Markets Have "Considerably More Downside" In 2023: Mark Spiegel
Submitted by QTR's Fringe Finance
Friend of Fringe Finance Mark B. Spiegel of Stanphyl Capital released his most recent investor letter last week, with his updated take on the market’s valuation and Tesla.
Mark is a recurring guest on my podcast (and will be coming back on again soon hopefully) and definitely one of Wall Street’s iconoclasts. I read every letter he publishes and only recently thought it would be a great idea to share them with my readers.
Like many of my friends/guests, he’s the type of voice that gets little coverage in the mainstream media, which, in my opinion, makes him someone worth listening to twice as closely.
Mark was kind enough to allow me to share his thoughts from his December 2022 investor letter, where he noted that his fund was up 17.4% for the month, rounding out a year where he finished up 75.5% net of fees.
In his most recent letter he opens up about a new short position, his thoughts on Tesla, how he’s positioned overall in the market and other names he owns. He also, in my opinion, absolutely nails the current (bear) case for the overall market heading into 2023.
Mark On Macro And Tesla
December 30, 2022
Before I continue, I want to clearly state that the chance of this fund’s 2023 performance being anywhere near that of 2022’s is roughly equal to the chance of Elon Musk offering me a board seat at Tesla. (For the record, I would not accept such an offer as I don’t want to go to jail!) Okay, now that that’s out of the way…
Tesla’s inevitable meltdown (alright, so I was a mere eight years too early!) was a big contributor to this year’s performance (and we remain short it, as I believe it has another 90% to go), as were our other short positions in the S&P 500 (via SPY) and, early in the year, the garbage-stock ETF ARKK (which I covered way too early, leaving lots of additional profit on the table).
Another meaningful December contributor was an arb position we’ve had on for several months but I haven’t written about here as it was crowded: short AMC shares and long an equal number of APE shares—two essentially identical securities from the insolvent AMC movie theater chain that—thanks to the deliberate ignorance of AMC’s “meme stock” shareholder base—had a massive price disparity between them. In December the inevitable happened when the company announced a financing deal that will merge the two share classes and end that spread; their prices subsequently converged significantly and I anticipate further convergence in January.
Meanwhile, we continue to carry a large SPY short position, as I believe the major indexes—although not all individual stocks—have considerably more downside to go, the inevitable hangover from the biggest asset bubble in U.S. history. Stated simply, there’s no way an “everything bubble” built on 0% interest rates and $120 billion/month in quantitative easing can not implode when confronted with near-5% rates and $90 billion a month in quantitative tightening.
Although the current rate of 6% to 7% year-over-year inflation (down from over 8%) is unsustainable, I believe we’re in for a new “inflation floor” of around 4% (double the Fed’s already-too-high 2% target) thanks, in the near-term, to a new tailwind in commodity prices as China ends its “zero-Covid policy” and bails out its real estate industry while Biden ends his SPR drawdown and continues his war on fossil fuels.
Longer term contributors to that higher inflation floor will be expensive “onshoring,” wage increases due to fewer available workers, and perpetual government budget deficits (most recently exemplified by the egregious new “Omnibus Spending Bill”). And even if there’s a temporary dip in inflation (as we appear to be seeing now), the Fed does not want to reverse rates too soon and repeat the 1970s:
Even an early-2023 Fed interest rate “pause” at 4.75% (and remember, a “pause” is not a “pivot”!) would, combined with $90 billion a month in ongoing QT, make current stock market valuations unsustainable, as stocks are still expensive.
According to Standard & Poor’s, with 99% of companies having reported, Q3 S&P 500 GAAP earnings came in at around $44.41, which annualizes to $177.64. (And these were the sixth highest quarterly earnings in history; i.e., they were not “trough.”) A 16x multiple on that—generous for a rising rate, recessionary (or even just slow-growth) environment—would bring the S&P 500 down to 2842 vs. its current 3839. And remember, just as in bull markets PE multiples usually overshoot to the upside, in bear markets they often overshoot to the downside. A bottom formed at a considerably lower multiple is not unfathomable.
Additionally, we can see from CurrentMarketValuation.com that the U.S. stock market’s valuation as a percentage of GDP (the so-called “Buffett Indicator”) is still very high, and thus valuations have a long way to go before reaching “normalcy”:
For some historical perspective on current market excitement about inflation reports that are trending lower, keep in mind that 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.
In other words, once the bubble burst and the economy slowed, lower inflation did not help stock prices. A 50% drawdown from the S&P 500’s recent bull market peak of 4818 would drop it to 2409, while even a more modest 40% decline would bring it to 2891.
