Wednesday, February 5, 2020

Tesla Bubble?

Paul Vigna in the Wall Street Journal

Source: Wall Street Journal
"Tesla TSLA -18.51% Inc.’s shares rose 14% Tuesday to $887.06. They have surged 56% in the past week and have nearly quadrupled since early October.  Those outsize gains don’t match Tesla’s more modest fundamentals, which include annual losses."
"They do, however, resemble any number of other assets that have experienced prolonged bubbles, including shares of Qualcomm Inc. and other tech stocks of the dot-com era; oil in 2008 and bitcoin in 2017."
At these prices, Tesla is worth more than Ford and GM combined.



Holman Jenkins:
Tesla can earn a lot more profit per car, and can sell a lot more cars than it does now, and still its stock is priced as if its future profits will be coming from some unnamed something that is not the car-making business.
A correspondent:
I just looked at the minute by minute data for TSLA.  In the last 12 minutes of trading volume was 4.5 million shares, high price was 967, low price (in the last 12 minutes not the day) came 5 minutes later at 860, closed at 887.06.  
Shares outstanding is 180 million so the move from 969 to 860 erased 20 billion of market cap, in five minutes, on no news.  These numbers are so crazy they seem almost meaningless but they make for a good sound byte in a video.
And implicitly (he's more polite)
So Mr. Efficient Market, what do you make of that? 
I can't resist the temptation to plug an old paper, that I have long wanted to return to, "Stocks as Money." I wrote it in response to the internet boom and bust, and the excellent Owen Lamont -Richard Thaler "Can the market add and subtract" in particular. 

This pattern happens over and over (and over and over) again in financial markets. Surely we can do better as an "explanation" than "people are dumb." Or, as Lamont and Thaler put it so nicely,
one needs investors who are (in our specific case) irrational, woefully uninformed, endowed with strange preferences, or for some other reason willing to hold over-priced assets.
Patterns that are repeated over and over again need ether irredeemable human folly -- not much of an "explanation" as it can explain anything -- or economics, a model by which rules of the game produce a strange outcome despite people in the game understanding the game and where it ends. That's what "stocks as money" suggested.

Stocks as money points out these events do not happen in isolation. High prices are only one symptom. They always occur with 1) huge price volatility (check) 2) huge share turnover (check) 3) impediments to short-selling, especially at a longer horizon (check, more below)  4) in an asset where there is a lot of disagreement, a lot of potential news, a lot of different opinions about long run value. Bubbles do not happen in regulated public utility stocks.

"People are dumb and will pay too much for flashy stuff" does not explain why they should, a week later, change their minds and sell. It does not explain why high prices only happen with the other four.

So why would anyone buy Tesla?


Well, duh, because he or she thinks the price will go up in the next week or two. I venture that very few people are buying Tesla to line their retirement accounts and live off the dividends for 20 years. The level of Tesla's stock -- its long-run "overpricing" is pretty irrelevant to that trade. If the expected return of Tesla is even minus 6% per year, that's 1/2% per month, or 1/8% per week. If you think Tesla will go up 20% in a week, that is a tiny cost of doing business -- less than transactions costs and capital gains taxes on the trade. But from P/D=1/(r-g) it takes a lot less than -6% per year expected return to drive the price level to the stratosphere.

OK, but for every buyer there is a seller and someone who thinks it will go down 20%. Why don't short-sellers push the level of the price down? Now you know why item 3 impediments to short-selling are important. If you think Tesla is overvalued, and must at some point in the next 5 years come down to earth, it is still awfully hard to trade on that opinion.

First, you have to find shares to borrow. This is hard, especially given that much of Tesla's shares are held by retail investors. Then, if the price rises before eventually plummeting, you have to post cash against the loss of value of your position. Yes a screaming sell became a scream from the mountaintops sell, but you need cash and you need it now.   Vigna:
Despite some short covering over the past few weeks, there is still $14 billion in short interest against Tesla, making it the most shorted U.S.-traded company,
Last fall, short interest in the stock was about 25%. As the price went up, some traders were forced to buy the shares they had borrowed when opening the short position. That drove the price up further, forcing other shorts to also buy, which in turn drove the price even higher. “And so on,” ..
Moreover, between when you borrow shares and when you sell them, you are holding shares of Tesla stock. Both buyers and sellers need shares. The demand for shares overwhelms the demand for stock.

So, in an environment where lots of investors have lots of (what at least they think is) news about the value of a stock, and want to trade at high frequency to profit on that news, the level of the stock can get pushed up, since nobody holding it cares about that.

The money as stock paper points out that this situation is exactly like money vs. bonds. Money is "overpriced" relative to bonds. But we hold money anyway because it provides "liquidity services." In times of hyperinflation, money can be dramatically overpriced. You can earn 1000% on bonds and zero on money. Yet people still hold money? Why? Well, not for a year, duh. They hold it for an hour or so in order to buy things.

The analogy makes other clear predictions that the "people are dumb" theory does not make. The overpricing should be larger as turnover is larger, and as the supply of shares is smaller. Check.

