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Five reasons why Tesla is the everything bubble

When financial historians reflect on 2020, they will probably focus on a few stock stories that capture the zeitgeist of our age. Tesla is sure to be on the list. It is the embodiment of several unsustainable dynamics that characterise today’s markets.

In some ways, the Tesla bubble is more about investors and our economic environment than it is about the company. The faith in market efficiency, the focus on being ‘green’, the fear of missing out, and the increasing power of storytelling by celebrity leaders have created fertile ground in which the Tesla bubble took root and grew. I believe it is about to burst.

How did we reach this point?

But before articulating why I think so, let’s understand how we got here. When it comes to bubble-spotting, context matters.

The first dynamic that enabled the Tesla bubble to blow is the widely-accepted faith in market efficiency and passive investing. As fewer and fewer professionals actively consider the merits of a company’s prospects, stocks become disproportionately driven by capital flows. Stocks disconnect from fundamentals as pricing distortions are compounded by momentum-driven algorithms and traders. Further, as hedge funds have been vilified and have shrunk as a percentage of the market, the useful price-discovery role played by short-selling has been diminished.

This is a dynamic likely to get worse as the passive investing bubble continues to inflate. Relatedly, interest in environmental, sustainability, and governance (ESG) matters has grown rapidly. Yet the availability of ESG investment opportunities has not grown as quickly, leading those with ESG mandates to focus on fewer and fewer investments. In the quest to invest in ‘sustainable’ companies, many investors have stopped thinking about prices, creating unsustainable investments.

Second, the rise of social media has exacerbated the dreaded ‘fear of missing out’ (FOMO). Individuals and portfolio managers alike are uncomfortable with contrarian and independent thinking. Greed has come to trump fear. Everyone wants to keep up with the Joneses, either personally or professionally. Such a dynamic is easily spotted when higher prices incentivize, rather than reduce, the number of new buyers. Consider the fact that Tesla is worth 10x what it was around one year ago. Fewer and fewer investors are worried about downside risks.

Source: Morningstar, as at 18 September 2020

Lastly, stories have come to trump reality in many walks of life. Like the movie Wag the Dog, sentiment can and is manipulated to create perceptions that often differ radically from underlying reality. Celebrity story tellers in business and government come to wield enormous power over cult-like followers. This tends to generate highly polarized groups that blindly follow or routinely criticize. Facts matter less in our post-truth society. Nuanced and critical thinking have been replaced by unquestioned faith.

As fewer investors think for themselves, the bubble has grown to concerning levels and a five-lens framework I’ve developed to spot bubbles before they burst points to imminent risk.

1. Price action

My first lens is price action. The stock’s parabolic rise to $500 per share ($2500 pre-split) is the result of individuals buying without regard to price. This may be hedge fund managers covering shorts or individual traders planning to buy high and sell higher. As the FOMO music plays, investors continue to dance. The music appears to be slowing, if not stopping.

2. Mispriced or misallocated capital

Evidence of mispriced or misallocated capital is my second indicator. And here, global central banks have penalised savers and rewarded those with ongoing capital needs. Tesla has tapped capital markets numerous times (including a recent offering) over the past year and achieved a $400+ billion valuation, making it worth more than Walmart, Procter & Gamble and JP Morgan. When money is mispriced, it tends to be misused and enables unsustainable business models to thrive. Further, as the share price rises, the company’s cost of capital falls, enabling investors to justify higher prices.

3. Misplaced vision

Almost every bubble has a sexy new story associated with it that allows investors to envision a fantastic new world that lies ahead. Tesla’s 'new new thing' is autonomous driving and the vision that CEO Elon Musk paints of robotaxis taking over transportation is one that captures the imagination. Add on top of this the allure of the recently announced US$25,000 electric (autonomous) vehicle, and you’ve got a strong cocktail. Investors are giddy with optimism.

The vision is so seductive that analysts reach inordinately far into the future to justify today’s prices. Several analysts now have valuation-based models using operating assumptions in 2030 (or beyond) to justify today’s prices. Between now and then, rapid growth is assumed to be certain. Hope turned to expectations which in turn are now assumed to be virtually certain. Competition (and lots of it) appears on the horizon. Yet headlines like 'Why Tesla could become the world’s first US$10 trillion company' capture the spirit of the times. There is widespread belief that 'it’s different this time'. It rarely is.


