Stanphyl Capital's commentary for the month ended July 31, 2024.
Friends and Fellow Investors:
As we continue to run net short, stocks keep climbing almost entirely on PE multiple expansion (more about that below) despite an economy that’s beginning to crumble beneath them. In particular, Tesla, currently our largest short position, was responsible for the bulk of this month’s loss, as it was up as much as 36% for the month at its July 11th peak before correcting a bit following a terrible Q2 earnings report. (I discuss Tesla in detail later in this letter.) In mid-July I swapped our S&P 500 short position (via the SPY ETF) for one in the Nasdaq 100 (via the QQQ ETF) and then profitably covered some of that QQQ short near the lows of the month when the index became oversold, then resorted some after hours tonight on today’s huge spike. I made that SPY-QQQ swap because the Nasdaq 100 seemed more overextended to me (we shorted it in the $496s) than the S&P, and I felt that if one of the reasons the S&P was so risky was its huge overconcentration in a handful of Nasdaq stocks then it was time to short the index dominated by those stocks and, as just noted, so far that position has been profitable.
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 it feels as if both the market and the economy are starting to simultaneously crack, and thus are finally about to trending in the direction I thought they would months ago: down.
That said, the fund is extremely liquid and if you notify me by August 28th I will redeem any of you either partially or fully as of August 31, waiving our normal “three-month notice” and giving you a chance to see how things go over the next few weeks. Happily, we had no redemptions in July (or this entire year) and, in fact, a bearish new investor just joined us for August. 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…
This is a very expensive market (the S&P 500 is at approximately 24x run-rate operating earnings and the Nasdaq 100 is at around 38x trailing earnings) while the U.S. consumer is finally cracking in this consumer-driven economy. Retail sales comps are now running negative on an inflation-adjusted basis (June retail sales reported in July were +2.3% year-over-year vs. 3% CPI) and scores of retailers have recently warned about a tough business environment. (Even heretofore fairly strong Walmart warned in June and McDonald’s warned in July about a weakening consumer.) And clearly, corporate insiders now sense big problems…
I believe this stock market is finally in the process of switching from "bad news is good news" to "bad news is bad news" as it slowly realizes that a recession is on the way, and I expect a “hard” landing while, according to the most recent Bank of America survey, 86% of investors expect either a “soft” landing or no landing:
…while sticky inflation (3.3% core CPI and 2.6% core PCE) driven by massive federal budget deficits will prevent the Fed from cutting enough to compensate for that. That's what we remain positioned for.
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-adjusted those earnings to show that in real terms they’re lower now than they were in 2021! I then calculated 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 July 31 the S&P 500 is at 5522, making its PE multiple over 24.)
Annualizing the Q2 2024 earnings estimate to $227.36 ($56.84 x 4) and using the traditional “rule of 20” (which says that the S&P 500’s PE ratio should be 20 minus the rate of inflation) would put a 17x multiple on those Q2 earnings and bring the S&P down to just 3865 vs. the current 5460. 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…
I believe Audi alone is worth around €30 billion and the entire company is worth around €150 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 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! (In fairness, those credits were partially offset by a restructuring charge.) And for the full first half of 2024 Tesla earnings were down 50%! Additionally, Tesla’s Q2 operating margin of 6.3% (including those credits!) 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. July’s insane closing price of $232.07.
This year Tesla will sell fewer cars than last year and at considerably lower prices, and will 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 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? If Musk’s favored presidential candidate wins, Tesla is in big trouble:
Trump needs ways to offset the cost of some of his massive tax cuts, and in his mind eliminating “green subsidies” is a great way to do that. In response to those who believe Musk’s Trump endorsement will buy a change in this policy, I believe Musk is actually supporting Trump in the hope that Trump will kill the DOJ’s extensive and ongoing criminal investigation into how Musk runs Tesla’s autonomy program, and is willing to sacrifice Tesla’s business (by helping elect a “subsidy killer” and alienating the vast majority of Tesla’s customer base) in an attempt to stay out of prison.
Also in July Musk’s suddenly (in April) announced August debut of a Tesla robotaxi “prototype” was postponed until at least October. Robotaxis (already available from multiple competitors in both the U.S. and China, as are humanoid robots more advanced than Tesla’s) are something Musk has lied 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”! Last spring 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”:
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!
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 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 and in July 2024’s Q2 conference call he said “I recommend anyone who doesn't believe that Tesla would sell vehicle autonomy should not hold Tesla stock.” 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:
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 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 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,
Stanphyl Capital
