The combination of the stimulus, Fed policy, and lockdowns was a potent combination that led to extraordinary moves in many growth and momentum stocks in 2020. One of the most notable of these stocks was Tesla (TSLA), which climbed by 1,185% between the March 2020 stock market bottom and its peak in mid-January.
Since January TSLA and many other growth stocks retreated, as money flowed into value and cyclical stocks due to rising interest rates and increasing optimism about the economy returning to normal. However, over the last couple of months, many technology and growth stocks have been rallying and recovered the bulk of their losses, with a handful even making new highs.
TSLA is up 25% since mid-May and bulls are optimistic shares will continue climbing higher. I am not one of those bulls. I view the recent rally in TSLA as an opportunity for investors to take a short position in the stock. The major vulnerabilities that I see in Tesla are slowing sales in China, slowing sales growth as competitors are launching new EV models and some of CEO and founder Elon Musk’s allure wearing off.
Slowing Chinese Sales
UBS recently cut Tesla’s target price to $660 from $730 due to several, negative factors. However, one of its main factors is that “Tesla's demand momentum in China is slowing, and our checks on the ground suggest that BEVs (battery electric vehicles) from domestic brands are gaining further ground vs. Tesla, which may trigger additional pricing action by Tesla and consequently lower gross margins.”
In essence, China is one of Tesla’s largest growth markets, and it’s facing an onslaught of competition from domestic and international companies. UBS is concerned that it may force Tesla to cut prices to retain market share.
Another looming concern is that many Chinese EV makers like NIO (NIO) are eager to enter the US market. Given heightened tensions between the US and China, there’s no guarantee that it will get approval, especially with a polarized Congress. Many fear that if NIO’s bid to enter US markets is rejected, then China could pursue retaliatory actions against US companies like Tesla.
Slowing Momentum
Momentum stocks are driven by improvements in second-derivative measures such as revenue growth and margin expansion. Often, narratives develop around these stocks especially as investors become enthused by rising prices and stellar returns. Of course, this becomes harder to sustain once a company reaches a certain size.
In Tesla’s case, the major narratives fueling the stock higher were its leading position in the EV industry which is expected to rapidly grow over the next decade, its energy storage solutions, and its leading position in self-driving cars.
Over the last few months, each of these narratives has been undermined by new developments. Legacy automakers have fully jumped onto the EV bandwagon and numerous new models will hit the market in coming years. Tesla’s energy storage solutions have been a steady contributor to revenue growth but have failed to capture market share or differentiate itself from competitors in a meaningful way.
Finally, Tesla’s self-driving upgrade has been long-promised but has not been delivered yet. Many TSLA owners have already paid for the feature and are becoming frustrated with the delay. Additionally, many of its competitors like Waymo and Cruise have been making strides in terms of the public demos which indicates that TSLA’s gap and early-mover advantage is dissipating.
If we look at Tesla’s recent earnings report, a drop in revenue growth seems imminent especially as the company is going to face tougher comps due to the drop in sales during the coronavirus. Last quarter, Tesla had 74% revenue growth due to this factor. This is certainly going to see a steep drop in the next quarter due to much higher comps.
These developments could detract from the stock’s allure to momentum traders.
Elon Musk Losing Some of His Appeal
Often, stocks like TSLA are referred to as ‘cult stocks’, and it seems that every bull market has a few of them. It’s not hard to see why there are so many fervent believers in TSLA given its astounding returns, incredible technology, and the achievements of founder and CEO Elon Musk.
Musk has had many successes including PayPal (PYPL), SpaceX, and of course, TSLA. Even though TSLA has survived many brushes with bankruptcy, these struggles have only burnished Musk’s legacy and esteem with his investors.
However, Musk seems to have made a rare misstep with his forays into crypto. His social media reach resulted in big swings in crypto prices such as TSLA’s announcement that it would be holding bitcoin on its balance sheet and later his critique that bitcoin was doing considerable environmental damage.
Many crypto zealots have accused him of “pumping and dumping” bitcoin and dogecoin. In part, this is due to the inscrutability of Musk’s tweets, where it’s tough to figure out if he is serious or joking. The latest example is his advocacy of dogecoin which rallied sharply into his SNL announcement, only to top at the moment, he declared himself the “Dogefather”.
In the long term, these absurdities won’t affect Tesla’s long-term future. However, it could matte in the short term as there’s certainly some crossover between Tesla bulls and crypto zealots. Given that momentum stocks are driven by investors’ faith in the companies’ future being bright, these developments could certainly dent some investors’ faith in Musk’s judgment and Tesla’s outlook.
Conclusion
Occasionally, markets serve up opportunities that are attractive from a risk/reward perspective. I believe that TSLA currently qualifies especially as the stock is currently in a zone, where there is a heavy overhead supply. Further, the stock’s recent rally has resulted in an overbought, short-term state which could also result in some selling pressure.
Finally, recent developments for TSLA such as slowing revenue growth and Musk’s alienation of some crypto bulls might make the stock less appealing to momentum investors and traders.
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TSLA shares were trading at $680.65 per share on Tuesday morning, down $8.07 (-1.17%). Year-to-date, TSLA has declined -3.55%, versus a 15.22% rise in the benchmark S&P 500 index during the same period.
About the Author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of POWR Growth newsletter. Learn more about Jaimini’s background, along with links to his most recent articles.
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