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4. Government policies

The fourth sign of a bubble about to burst is political manipulation of underlying demand. And in this regard, the impact of subsidies has proven that Tesla demand has been impacted by government policies. A quick glance at California and the Netherlands demonstrates that demand can and does plunge after subsidies end. Demand has been artificially elevated by political actions. Further, because owners of electric vehicles don’t contribute to the Highway Trust Fund but use the same highways as the contributing gasoline car drivers, the cost of operating a Tesla is being indirectly subsidised. Lower subsidies will reduce demand, particularly if the economy slows further.

5. Popular sentiment

My final indicator is one about popular sentiment. Think of a financial bubble like an epidemic, one spreading through a population. One key variable to watch in gauging the maturity of a bubble is the population of still ‘infectable’ individuals. And with respect to Tesla, the question is about popular sentiment. When cocktail party banter and dinner conversations turn to a topic, the universe of new buyers is likely dwindling. The fuel to pour on the fire is running low. Everyone is talking about Tesla.

The recent surge in advance of the stock split suggests amateur investors are a driving force. Others, eager to join the party, justified purchases as a trade to profit from the company’s inclusion into the S&P 500 index, a hope that failed to materialise. While games can and do go into extra innings, Tesla appears to be a ninth-inning bubble.

Some have suggested Tesla should be thought of as similar to Amazon during the internet bubble. But let’s not forget that Amazon stock fell from over $105/share to under $6/share as the internet bubble burst. It took almost a decade for the company’s share price to again cross the $105/share value. Even if Tesla does achieve its grandiose ambitions, its stock appears to be way ahead of itself. Musk himself seemed to suggest this very fact, highlighting during Battery Day this week that the company is not as profitable as its valuation may suggest. Like Amazon, Tesla may prove to be a wildly disruptive and successful company that changes the world, but that does not make it a promising investment today.

Distancing from popular sentiment

Investors need to step back and think for themselves, free and clear of the popular sentiment that surrounds them. When I did so, it led me to short Tesla’s stock and buy put options. Some may argue I’ve written this piece because of this economic exposure, but such logic is flawed. I’m betting against the company’s equity because of my arguments in this article, not the other way around.

 

Vikram Mansharamani is a Lecturer at Harvard University and the author of "Think for Yourself: Restoring Common Sense in an Age of Experts and Artificial Intelligence" (HBR Press, 2020). He is also the author of "Boombustology: Spotting Financial Bubbles Before They Burst" (Wiley, 2019) and previously taught a course on Financial Booms & Busts at Yale University. This article is general information and does not consider the circumstances of any investor. A version of this article previously appeared in Newsweek.

 

18 Comments
Peter Capomolla Moore
October 05, 2021

I am glad I didn't read or take any notice of this article although I did read many like it at the time and am still reading similar - I was buying Tesla shares in 2019, 2020, 2021 - This article has not aged well Tesla share price nearly double what it was 12 months after this article written -

Genti S
December 13, 2020

Hey Everyone,
I live in CA & I’m a Tesla Model X owner so I thought I’d add my two cent. The article raises valid concerns and it’s based in facts. The fact that people are so passionate regarding their potion has the markings of a cult following. I did purchase my Model X last year with the help of some subsidies and now that they’ve dried up for Tesla other manufacturers will reap those benefits. The Model X is ridiculously expensive & has not improved much over the course of 1 year from when I purchased. So I agree with the author that Musk is selling a dream you won’t experience with the life of the asset being the car between 5-6 years? Tesla service is terrible with more and more vehicles on the road so the customer loyalty is decreased and I do realize that every time I charge I most likely use non renewable energy to power my car so the oh so green feeling gets whipped off. Lastly I’ll say I don’t own any Tesla stock but at the end of the day you may say they’re not a car company but they sell cars for profits & the green credits bought by other manufacturers those will go away soon as well. So unless they start selling millions of cars which I wouldn’t buy one myself again I don’t see how this bubble doesn’t burst.