Regarding sentiment, we can see from Ed Yardeni that in the Investors Intelligence poll the highest the “bear percentage” got so far in the current market was only around 45% (in the most recent poll it was just 33.3%), yet there were multiple times during the 1980s, 1990s and 2008 that it climbed much higher:
Also, we can see from thi old academic paper that during the grinding bear market of 1973 to 1975, when the S&P 500’s GAAP PE multiple dropped from 18x to 8x, the bears in the Investors Intelligence poll climbed to around 75% and went over 80% during the bear markets of the 1960s. So if you think that based on this bear market’s sentiment we’ve “seen the bottom,” I wish you luck!
Meanwhile, interest costs on the Federal debt are already set to grow massively. Does the Fed have the stomach to face the political firestorm of Congress having to slash Medicare, the defense budget, etc. in order to pay the even higher interest cost that would be created by upping those rates to a level commensurate with crushing even just 4% inflation? Powell may not have the guts for that, nor does anyone else in Washington; thus, this Fed may be behind the inflation curve for at least a decade. That’s why—as an inflation hedge—we remain long 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). VW currently sells for around 3.5x estimated 2022 earnings due to a combination of “recession fears” and short-term issues obtaining energy (until either the Ukraine war is over or alternative supplies are in place), but it controls a massive number of terrific brands including recently IPO’d Porsche, of which it owns 75% at a current market cap (for Porsche) of $92 billion, thus valuing the rest of VW at only around $2 billion! I believe Audi alone is worth $40 billion, and a Lamborghini IPO (at around $15 billion) may be next. Additionally, VW is paying a January special dividend of around $1.90 per VWAPY share in proceeds from Porsche’s IPO (the stock went ex-dividend in December), and the regular yield is currently over 6%! Meanwhile VW Group’s EVs (several of which are more technologically advanced than any Tesla) combine to heavily outsell Tesla in Europe and by 2025 may outsell Tesla worldwide.
We continue to own automaker Stellantis (STLA), which has a great balance sheet with plenty of net cash (and a 7.6% dividend yield!) and which—at a current price of $14.20/share—sells for only around 2.6x 2022 earnings estimates of $5.35/share. I believe Jeep alone (which in September announced a full electrification strategy) could be worth more than what we paid for the entire company, which also includes Dodge, Chrysler, Ram, Fiat, Citroen, Peugeot, Opel, Alfa Romeo, Vauxhall, Lancia and Maserati. And if current EV sales are your interest, Stellantis already has Europe’s best-selling mass-market model.
We continue to own General Motors (GM), which currently sells for only around 5.4x the $6.26/share midpoint of its 2022 GAAP EPS guidance (which was reiterated in November). GM is doing all the right things in electric cars, software and autonomous driving (via its Cruise ownership); in fact, Cruise is already running a fleet of fully autonomous cars in multiple U.S. cities—you can see many videos of this on its YouTube channel. GM will also benefit more than any other manufacturer from the proposed new EV tax credit, as it will soon have the largest variety of North American-made (a requirement of the credit) EV models fitting within the new price restrictions. Additionally, the company pays a modest dividend.
I thus consider these positions (Stellantis, GM and VW) to be both “freestanding value stock buys” and “relative-value paired trades” against our Tesla short. One oft heard knock against “the autos” is a belief that their recent earnings have been “peak,” but keep in mind that due to supply chain issues they all sold around 20% fewer cars than they otherwise could have. Thus, I believe those recent earnings are more like “strong midcycle” and should likely have around a 10x run-rate PE, not the current 3x to 6x. Also, thanks to those same supply chain issues they’re much lighter on inventory than they’d normally be heading into a recession. Therefore, I believe these stocks have considerable long-term upside from here.
We continue to own Fuel Tech Inc. (FTEK), a seller of air and water pollution control technologies, which in November reported a solid Q2, with revenue up 6.1% year-over-year (although at a lower gross margin), .01/share in GAAP earnings and around $600,000 in free cash flow. At a current price of $1.275/share with 30.3 million shares outstanding and $33.9 million in cash and Treasuries (and no debt), this is a 43% gross margin business selling for an enterprise value of only around 0.18x 26.4 million in TTM revenue. This is the kind of company that will either ignite growth and its stock will take off (its new “Dissolved Gas Infusion” water treatment technology is a potential medium-term catalyst for that), or it’s so cheap that it will make for 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 very cheaply. In short, I think it’s a good “value stock” in which to park some money and see what happens.
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And now, Tesla…
Despite running its new factories in the U.S. and Germany at only around 20% of capacity, massive amounts of excess Tesla inventory piled up in Q4, spurring huge, margin-slashing price cuts in China, Europe, the U.S. and Canada & Mexico, and even forcing the company’s China plant to slash December and January production. Tesla’s production capacity now hugely outstrips its rate of incoming orders, which undoubtedly explains why the company is implementing layoffs and a hiring freeze, and its used car prices are plunging too, further killing demand for new ones. Goodbye “story-stock tech company” and hello “cyclical car company” in an industry with single-digit PE ratios!
