Last month it was revealed that famed hedge fund manager of “The Big Short” fame Michael Burry, was holding a position of 1.1 million put positions on carmaker Tesla valued at around $731 million. Not only that, doubling down on his bet against Tesla and on tech in general, it was also revealed that he was holding 235,000 put options on the ARKK ETF run by Tesla bull Cathie Wood. Many people have called Tesla overvalued and many have called for it to drop, but Burry brings a different credibility to the naysayers as one of the few who correctly called the subprime crisis and was able to profit from it (against the wishes of his shareholders).
What’s more intriguing is that the put positions place a hard deadline on when his call on the drop will be realized. Many analysts who short stocks know they are overvalued but short the stock in the hopes that it will fall in value soon. It doesn’t require however, a bet that loses you all your money if it doesn’t happen by a certain date. The filings, which were for Burry’s firm Scion Asset Management, don’t disclose more intriguing details like the average strike price of his puts or when they will expire, but since many options expire within a year, it’s safe to say his bet is that at some point in the next year, both Tesla and ARKK will see significant drops.
The tweet from Burry above, makes a simple point for his case against Tesla. It shows that with revenues of less than a tenth of Toyota or Volkswagen and an EBIT of negative $69 million, Tesla has a market cap larger than the largest 10 (profitable) auto makers combined. Even the more richly priced companies like the Chinese electric car maker BYD sell for around 21x EBIT. We’re Tesla to make a few billion in EBIT they would still be selling at 323x EBIT, an absurd valuation, even for a fast growing company.
My last post was on the potential opportunities that were lurking for the next phase of the market. If you read this blog regularly, you know that I am skeptical of trends and don’t chase them. I don’t hold Bitcoin and my tech portfolio consists of my S&P 500 index shares as well as the Powershares Nasdaq 100 ETF (QQQ). I am balanced across styles and geographies such as value, growth, large cap, mid-cap. small cap, emerging market and international shares as well as medium term bonds. Outside of that, real estate, through my own home as well as rental properties provide the other portion of my returns.
Yet the opportunity that seems attractive lately which I don’t have much exposure to, is the bubble that has emerged in tech. Burry’s bet is an intriguing one for its call on timing. Having started investing in the late 90’s and seen my investments fall with the tech bubble, I grew a healthy skepticism of trends and hot stocks and I am seeing many of the same things repeat themselves today. From young people quitting their jobs to trade to “gurus” who tout their get rich quick schemes in the hopes of securing their own price of the pie before the mania ends.
Looking back at the history of the Dot Com crash however can offer clues into how the current bubble may burst and how savvy investors can position themselves before the crash to protect returns.
Those Who Profited
One of the more famous short sellers of the last tech bubble was Sir John Templeton. Templeton. Templeton is now largely forgotten by the financial press in favor of Warren Buffet, who through his investments was able to grow his company into one of the largest in the world. Yet Templeton and Buffet were both value investors. The difference is that Templeton went on to create mutual funds while Buffet preferred to manage the float of his insurance company and acquire others.
Templeton famously bought 100 shares in each of the companies on the NYSE trading under $1 (or about $20 today), after the crash of 1929. He then turned his attention towards global investing. His Templeton Growth Fund, opened in 1954, was one of the first to invest in Japan and his fund rode the boom of the 1960’s there. When Japan became hot in the 1970’s and early 80’s. He dumped much of his Japan stakes to invest back in the US. These moves saw his fund accurately time some of the greatest moves in global stock markets. The US market from 1982 on, went on a 17 year bull run until the year 2000. Templeton’s Growth Fund saw returns of 15% on average for a period of 38 years, a fantastic run which would have returned 202 times every dollar invested from the inception of the fund.
