Stanphyl Capital commentary for the month ended March 31, 2024.
Friends and Fellow Investors:
For March 2024 the fund was up approximately 3.3% net of all fees and expenses. By way of comparison, the S&P 500 was up 3.2% and the Russell 2000 was up 3.6%. Year to date the fund is up approximately 7.4% while the S&P 500 is up 10.6% and the Russell 2000 is up 5.2%. Since inception on June 1, 2011 the fund is up approximately 137.7% net while the S&P 500 is up 400.9% and the Russell 2000 is up 198.9%. Since inception the fund has compounded at approximately 7.0% net annually vs. 13.4% for the S&P 500 and 8.9% 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 gain was due to a drop in the price of Tesla (which we’re short) partially offset by an increase in the price of the S&P 500 which we’re also short (via the SPY ETF). I discuss Tesla later in this letter so let’s talk about SPY, which is now extremely overbought (for those of you technically inclined: ten straight weeks of a weekly RSI in the 70s) and, in my opinion, the most overpriced since the 2000 bubble.
In the far-right column below from Standard & Poor’s are the 11 most recent quarterly operating earnings for the S&P 500 (with Q4 2023 estimated with 99.4% 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 5254!)
Notice anything interesting?
Even with strong GDP growth earnings have barely grown in the last 2 ½ years and in fact were higher in Q4 2021 and Q2 2023 (when stock prices were much lower) than they were in Q4 2023. Annualizing Q4 2023 earnings to $215.56 ($53.89 x 4) and putting a 16x multiple on them would bring the S&P 500 all the way down to just 3449 vs. March’s close of 5254. Even an 18x multiple would bring the S&P down to just 3880 vs. the current 5254. 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 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.
Meanwhile, according to Warren Buffet’s favorite indicator stocks are now staggeringly expensive. And here are a few more charts 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 believes will soon run out), and consumers loading up on credit card debt, but a hard landing will soon arrive as consumer debt delinquencies are rapidly increasing while personal savings have collapsed and credit scores are declining, and shipping freight data is already recessionary.
Meanwhile, the high current year-over-year inflation rates of 3.8% core CPI and 2.8% core PCE seem increasingly sticky, 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 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 March VW reported terrific 2023 results and while 2024 is expected to improve over those only slightly, the company is doing all the right things to position itself for the future. VW currently sells for only 4x 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 €84 billion and Traton, of which it owns 89.7% at a current market cap (for Traton) of €17 billion, thus making VW’s €63 billion Porsche stake and €15 billion Traton stake alone worth around €11 billion more than the entire €67 billion market cap of VW; in other words, at current prices you’re getting paid €11 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 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.
I sold our Fuel Tech Inc. (FTEK) in March when it reported a disappointingly large revenue decline for Q4 2023 vs. the year-ago quarter and guided to a slow first half of 2024. I may revisit this if the enterprise value again drops below zero, but for now we’re on the sidelines.
We remain short Tesla, which in March slashed production at its most important factory (China) due to slack demand and, despite yet more price-cutting, in early April will report a large sequential delivery decline for Q1 2024 vs. Q3 2023, and may even report a year-over-year decline. This year Tesla will be lucky to sell roughly the same number of cars as last year and at considerably lower prices, and will likely earn in the low $2s per share (considerably less than last year) with an industry-average operating margin of around 8%. In other words, Tesla is now just another cyclical car company (only around 5% of its revenue comes from its low-margin energy business), and similar car companies sell for anywhere from 4x to 8x earnings, which makes Tesla worth less than $20/share vs. March’s closing price of $175.79.
Accompanying Tesla’s stagnant (or declining) business is 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, 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 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
