“Even the intelligent investor is likely to need considerable willpower to keep from following the crowd.“ - Ben Graham
The quote above is from Ben Graham, considered to be the father of
value investing. Graham followed the crowd in 1929 and lost a small
fortune for himself and his investors. Graham collected his learning
experience from that disaster and eventually wrote, “The Intelligent
Investor,” which is considered to be the one of the best investment
books ever written. Warren Buffet enrolled at Columbia to study under
Graham. Graham’s teachings formed the foundation of modern money
management theories. To this day it is considered the value investor’s
“investment bible.”
Wall Street is incentivized to sell the idea that stocks only go up.
When I started on the junk bond desk as a salesmen (before switching to
trading), I was told my job was to “reach into the portfolio manager’s
pocket and take as much money as you can from his pocket and put it into
your pocket.”
Wall Street greed has been around as long as stocks have been trading
(the NYSE was founded in 1792). But it’s hard to blame stockbrokers for
the damaging effects of greed. Stock-peddlers are like well-paid
psychologists. They take advantage of human greed. Without investor
greed, the stock brokerage business would be considerably smaller than
it is today.
A stock bubble can’t exist without investor greed. It starts with
greed. It moves into the “bubble” phase when greed is consumed by
hysteria. The U.S. stock market has moved into the “hysteria” stage.
This would be the point at which the bubble has almost reached maximum
inflation. The upward movement in stocks is dominated by a handful of
the stocks that, for whatever reason, are moving higher at the fastest
rate of levitation. The graphic on the next page shows visually what
“bubble to hysteria” looks like.
I reached the conclusion the stock market has moved into the hysteria
stage by spending time studying the “Five Horsemen” (AAPL, AMZN, NFLX,
FB, MSFT) + TSLA. Even during periods of the trading day when the Dow
and SPX are go red, most or all of those six stocks remain green,
sometimes moving higher while the broad indices move lower. It’s
incredible to watch real-time.
“It’s not to late to catch a ride on the FANG rally” was a headline seen on CNBC last week. This is the type of hysteria that is reflected in the media at bubble peaks.
In the image above (click to enlarge), the graph on the left is the NASDAQ index since the election (from Jesse’s Cafe Americain).
The graph on the right is the price-path that occurred during the Dutch
Tulip Bulb mania of the 1630’s. You can see that both graphs go
vertical. The vertical stage is driven by hysteria in which investors
are terrified of missing the next move higher. It also ends with a
decline, the rate of which is typically stunning.
The push higher in stocks like AAPL and AMZN is irrational, but TSLA has been infected with outright hysteria.
The worse the news on Tesla gets, the more quickly the stock seems to
move up in price. Early in the week last week, Triple-A (the Auto Club
group) announced that it was going to raise the its insurance premiums
on Tesla cars by as much as 30%. A highway loss data study revealed that
Tesla’s vehicles have higher claim numbers and repair costs vs. other
vehicles in Tesla’s category. The Tesla S model claims were said to be
46% greater than the average number of claims for similar vehicles.
Servicing those claims cost twice as much. The X model car reported a
41% higher crash-rate than similar vehicles and cost 89% more to repair.
In addition, it was reported on Monday that Toyota had unloaded the
last of its remaining stake in Tesla before the end of 2016. It marked
the end of a collaboration between Tesla and Toyota that began in 2010.
Toyota announced that it plans to release its own fleet of long-range
mass produced electric vehicles by 2020. Despite this blow of negative
news about Tesla, the stock powered up over 8% last week before a
late-day sell-off in the 5 Horsemen + Tesla inflicted a $19 reversal in
TSLA’s stock price from its high Friday to the close. My puts, the June
30th $317.50-strikes, traded from Friday from a low of $1.06 to close at
$2.40 on the bid side.
The graph below shows the price-path of TSLA’s stock since the
election. Note that the graph looks very similar to the graphs of the
NASDAQ/Tulip Bulb mania. In the 1800’s, writer Charles Mackay wrote a
highly acclaimed book called, “Extraordinary Popular Delusions and the
Madness of Crowds,” in which he presented his studies on crowd
psychology and how it leads to financial manias, among other destructive
events. The chart below reflects “crowd” madness as it applies to TSLA
stock (the inset price-box from last Thursday morning) – click to
enlarge:
While the NASDAQ has appreciated 22% since the election, TSLA’s
stock, on deteriorating fundamentals, has shot up 191%. TSLA’s market
cap now stands at nearly $61 billion. It burns over $1 billion per year
in cash and
its financials are riddled with what would have been considered accounting fraud 20 years ago.
It sold 72.6 thousand cars in 2016. Compare this to GM, which has a
market cap of $51 billion and sold over 3 million cars in 2016, and
Ford, which has a market cap of $44 billion and sold 2.5 million cars in
2016.
To say that the action in TSLA’s stock price and its market cap is
“insane” does not do justice to the word in “insane.” TSLA is the
“poster child” for the mass hysteria that fuels investment bubbles. The
problem with shorting TSLA is that the hedge funds are chasing its
momentum higher, as investors as investors embrace the negative news
events as a reason to pay more for the stock. As such, it’s hard to see a
catalyst that will “correct” the price, like with retailers for
instance. TSLA, along with AMZN, is one of the rare stocks which will
continue levitating until it doesn’t – like a meteor that eventually
burns out falls to earth.
In my opinion, the ride down will be worth the pain and blood-loss of
sticking with a short bet on TSLA, which is why I continue to buy small
quantities of put options that have been expiring worthless. I know at
some point I’m going to catch a $100+ reversal in TSLA stock which will
more than make-up for the small losses I’m enduring in the puts while I
wait for that occurrence. Using puts protects me from the unknown
magnitude of upside risk from shorting the stock. Plus, I don’t have
make a “stop-loss” decision because I don’t have the theoretic “infinite
upside” loss potential that I would face shorting the stock. With my
loss capped, I can hang on to the puts through expiration. With a stock
like TSLA, often a stop-loss exit is followed up by reversal to the
downside, leaving the short-seller without a short position.
As we saw on Friday, TSLA stock can reverse to the downside quite
abruptly and sharply. I can guarantee that some number of shorts covered
as TSLA was soaring over $370, leaving them with no position when the
stock reversed, closing at $357. I don’t want to recommend specific puts
to use but I can recommend giving yourself at least four weeks of time.
If I were putting on a new put position today, I would probably buy a
very small quantity of the July 7th $340-strikes. If TSLA sells back to
the $310 area before expiry, which could easily happen as $310 is where
the last 2-week push up in price began, the puts would have an intrinsic
value of $30. The current cost is about $10.
TSLA reminds me of Commerce One (CMRC), a B2B internet company that
went from $10 to $600 in a very short period of time in late 1999 –
2000. It eventually went to $0. I shorted and covered small quantities
of stock starting around $450. I was fortunate to have been short from
the high $500’s when it finally topped out a $600. The volatility of
this stock was extraordinary but persistence and “thick skin” paid off.
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Dave Kranzler spent many years working in various Wall Street jobs. After business school, he traded junk bonds for a large bank. He has an MBA from the University of Chicago, with a concentration in accounting and finance, and graduated Oberlin College with majors in Economics and English. Dave has nearly thirty years of experience in studying, researching, analyzing and investing in the financial markets. Currently he co-manages a precious metals and mining stock investment fund in Denver and publishes the Mining Stock and Short Seller Journals. Contact Dave at dkranzler62@gmail.com.
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