FINANCIAL MARKET UPDATE 7.21.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

HAS TESLA REACHED BUBBLE TERRITORY?

By all accounts, 2019 was an excellent year for investors. Unless you hid your cash in your mattress, you likely earned a positive return on investment. Even if you hid your cash, you still didn’t lose money!

Few stocks have captured the public’s attention the way Tesla has over the past year. Its meteoric rise in value has made it one of the world’s largest publically traded companies by market-cap. At the same time, a heated debate has been raging on whether the stock’s price has divorced itself from reality. With the company set to report earnings this Wednesday (7/22/20), the spotlight appears unlikely to dim anytime soon. 

Over the past twelve months, Tesla’s share price has increased a staggering 536%, raising its market-cap from $46 billion to over $305 billion (as of 7/20/20). If it were a member of the S&P 500 index, it would replace consumer staples giant Proctor and Gamble as the 10th largest holding. For context, the S&P 500 is up just 11.4% over this time.

Source: Morningstar Direct. Data from 7/19/2019 to 7/20/2020.

The Tesla rally picked up following a series of better than expected earnings reports covering the latter half of 2019. This includes an unexpected profit in Q3, and much better than expected results in Q4. Additionally, Tesla announced it expects net income and cash flow to be positive on a continual basis moving forward. While the stock’s ascent appears rooted in fundamentals, other factors may have since taken over, including:

  • Momentum chasing: Strong performance attracts new buyers in search of a quick profit
  • A short squeeze: Investors wagering on price declines were forced to repurchase the stock to cover their short position
  • Index front-running: Traders may be purchasing shares in anticipation of the stock being included in the S&P 500 

The recent price action for Tesla has renewed calls that that stock is in bubble territory. Stock bubbles are generally described as asset prices that rapidly increase beyond what fundamentals warrant, often driven by exuberant, herd-like behavior. When the supply of new speculators willing to buy at ever-rising prices is exhausted, the bubble deflates, and prices crash back down to reasonable levels.

Much of the latest excitement relates to the hope that Tesla will have achieved profitability on a trailing 12-month basis when they report Q2 results on Wednesday. Doing so would satisfy the final requirement for inclusion in the S&P 500 index. According to S&P Global, there are currently over 11.2 trillion dollars indexed or benchmarked to the S&P 500. Therefore, inclusion in the index would require both active and passive fund managers to add a significant amount of the stock to their portfolios to track and/or compete with the index. That increase in share demand would be considered a tailwind, all-else equal.

If all of the excitement surrounding the stock has interested you in purchasing shares, you would not be alone. According to Robintrack.net, which monitors holdings data for the popular Robinhood stock trading app, nearly 170 thousand users have added Tesla to their accounts this month alone (through 7/20). This massive increase in interest coincides with the shares gaining over 71% in the last 15 trading sessions. On Monday alone, Tesla’s market cap increased by $26.4 billion. Consider that one-day move in the context of the world’s largest automakers. In one trading session, Tesla added to its market-cap the entire value of Ford Motor Company, despite its 2019 revenue comprising just 16% of Ford’s.  

Source: Market-cap and P/S ratios are from Morningstar direct as of 7/20/20. 2019 Revenues were from aswathdamadaran.blogspot

Tesla clearly does nowhere near the volume of business that is done by the other auto companies. The massive premium investors are paying for the stock, therefore, can only be justified if the business grows dramatically. With Tesla currently valued roughly equal to the next three largest companies combined (Toyota/VW/Daimler), investors are essentially banking on it becoming the largest most profitable carmaker in the world. Tesla, as a business, could go on to be massively successful, but if it fails to achieve anything short of Amazon-like dominance, the stock price could suffer. Continued success for Tesla is by no means guaranteed, either. Competition from new entrants to the electric vehicle (EV) market appears to be ramping up, while the established players have also worked to launch and expand line-ups of EVs.

Is Tesla in a bubble? We may not know until either A) its shares plummet, or B) we are all being driven to work by our fully autonomous Model-“?”s. Tesla has an innovative leader, great product, and a head start on its competitors in various technologies. The rally we have witnessed began with tangible improvements in the business, but it has since detached itself from the fundamentals. At the very least, an extreme level of optimism has stretched its valuation considerably. At worst, Tesla is in a bubble and is destined to become another cautionary tale of speculative excess.

WEEK IN REVIEW

  • Late yesterday EU leaders announced they had reached an agreement on a $2 trillion spending package after four days of negotiations. The deal involves the first ever large scale issuance of common euro area debt. It includes a 750 billion Euro recovery plan (390 billion in grants), and a multi-year 1 trillion euro budget that will run from 2021 to 2027. 
  • Retail sales for June were published last week. The figures exceeded analyst estimates and marked the second consecutive monthly improvement of the data. Some economists have suggested the strength of retail sales reflects prior pent up demand and may slow moving forward. The resurgence of Covid-19 cases and the move by some states to slow or reverse reopening could provide additional headwinds.
  • Coming into this week, 9% of S&P 500 companies had reported earnings for the Q2, according to Factset. The YoY earnings growth of the companies that have reported, blended with the estimates for the companies that have yet to report, was -44.0%. This marks a slight improvement over the -44.7% rate from the prior week. One company has issued negative guidance for Q3 earnings, while four companies have issued positive guidance.  

HOT READS

Markets

  • EU Leaders Reach ‘Pivotal’ Deal on Pandemic Recovery Fund After Marathon Summit (CNBC)
  • How the S&P 500 Uncoupled from Your Local Economy (Reformed Broker)

Investing

  • Two Common Sentiment Indicators are in Complete Conflict (Sentiment Trader)
  • From 1720 to Tesla, FOMO Never Sleeps (Zweig)
  • The Big 3 Index Providers Have a Huge Amount of Power-Even Over Tesla (Barron’s)

Other

  • The Greatest Coronavirus Risks When you Fly (WSJ)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

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JOSH JENKINS, CFA + SENIOR PORTFOLIO MANAGER & HEAD OF RESEARCH

Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

AREAS OF FOCUS
  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

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