Tesla has lost nearly 30% since early February to Monday’s close.
by more than 30%, an astonishing turnaround since the beginning of last year.
It would be easy to conclude that oil is back in fashion and that electric cars are suddenly obsolete. But the former is only partially true and the latter is clearly false. In fact, these movements reveal two main trends: the stimulation of the economy and its effect on bond yields.
Tesla is a long term bet and Exxon is a short term bet. Last year, investors were convinced by the combination of poor short-term prospects and Fed pressure on interest rates and bond yields. Since November, investors have been increasingly focused on short-term gains as these two trends reverse, although sensitivity to Treasuries went the other way on Tuesday, when a sharp drop in interest rates sent Tesla shares soaring 20%.
Cyclical stocks, which are the most sensitive to short-term economic growth, have performed well since the Covid-19 vaccines raised hopes of a recovery in economic growth. Stimulus trading accelerated in February when it became clear that President Biden’s $1.9 trillion package would be approved. Cyclical stocks like airlines and oil companies, commodities like oil and copper, and bond yields rose.
Exxon is what a winner looks like in this new world of challenging demand. Oil is the world’s most sensitive commodity and will be rediscovered everywhere this year. As demand rises, so does price.
Exxon has such high fixed costs and last year, even before the $20 billion asset write-down, profits couldn’t cover costs, and any revenue growth would be almost entirely below the line. It has a lot of what investors call operating leverage, which is the same effect as many loans: Each additional dollar of revenue has a much greater effect on profits than in a business where costs are variable.
David Costin, senior US equity strategist at Goldman Sachs, believes last year’s market weakness means that operating leverage is at its highest since the 2008-09 recession.
Tesla barely makes a profit, but that doesn’t really bother investors. The stock is not dependent on this year’s earnings (which should rise), but on earnings in the future, when sales should be much higher and there is finally hope for the promise of self-driving cars.
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Unfortunately for Tesla’s investors, the stock market couldn’t care less about the long term, and it didn’t. The election of a Democrat committed to fighting climate change has certainly improved the long-term prospects for electric cars. But investors are attracted to the rapidly improving outlook for companies that can benefit from a better economy here and now.
This is not about short-term greed, of which stock markets are so often accused. The improving economy leads to higher bond yields as the market expects higher inflation in the future. Rising yields are forcing investors into an even shorter time frame. This is because the return seems less attractive over time when a safer Treasury alternative offers a decent return. The decline in the prices of long bonds due to rising yields is accompanied by a decline in the prices of income stocks, which are also long.
This pattern is typical of speculative stocks, i.e. companies with little or no profitability but rapidly increasing sales. Biotech, fintech, electric vehicles and clean energy all peaked at about the same time and then began to decline.
Tesla’sshares have fallen in recent weeks.
Cilai Shen/Bloomberg News
It’s not that sales don’t seem to be that good (except for some who have benefited from blockchain). It’s not that their earnings forecasts have been muted – in many cases, including Tesla’s, 12-month earnings forecasts have actually risen while share prices have fallen. The fact is that the future returns on these higher sales are worth less as bond yields rise, so even many of their fans recognize that they should not be traded at such stratospheric multiples. As momentum added to the mix and traders moved from higher to lower prices, things darkened.
Yet the declines are only now beginning to offset last year’s gains. Tesla has still more than tripled in the past year, even though the stock has lost more than a third of its late January high.
If bond yields continue to rise, that will hurt speculative growth stocks. Some of the weaker ones may even suffer the ignominy of having to switch from expansion mode to cash reserve mode at all costs, as it is harder for them to attract investors for new money. Uneconomic stocks listed through SPARK are the riskiest.
On the contrary, bond yields have already risen sharply and if they fall back, that could boost speculative stocks, as Tuesday’s sharp moves showed. Everyone knows that economic growth is continuing, and oil prices briefly rose above $70 a barrel this week, higher than before the pandemic, suggesting that a price rally may already be underway.
I think even after big gains in cyclicals and bombs and big losses in growth stocks, there will probably be more moves before life returns to normal. But the magnitude of the shifts means I have much less confidence in future gains for the exons in this world.
No more long waiting times at charging stations: Chinese electric car startup NIO is leading the way with battery swapping systems to challenge Tesla and other rival automakers. Here’s how NIO and Tesla are capturing the world’s largest EV market, in China. Illustration photo: Sharon Shea
Email James McIntosh at [email protected]
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