By George K. Livadas
After a rocky Q1, U.S. equity markets appeared back on track in Q2: large- and mid-caps returned 4%, while small-caps returned almost 8%. Beneath the surface, however, things seemed different. Hedge funds struggled, as ‘shorts’ (often lower quality companies) outperformed. 2 Banks and other financials fell for a record-setting 13 consecutive days in late June.3 China, along with several other emerging markets, entered a bear market (-20% from peak). And, volatility appears to have shifted to higher ground.
I could go on and discuss how the picture being painted – by both market and economic observations – suggests we’re in the late stages of the economic cycle. I believe it. But, I’ve been (too) cautious for a while now. I’ve worried about all sorts of downfalls for the market (my formative years as an investor were the heart of the 2008 financial crisis – why do you ask?) and I don’t need to bore you.
The relevant issue is really: how do these concerns impact portfolio construction? The portfolio is constructed on a bottom-up basis: seemingly attractive longs and shorts are added and net exposure mostly falls where it may. But, my caution influences the types of stocks I research (longs vs. shorts, etc.). If I’m doing an adequate job picking stocks, my market views shouldn’t impact overall performance too much.
Tesla: New Short Position
I confess that we are short Tesla (NASDAQ:TSLA), the high-flying electric auto manufacturer. I am mildly embarrassed to hold and discuss the position, given how crowded and unoriginal it is (I’ve even mocked the idea in the past, noting it’s quite stupid to short a stock that rises as the short thesis plays out). However, I think the time may finally be right.
Why now? In addition to the many well-known arguments for shorting Tesla, there are real signs that Tesla’s stretched balance sheet may be having an adverse impact on its quality and service. Combine this with the very public and increasingly erratic (to be very generous) behavior of its CEO (Elon Musk) and it’s not hard to see that the Tesla brand – for both consumers and institutional shareholders – is being tarnished.
Given how crowded the short is, managing risk is as important as getting the call right. To do this, we’re maintaining a modest short in the stock and pairing it with options. Lastly, I’ll leave you with this notable quote from Elon Musk about the now-bankrupt solar company, Solyndra:
“The most you could say is that Solyndra executives were too optimistic. They presented
a better face to the situation than should have been presented in the final few months,
but then, if they didn’t do that, it would have become a self-fulfilling prophecy of – as
soon as a CEO says I’m not sure if we’ll survive, you’re dead.”
– Elon Musk (2011)
Disclaimer: The author has a short position in TSLA. The author is not receiving compensation for this article. This article is intended for informational and entertainment use only, and should not be construed as professional investment advice.