08 Apr 8th April 2024

Weekly Index Movement

S&P500	-1.0%
Nasdaq	-0.8%
Aussie All Ords	-1.6%

Bulls let Bears gain a little ground last week as the Fed tried to calm down expectations of when the first interest rate cut will happen.

Jay Powell said the Federal Reserve’s job of bringing down inflation was “not yet done” and the US central bank needed “greater confidence” that price pressures were easing before cutting interest rates, striking a cautious tone on any quick changes to monetary policy.

Powell’s comments at Stanford University’s Business School on Wednesday come after the latest projections from Fed officials in March showed they expected to cut rates by 0.75 of a percentage point this year, down from its 23-year high of 5.25 per cent to 5.5 per cent. But strong data on the labour market, and signs of stubbornly high inflation, have cast doubt on those forecasts.

Thursday was an exciting day. For the first half of the session, stocks were comfortably higher with the Nasdaq leading the rally as oil prices were pulling back. Just before noon, though, Brent crude bottomed for the day and started to gradually move higher. As that rally simmered, the rally in the Nasdaq hit a wall. At the high of the day right before 1PM, the Nasdaq was up 1.2%, and Brent was trading just above $89 per barrel. Shortly before 2 PM, the rally in crude came to a boil on rumors that Israel was preparing for an imminent military strike from Iran. What was a 1.2% intraday gain for the Nasdaq finished with a 1.4% decline.

Nothing further came of this news story, but tensions are building in the Middle-East. This is why I say it is always good to maintain some exposure to oil companies. They provide a nice hedge in what is a sector extremely subject to supply shocks.

Is Debt Out Of Control

I’m getting fed up with hearing the Bears argument about excessive levels of government debt. It seems some think this is an unsustainable trend that will end in a 2008 style financial crisis.

There is some truth to what the Bears say:

Over the last 20 years Federal debt held by the public has grown by $29.9 trillion

Over the same period, GDP has grown by $15.2 trillion.

This is a simplistic way of looking at it but from this view it does appear like the magnitude of debt relative to economic growth is troublesome.

But of course, it is more complex than this. One thing to remember is US tech companies innovate and monetise faster than any other country in the world. This creates an offsetting income stream to the debt. Whatever happens with Gen AI, it will be dominated by US companies and that will make the debt insignificant.

To put it another way, if balanced government budgets determined the success of a country’s economy, business and equity market valuations, German stocks would lead the world. But they do not. Over the last 10 years, the MSCI Germany index has averaged just 2.2% per year.

The bears won’t win this debt argument and I’m fed up with hearing the same speculation without fact.

Artificial Intelligence

I’ve been thinking a lot about artificial intelligence and why the market is all hyped up about it. It could very well be much bigger than I first thought.

When I think back on history, the process over the last 50 years has been, man first took things and electrified them. Think of a garage door. Gone are the manual roller doors lifted by hand. We took that product and added electricity to it so the machine does the work for us.

Once everything became electrified our next step was to add it to the internet. Even our fridges these days can connect to the internet.

What comes next is adding AI to everything. Probably even your garage door. How much of a step is it to think your garage door recognises your car on approach and automatically opens for you?

I have no idea what this looks like, but I am sure it is going to happen.

The AI we have now is nothing like the AI we will have in 12 months.

I’ve been playing with an AI tool called Pi. Google searches are so 2022. Who does that anymore?

We are working on a list of AI stocks as we should all have some exposure. Watch this space.

Ta Ta Tesla

This week Tesla (TSLA) reported a historic miss for Q1 deliveries and production. Total delivered vehicles were 14% lower than estimates; that was driven mostly by weaker sales of the much higher volume Model 3 and Model Y sales group (13% miss). But Model X and Model S sales were also 23% below estimates.

It’s not unprecedented for TSLA to see production down YoY. There were YoY declines in both Q4 2017 (as Model 3 retooling hurt production) and Q2 2020, when the COVID shock disrupted production. On its own, production difficulties are pretty understandable: the official explanation of Red Sea shipping difficulties and weak output due to production lines receiving modifications for an upgraded Model 3 basically tracks in that respect.

Weak production doesn’t explain why deliveries underperformed production though. It’s also odd that Model 3 retooling, which should drive a bigger miss for that model, seems to have hit Model X/S sales even harder. There’s good reason the stock was down over XXXXX this week. This was arguably the worst quarterly sales volume print in the history of the stock. Recent price action in TSLA has also been painfully unconstructive. As shown below, the stock has consistently traded to lower highs since late 2021. More recently, a very strong trend of lower lows has also been present for the past ten months; this is a textbook technical downtrend.

Using a range of seven different large global auto OEMs and a range of valuation metrics, we can get a range of different possible prices for TSLA if it were to trade at the same valuation as these other automakers. Of course, there may be good reason that the EV maker should continue to trade at higher multiples than legacy OEMs. But those reasons are probably less compelling if unit sales are falling at a mid-single digit pace rather than rising at a high double-digit pace. Therefore it’s at least worth thinking about the implications of TSLA returning to a typical OEM’s valuation.

The implications are straightforwardly brutal. If TSLA were valued at the same multiple as Toyota, it would drop 75% from here. If it was valued comparably to any other GM, it would drop over 90% from here. This trend is clear across valuation metrics as well. Simply put, if TSLA’s valuation premium falls to traditional OEM levels, shares would fall a lot. Thus far, TSLA has traded more like a Tech stock than an OEM.

But, Telsa isn’t just another OEM vehicle producer.

To explain this next bit about stock valuations I am going to tell you about how funds are raised in IPOs or any other sale for that matter.

A stock is never valued just on a discounted cash flow basis. A stock price always has a built-in “What If?”

For a mining company it could be “what if it strikes a rich vein of gold?”

For a tech company it could be “what if their software becomes the standard”

These what if’s have a value. The problem is investors tend to assign too high a value to a what-if.

The Tesla what-if is – what if Tesla can make autonomous driving work?

As time goes on and this what-if becomes clearer Tesla will trade differently. It will either trade like a tech stock or a car company.

At the moment it is trading like a tech company but beginning to start to move towards a car company.

I suspect autonomous driving is a long way off and as such I fear there is only one direction for the Tesla stock price, and that is down.

Warning

Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account and might not be suitable for you.