As Tesla slashes prices it will undoubtedly sell more cars (I expect Q4 deliveries to be slightly over 400,000 vs. previous quarters in the 300,000s, thanks to the aforementioned massive price cuts plus a rush to beat big year-end expiring EV incentives in China, Germany, France and Norway), but any other car company can slash prices and do the same thing. And again, Tesla’s apparent market saturation rate of around 1.6 million cars/year worldwide (at least until it slashes prices yet again!) is massively below its current factories’ production capacity, much less the bulls’ absurd expectations of adding a new factory every six months for the next ten years in order to sell 20 million cars a year!
For some valuation perspective, BMW sells around 2.5 million cars a year with very high margins (including the best electric SUV now on the market (the new iX), the best luxury EV (the new i7), and among the best small luxury EVs (the new i4), and has a market cap of around $59 billion. If Tesla grew annual deliveries to the size of BMW’s (50% higher than its current run-rate!) and had BMW-level margins, at BMW's current market cap it would sell for less than $19/share vs. this month's closing price in the $123s! (Remember: Tesla now has 3.16 billion shares outstanding!)
Meanwhile, Elon Musk remains the most vile person ever to head a large-cap U.S. public company, and we remain short Tesla, the biggest bubble-stock in modern market history, because:
It has a sliding share of the world’s EV market yet—even after its recent plunge—still has a market cap greater than those of Toyota, Volkswagen, Hyundai, GM and Ford combined (all of which now offer great EVs), despite stalling out at around 1.6 million annual deliveries vs. a combined 34 million for those other companies!
It has no “moat” of any kind; i.e., nothing meaningfully proprietary in terms of its electric car technology (which has now been equaled or surpassed by numerous competitors) and its previously proprietary Superchargers are being opened to everyone).
Excluding working capital benefits and sunsetting emission credit sales, Tesla generates only minimal earnings and free cash flow.
Elon Musk is a pathological liar who—through his recent “Twitter insanity”—has wrecked the already competition-diminished Tesla brand.
In January Tesla will likely announce Q4 deliveries of a bit over 400,000 cars, yet thanks to the massive amount of price-cutting necessary to sell those cars, its earnings (excluding unforeseen extraordinary items) will likely only slightly surpass its Q3 GAAP number of around .87/share excluding sunsetting emission credit sales. And if—after viewing this chart from Twitter user @Keubiko—you believe that Q3 earnings number wasn’t grossly exaggerated, I have a bridge to sell you in Brooklyn:
Furthermore, Tesla’s minimal depreciation of its new factories appears fraudulently low, as does its warranty reserve.
Even if you believe Tesla’s clearly nonsensical reported earnings, excluding emission credit sales they annualize to only $3.48/share, which based on the current price of $123.18 = a run-rate PE ratio of around 35 for a now slow-growing, margin-slashing car company in an industry with a current average PE of around 5!
Meanwhile, Tesla has objectively lost its “product edge,” with many competing cars now offering comparable or better real-world range, better interiors, similar or faster charging speeds and much better quality. (Tesla ranks near the bottom of Consumer Reports’ reliability survey while British consumer organization Which? found it to be one of the least reliable cars in existence.) Thus, due to competitors’ temporary production constraints, waiting times are now longer for nearly all of Tesla’s direct EV competitors than they are for a Tesla.
In fact, Tesla is likely now the second, third or fourth choice for many EV buyers, and only maintains its volume lead though a short-lived edge in production capacity that will disappear over the next 12 to 36 months as competitors rapidly increase the ability to produce their superior EVs. Tesla’s poorly-built Model Y faces current (or imminent) competition from the much better made (and often just better) electric Hyundai Ioniq 5, Kia EV6, Ford Mustang Mach E, Cadillac Lyriq, Nissan Ariya, Audi Q4 e-tron, BMW iX3, Mercedes EQB, Volvo XC40 Recharge, Chevrolet Blazer EV & $30,000 Equinox EV and Polestar 3. And Tesla’s Model 3 now has terrific direct “sedan competition” from Volvo’s beautiful Polestar 2, the great new BMW i4, the upcoming Hyundai Ioniq 6 and Volkswagen Aero, and multiple local competitors in China.
And in the high-end electric car segment worldwide the Porsche Taycan (the base model of which is now considerably less expensive than Tesla’s Model S) outsells the Model S, while the spectacular new BMW i7, Mercedes EQS, Audi e-Tron GT and Lucid Air make it look like a fast Yugo, and the extremely well reviewed new BMW iX, Mercedes EQS SUV and Audi Q8 eTron (as well as multiple new Chinese models) do the same to the Model X.