Just what is the "information" on which people are trading? I don't know - I don't trade. Surely the process by which information makes its way into market prices -- how actual news is passed around, interpreted, considered, and aggregated -- is one of the things we understand least in asset pricing. It seems to need a lot of actual trading. The model that we announce demands, hear others demands, infer their information, wait, and the "auctioneer" posts a final price, at which nobody trades, is obviously wrong. Just as the microfoundations of money are important to understand what this venerated "liquidity preference" is (and whether it will last), similar investigation is important for finance. But that doesn't stop us for recognizing the signs of a trading demand in stocks.

This view makes a prediction however. The price spikes need limited supply of shares. If shorting were easier, especially in the long term, the price spikes would disappear.  Most regulation, however, shows mostly interest in suppressing short-sellers.  Easier share issuance would also help.

"Demand curves" for stocks do slope down, and I think this is a plausible mechanism. (Though "demand curves slope down" is repeated a lot, models of the phenomenon that go much past "people are dumb" -- or rather "all those other people are dumb" -- are pretty rare.) But the real question is why does  the supply curve slope up? With a flat supply of shares, there would be no bubbles. 

13 comments:

  1. There was a stock that (adjusting for splits) was selling for about $6 in September 2001, and by the end of 2003 it was up by a factor of 10 to around $60. Bubble? It's now priced at over $2000. That's of course Amazon. One could tell similar stories with Apple and Google. Obviously that's cherry-picking after the fact, but the point is that if even one in 10 of these "bubbles" turns out to be the next Amazon, maybe they're not entirely irrational?

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  2. Always a fascinating topic. I am surprised that Tesla introduced a pickup truck rather than a city delivery van, given the ability to line the floor of the vehicle with batteries and get up to 500 miles of range.

    The bigger story may yet be on the horizon. That is the promise of commercialized solid-state batteries. The whole industry may be in for a shake-up if such batteries are commercialized, as the cost of producing battery cars is a lot cheaper than the old internal combustion engine cars. Except for the batteries.

    Stay tuned. You may see a lot of entry into automobile manufacturing, and perhaps a wonderful return to the idiosyncratic designs we used to see.

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    Replies
    1. "... I am surprised that Tesla introduced a pickup truck rather than a city delivery van...."

      Experienced competitors for electric and alternatively-fueled city delivery vans already exist. For full-size pickup trucks, not so much.

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  3. Markets are efficient as water always goes down. The existence of waves and tsunamis didn't invalidate the later as the existence of bubbles, short squeezes or flash crashes didn't invalidate the former.

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  4. One thing people miss is that all the major auto companies globally are bound by contracts to work through dealerships. These dealerships make it very difficult for car companies to have a direct relationship with the consumer and introduce massive inefficiencies in the supply chain, and arbitrarily increase prices by about 30%.

    I would not be surprised if *all* of the major auto companies world wide go bankrupt to be replaced by companies that are not limited that way.

    That's essentially what ToysRUs recently did.

    Another thing people miss is that as time goes on and incumbents have failed to put out a better product than Tesla, we have more confidence that Tesla has surmounted some serious barriers to entry. In 2007, people thought that RIMM would have no problem putting out a competing product. RIMM went bankrupt.

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    Replies
    1. Actually much of this is not contracts, which can be rewritten, but state and local laws forbidding companies from selling direct. These are written and enforced by the car dealerships, duh. Tesla got in a lot of trouble for wanting to sell factory direct. I haven't followed how this worked out.

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    2. Beign so clear to everybody this does not make any economic sense. Why is still in place?

      https://www.justice.gov/atr/economic-effects-state-bans-direct-manufacturer-sales-car-buyers

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  5. John-could you clarify your point regarding hyperinflation?

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    Replies
    1. In a 1000% hyperinflation $1 will be worth $1 in a year. $1 invested in bonds paying 1000% interest are worth $11 in a year. What fool holds money when bonds pay so much more? The dollar of money should be worth 9 cents at the same rate of return. Money is wildly overpriced -- trading at 10 times its fundamental value. Yet people hold it -- briefly -- just like Tesla stock.

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    2. $1 held for a year in 1000% hyperflation is worth 9 cents at the end of such year. Very expensive to hold that buck!

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  6. Moreover, between when you borrow shares and when you sell them, you are holding shares of Tesla stock. Both buyers and sellers need shares. The demand for shares overwhelms the demand for stock. Exactly. Transfer of risk at a price is only determined at the time of the trade. Two comments. I was a market maker on both the CBOE and AMEX. Time and again, I watched traders who were short options chase offers until they were out of the position. Currently, clearing firms have increased margin requirements for Tesla short sellers. I don't understand why these short sellers don't just buy out of the money puts or create synthetic puts, long deep in call and short stock. Risk is defined apriori. Current Tesla short side is 40%.

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  7. If you're not short Tesla stock, it's kinda hard to take this bearish talk seriously.

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  8. Your explanation of bubbles ought to at least address the Gjerstad/Smith analysis in experimental markets, where even with known finite time horizons, asset bubbles occur most of the time (prior to crashing at the very end). The mechanism appears to be a lack of common knowledge of rationality among the group of traders--I know it's only worth the fundamental, you know it's only worth the fundamental, but do you know that I know? Do you know that I know that you know? Etc. The empirical result is that traders timing the bubble successfully make the most money, those attempting to time it and waiting too long make the least, and those trading according to fundamental value are in the middle somewhere.

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