs
• Toyota partners with BYD to build affordable $30,000 electric car
• Lexus RZ 450e Steers For China
• Dongfeng
• SAIC
• Renault launches sales of first EV in China
• Nissan expects 40% of sales in China to be electrified by 2026
• Changan forms subsidiary Avatar Technology to develop smart EVs with Huawei, CATL
• Chery
• Seres
• Enovate
• Singulato
• JAC Motors
• Iconiq Motors
• Aiways
• Skyworth Auto
• Youxia
• Human Horizons
• Xiaomi

Here’s Tesla’s competition in autonomous driving; the independents all have deals with major OEMs…

• Waymo ranked top & Tesla last in Guidehouse leaderboard on automated driving systems
• Tesla has a self-driving strategy other companies abandoned years ago
• Waymo
• GM’s Cruise
• Mobileye
• May Mobility (owned by Toyota)
• Cadillac Super Cruise™ Sets the Standard for Hands-Free Highway Driving
• Ford’s hands-free “Blue Cruise”
• Mercedes Launches SAE Level 3 Drive Pilot System
• Honda Legend Sedan with Level 3 Autonomy Now Available in Japan
• Motional (Hyundai) & Uber Announce Autonomous Ride-hail and Delivery Services
• Stellantis Completes Acquisition of aiMotive to Accelerate Autonomous Driving Journey
• Amazon’s Zoox will test its autonomous vehicles on Seattle’s rainy streets
• Baidu to further deploy 200 driverless vehicles in China in 2023
• Baidu Apollo City Driving Max
• Alibaba-backed AutoX unveils first driverless RoboTaxi production line in China
• Pony.ai approved for public driverless robotaxi service in Beijing
• SAIC-backed Xiangdao Chuxing kicks off Robotaxi pilot operation in Shenzhen
• WeRide greenlighted for autonomous road test with empty driver’s seat in Beijing
• GAC-backed Ontime greenlighted for pilot operation of Robotaxi service in Guangzhou
• Xpeng debuts most advanced semi-autonomous driving system to rival Tesla

Here’s where Tesla’s competition will get its battery cells…

• Panasonic (making deals with multiple automakers)
• LG
• Samsung
• SK Innovation
• Toshiba
• CATL
• BYD
• Northvolt
• Volkswagen to Build Six Electric-Vehicle Battery Factories in Europe
• GM’s Ultium
• GM to develop lithium-metal batteries with SolidEnergy Systems
• Ford building $2 billion battery plant in Michigan
• SK On and Ford form BlueOval SK, an EV battery joint venture
• Hyundai teams with SK to make batteries for U.S.-built EVs
• Hyundai Motor developing solid-state EV batteries
• BMW & Ford Invest in Solid Power to Secure All Solid-State Batteries for Future Electric Vehicles
• Stellantis affirms commitment to build battery factory in Italy with Mercedes, TotalEnergies
• Stellantis and Samsung SDI to Invest Over $2.5B in Battery Production Plant in United States
• Stellantis and LG to Invest Over $5 Billion CAD in Joint Venture for Li-Ion Battery Plant in Canada
• Stellantis and Factorial Energy to Jointly Develop Solid-State Batteries for Electric Vehicles
• Mercedes-Benz to build 8 battery factories in push to become electric-only automaker
• Mercedes-Benz and Sila achieve breakthrough with high silicon automotive battery
• Toyota pledges $2.1bn more for U.S. EV battery plant
• Toyota to roll out solid-state-battery EVs as soon as 2027
• Nissan preps an old engine plant to make solid-state EV batteries
• Honda and LG Energy Formally Establish Battery Production Joint Venture
• Honda, GS Yuasa agree to collaborate in lithium-ion batteries
• Daimler joins Stellantis as partner in European battery cell venture ACC
• Renault signs EV battery deals with Envision, Verkor for French plants
• Nissan to build $1.4bn EV battery plant in UK with Chinese partner
• Nissan Announces Proprietary Solid-State Batteries
• Foxconn breaks ground on first EV battery plant
• Envision-AESC
• ONE
• EVE
• Freyr
• Verkor
• Farasis
• Microvast
• Akasol
• Cenat
• Wanxiang
• Eve Energy
• Svolt
• Romeo Power
• ProLogium
• Morrow
• Amprius
• CALB

And here’s Tesla’s competition in storage batteries…

• Panasonic
• Samsung
• LG Energy Solutions
• CATL
• BYD
• AES + Siemens (Fluence)
• Hitachi ABB
• Toshiba
• Saft
• Johnson Contols
• EnerSys
• SOLARWATT
• Sonnen
• Generac
• GM Energy
• Canadian Solar
• Kokam
• Eaton
• Tesvolt
• Leclanche
• Lockheed Martin
• Honeywell
• EOS Energy Storage
• ESS
• Electriq Power
• Redflow
• Primus Power
• Simpliphi Power
• Invinity
• Murata
• Bollore
• Adara
• Blue Planet
• Aggreko
• Orison
• Powin Energy
• Nidec
• Powervault
• Kore Power
• Shanghai Electric
• LithiumWerks
• Natron Energy
• Energy Vault
• Ambri
• Voltstorage
• Cadenza Innovation
• Morrow
• Gridtential
• Villara
• Elestor
• SolarEdge
• Q-Cells
• Huawei
• Toyota
• ADS-TEC
• Form Energy
• Enphase
• Sumitomo Electric
• Stryten Energy
• Freyr
• Growatt
• Polarium
• Alfen
• Quino Energy
• Gotion
• ZincFive
• Dragonfly Energy
• Salgenx
• Lunar Energy

Thanks,

Mark Spiegel

Stanphyl Capital