Indeed, for years I’ve said “Tesla is Blackberry”—the maker of a first-generation version of a product that—once the market was proven—would be supplanted into niche obscurity by newer, better versions; now I can provide a much more recent analogy: Tesla is Netflix. For years Netflix had an absurd valuation based on its pioneering position in streaming media, but once it proved that such a market existed myriad competitors swarmed all over it, and in 2022 the stock collapsed when we learned that not only is Netflix no longer in “hypergrowth” mode but for the first time since 2011 (when it transitioned from physical DVDs) it actually lost subscribers. I believe Musk knows that Tesla is “the next Netflix” (hence his recent “Twitter buying distraction”), with VW Group, Hyundai/Kia, Ford, GM, Stellantis, BMW, Mercedes, BYD & other Chinese competitors and, in a few years, Toyota & Honda, being the Disney, HBO Max, Amazon Prime, Peacock, Hulu, Paramount+, etc. of the electric car market, stealing Tesla’s share and eventually pounding its stock price into low double-digits, where it would be valued as “just another car company.”
Meanwhile, the NHTSA’s investigation of Tesla’s deadly Autopilot has expanded into “an engineering analysis,” the last required step before (finally!) demanding a full recall, and in October it was reported that this deadly scam is being investigated by both the SEC and the DOJ. The refund liability potential for Tesla for this is in the billions of dollars, and possibly even the tens of billions if a class action lawsuit proves that the cars involved were purchased solely due to the (fallacious) promise of “full self-driving.” And, of course, there will be a massive “valuation reappraisal” for Tesla’s stock as the world wakes up to the fact that its so-called “autonomy technology” is deadly, trailing-edge garbage. Meanwhile, the NHTSA continues to report a slew of Autopilot-related deaths, yet Tesla has sold this trashy software for over six years now and still promotes it on its website via a completely fraudulent video! (For all Tesla-related deaths cited in the media—which is likely only a small fraction of those that have occurred—please see TeslaDeaths.com.)
Want to see another Elon Musk/Tesla fraud summarized in a simple bar graph? In this recent Consumer Reports test, note which of these cars never comes close—in any environmental conditions—to meeting its claimed EPA range:
Another favorite Tesla hype story has been built around so-called “proprietary battery technology.” In fact though, Tesla has nothing proprietary there—it doesn’t make them, it buys them from Panasonic, CATL and LG, and it’s the biggest liar in the industry regarding the real-world range of its cars. And if new-format 4680 cells enter the market, even if Tesla makes some of its own, other manufacturers will gladly sell them to anyone, and BMW has already announced it will buy them from CATL and EVE.
And oh, the joke of a “pickup truck” Tesla previewed in 2019 (and still hasn’t shown in production-ready form) won’t be much of “growth engine” either, as by the time it’s in mass-production in late 2023/early 2024 it will enter a dogfight of a market vs. Ford’s hot-selling all-electric F-150 Lightning and GM’s fantastic 2023 electric Silverado (which already has nearly 200,000 reservations), while Rivian’s pick-up has gotten excellent early reviews, and Ram will also be out with a great electric truck in 2024.
Regarding safety, as noted earlier in this letter, Tesla continues to deceptively sell its hugely dangerous so-called “Autopilot” system, which Consumer Reports has completely eviscerated; God only knows how many more people this monstrosity unleashed on public roads will kill despite the NTSB condemning it. Elsewhere in safety, the Chinese government forced the recall of tens of thousands of Teslas for a dangerous suspension defect the company spent years trying to cover up, and Tesla has been hit by a class-action lawsuit in the U.S. for the same defect. Tesla also knowingly sold cars that it knew were a fire hazard and did the same with solar systems, and after initially refusing to do so voluntarily, it was forced to recall a dangerously defective touchscreen. In other words, when it comes to the safety of customers and innocent bystanders, Tesla is truly one of the most vile companies on Earth. Meanwhile, the massive number of lawsuits of all types against the company continues to escalate.
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About Mark Spiegel
Mark manages Stanphyl Capital, established in 2011, a deep-value equity & macro long-short investing fund based in New York City. Mark can be reached at email@example.com or at @StanphylCap on Twitter.
Disclaimer: This letter was not reproduced in full. I may own Tesla call and put options and may be long/short TSLA and or any names mentioned. You should assume I have positions in any names I publish about. I have no position in Mark’s funds. Mark is a subscriber to Fringe Finance via a comped subscription I gave him and has been on my podcast. The excerpts from Mark’s letter, above, shall not be construed as an offer to sell, or the solicitation of an offer to sell, any securities or services. Any such offering may only be made at the time a qualified investor receives formal materials describing an offering plus related subscription documentation. There is no guarantee the Fund’s investment strategy will be successful. Investing involves risk, and an investment in the Fund could lose money.