Commentary on Political Economy

Monday, 27 July 2020


Tesla’s market ride reflects larger forces at work

Tesla logo
Instead of powering higher after results that beat Wall Street estimates, Tesla shares suffered their first two-day run of declines in a month © AFP via Getty Images
Tesla bulls got exactly what they needed last week: blowout second-quarter figures from the electric car maker that helped justify a tripling in the company’s share price so far this year.
But the market reaction has once again left investors and analysts puzzled. Instead of powering yet higher after results that handily beat Wall Street estimates, Tesla shares suffered their first two-day run of declines in a month, shedding more than a tenth of their value.
The reverse course was a sign that the momentum driving a handful of US share prices is still poorly understood, and acts as a potential source of volatility for a broader stock market dominated by a small stable of companies.
“We have not been able to identify where that extraordinary level of volume is coming from, whether it’s quants, index [trackers], options, other derivatives, retail, momentum [traders],” said Adam Jonas, the analyst who covers Tesla at Morgan Stanley. “There are forces at work bigger than Tesla.”
Line chart of year-to-date performance (%) showing Tesla has outpaced both the broader market and other momentum stocks
Tesla’s fortunes have been the talk of Wall Street trading desks and internet message boards for the past four months as its stock surged in value; this month it briefly became the 10th most valuable publicly traded company in the US, surpassing JPMorgan Chase. Retail investors have piled in and trading volumes in options — which give users the right to buy at a fixed price in future — have ballooned.
Momentum alone has become an increasing draw for some investors, who rely on the belief that a stock’s strong gains over the past few months portend greater trading profits in the future, regardless of how a company’s business is actually performing.
Tesla is at the centre of that strategy and is now one of the largest components in momentum funds after its stock rocketed this year. But that alone cannot account for the full scale of the rally, which had puzzled even Tesla executives, according to one adviser to the company.
Line chart of daily trading volume in each stock ($bn) showing trading in Tesla shares surged in July
The company’s results last week were supposed to vindicate those investors who had pushed its shares to a handsome ratio of 310 times expected 2020 earnings on the prospect it would deliver on its long-touted goals to revolutionise travel. It delivered its fourth quarterly profit in a row, meaning it could be considered for inclusion in the S&P 500, helping it to attract new demand from index-tracking funds.
While the stock initially climbed on the results, the momentum that had earlier helped lift Tesla shares quickly died out. After falling 5 per cent on Thursday, they slid 6.3 per cent on Friday, even after credit rating agency Moody’s upgraded its view on the company.
The slide — which was followed by a bounce in early trading on Monday — cuts to the centre of a debate on whether the market is behaving rationally. “There is a lot of exuberance,” said Chris Murphy, co-head of derivatives strategy for Susquehanna Financial, a trading and technology firm. “It’s amazing to go from a global depression to a stock market bubble in three months.”
Valuations of technology groups have climbed about 15 per cent this year, helping to fuel both momentum funds and the broader market. The gains relied in part on the narrative that groups such as Amazon, Microsoft and Netflix would ultimately be beneficiaries of the pandemic, and their rise has strengthened their sway over market cap-weighted indices such as the S&P 500, leaving the whole index vulnerable to swings higher or lower based on the fortunes of a small group of companies.
The price-to-earnings ratio — a common measure of valuation — of tech groups in the benchmark S&P 500 US stocks index now sits at the highest level in more than a decade. The rise has in large part been spurred by stimulus from the Federal Reserve, which through bond-buying programmes and deep interest-rate cuts has prompted investors to shift out of haven sovereign debt and into riskier securities, including stocks. The low interest rates themselves have increased the appeal of companies enjoying rapid growth, which includes groups such as Tesla and the tech giants.
Bar chart of weight of the top 10 holdings in the iShares Edge MSCI USA Momentum Factor ETF (%) showing Tesla is one of the top holdings of the largest momentum ETF
Tesla and other popular momentum stocks have also been among the favoured trades on trading apps such as Robinhood that are aimed at amateur stock pickers. More than half a million Robinhood accounts now own a stake in Tesla, a record high. They have been buyers even when its stock has retreated, signalling at least one source of demand for Tesla shares has persisted.
Portfolio managers recently warned that the bet on the tech sector was a crowded trade, and strategists at Citi Private Bank on Friday cautioned that it was “almost impossible to predict where the top will be . . . while momentum and ‘fear of missing out’ pushes asset prices too far”.
“The frothiness of this market has been worrisome for a couple of months now,” said James Wong, a portfolio manager at Payden & Rygel, a fund manager based in Los Angeles. “It won’t take a lot to change market sentiment.”

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