In the late 90’s however, Templeton saw the specter of overvaluation and hype again and was searching for a way to short the market. Many hedge fund managers also saw the bubble and had attempted to short the market as well but lost their shirts in the process as stocks just kept going up. Yet Templeton noticed that many of the shares of the richly valued tech companies were held by insiders. Insiders likely knew their companies had little chance of turning a profit so many of them dumped their shares when their required vesting periods ended. Templeton shorted tech stocks on these dates and was able to profit from their drops when the bubble started to burst in 2000.
This strategy is relatively well known nowadays and has kept shares of other IPO’s like Uber and Lyft down as short sellers come in on those vesting days. The new phenomenon of meme stocks via Reddit chat rooms creates a new element however and the valuations of other stocks I have featured on this site such as AMC and GameStop will likely be subject to those retail holders eventually dumping their shares, and trust me, this will happen, it’s only a matter of time.
The Lessons
The lessons to take away from the Dot Com bubble are that valuations can remain lofty for some time but when they turn, it can be sudden and spread quickly. Within a year of the Dot Com bubble bursting, the 4th largest company by market cap in the US, Enron, went down in flames due to an accounting scandal. The company had pioneered new methods of trading energy, they even claimed to be able to trade internet bandwidth, famously taking bank analysts on a tour of a bandwidth trading room where traders were clicking away on screens that did nothing.
Other established companies traded at unreasonable valuations, General Electric at one time traded at a P/E of 50, Microsoft is currently close to 40. Although Tesla may not be hiding accounting scandals, it’s place as the 6th largest holding in the NYSE doesn’t seem to be founded on any type of fundamentals and is worryingly close to the relative size of Enron just before it’s collapse.
Couple this with a terrorist attack on September 11 in 2001 and a shift in global politics which brought on war and the global fight against terrorism and investors had every reason to cut their losses and get out of the stock market. The first to go were the retail investors which dropped tech and abandoned day trading in hot shares.
What is often forgotten is that not all segments of the market experienced this bloodbath. Investors need a place to put their money, even in tough times and institutional investors switched to value shares which had been neglected for the past decade. As FundX put it:
But there’s another important detail about the dot-come bust that often gets overlooked: when the tech bubble burst in 2000, it didn’t affect every area of the market in the same way. Large-cap growth and technology stocks plunged, while value stocks had gains. The tech-focused Nasdaq Composite Index fell -39.0% in 2000, while the Wilshire 5000 Large Cap Value Index gained 17.0%.
With small caps and value underperforming tech in the past few years, is it any wonder that small caps indexes like the Russell 2000 are on a tear in 2021? In fact, looking back on it, if we place ourselves as investors at the top of the last tech bubble, the outperformance of tech in the past few years is really just the Nasdaq catching up with the S&P 500 and Dow, which it had been underperforming for that hypothetical year 2000 Nasdaq investor.
That investor, if they held, eventually experienced 20 years of underperformance until the pandemic caught their returns up. For those that are saying international, value and small cap investing are dead and that a “new paradigm” like Bitcoin will usher in a new era of endless returns should take a hard look at the experience for investors of the past 20 years.
Side Note
Before his death in 2008, in 2005 John Templeton he wrote a brief memorandum predicting that within five years there would be financial chaos in the world, anticipating a collapse of the housing market and decline in yields on government-issued bonds to near zero. Templeton also predicted within the next few decades a major decrease in traditional schooling due to internet-based learning options.
It may not surprise many that Templeton also saw the housing bubble bursting but his vision for online education seems to be playing out as predicted. More and more, people are turning to social media for personal financial advice which lacks the formal structure offered to tech people like the skilled trades. Online learning has exposed the unnecessarily high cost of higher education and has acted to level the playing field in terms of financial education and is poised to do so for other forms of education as well. This is one reason I am predicting slower growth in tuition costs as colleges come to terms with this competition and start to incorporate it, hopefully lowering the cost for their students. If anything, his predictions lend even more credibility to those who are taking up the mantle of teaching the masses investing and empowering them through the markets. My hope is that this whole movement doesn’t go up in smoke when the next bubble bursts.
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