John Holiday
December 16, 2020

Genti S.: Thank you for the honest comment. I'm surprised that you would say the Model X has not improved much over the course of 1 year from when you purchased especially when the update for my Escalade was 6-10 years. Meaning, 6-10 years from when I bought my first one before they made any real updates. Plus, even 10-years (my 3rd Escalade) it still didn't have the technology from my Lexus that I sold to buy my first Escalade. Meaning, the update cycle for most car companies is extremely long and Tesla appears to be doing far better than everyone else.

I'm interested in the Model Y (or Model 3) for my son who turns 16 - so checking out current opinions ...

PhillipC
November 19, 2020

Is Tesla a bubble?

Guido
November 26, 2020

How’s that strategy working for you?

Parag
November 18, 2020

Tesla was added to S&P 500 as of yesterday.

Noel McIntrosh
September 28, 2020

In 2019 Tesla sold $2 billion worth of emissions credits to other car makers who cant meet their govt co2 reduction targets.
I back the most successful engineer of this century. If Tesla was his only success it would be ultra risky. But it is only his half day job. And in that half day he has made the execs at VW, BMW, Merc look like dummies.
He smashed Boeing with SpaceX in his other half day.
Musk is software king, robot manufacturing king, car maker king and inventor. On top of that he has built a very large organisation with the smartest people on the planet. A recent survey of the most desirable employers in the US have Tesla and SpaceX at #1 and #2

Nikhil K
November 04, 2020

My word that is an incredibly apt summary of Musk's achievements! Love him or hate him - he is a revolutionary genius and all-in on the organisations he has built. While CEOs are enriching themselves with stock buybacks and dividends, here's a guy who nearly went bankrupt trying to keep impossible ventures going. Once they stabilised he skipped the salary and got stock options against insane targets - and still got criticised when he achieves those targets and is rewarded with the stocks :D This is not to deny the BS he spouts quite often, but I find it ridiculous when a streak of narcissism or bold ambitions bordering on madness are used to justify cancelling out the very real and profound achievements of this man.

Michael J.
September 27, 2020

Vikram:
Respectfully you talk a lot about prudent investing and fail to address the needs of humanity. Electric cars and battery storage are the beginning of a change so that the planet can survive the ongoing business model of POPULATION INCREASE which is killing us all.
Did you see the fires in Australia earlier in the year? Have you seen the fires on the Arctic circle where its never burnt before? Have you seen fires in other parts of the planet which have been the worst ever? These are all markers of impending doom and you talk about prudent investing. We may not be here in 100 years time for historians to write anything. The belief that what is will be again is flawed.
Sorry to be the Grim Reaper. Reality sucks.

John
September 27, 2020

Tesla owners often enjoy Government subsidies beyond avoidance of Highway Trust Fund contributions. Unless changed recently, any pure electric vehicle in San Francisco uses transit lanes (e.g. Golden Gate Bridge) without requiring passengers, pays half the toll, and receives varying state and federal government tax rebates that subsidize the purchase price. At the margin, to the extent they rely on the electricity grid for battery charging, they place additional load on an already fragile CA grid, only some of which comes from "renewable" sources.

michael J.
September 27, 2020

Responsible citizens own their own rooftop solar and do not need coal fired power to run their electric vehicles. You also make no mention of the ongoing lament here in Australia that solar is causing grid problems because of the quantity of electricity being sent back along the grid.
Can't have it both ways. Personally I welcome electric cars as the environment of the planet does not belong to the fossil fuel industry and the industry needs to be would back asap if the planet is to survive. This is actually not just about business and who does/doesn't pay tolls.

Hazza
September 27, 2020

In california, rooftop solar powers on average 70% of a houses needs in summer and less than 50% in winter. So the notion that your tesla is powered by the sun is BS. Thats for a house dweller. There no discussion for apartment dwellers. Not to mentio that for an average solar on house set up in Ca (in never rains too, so the song goes) you need to plug your Model S in for 3 days to charge fully. They are coal fired cars.

C
September 27, 2020

ICE vehicles are not penalised for the health costs of their emissions either. Poor air quality kills people.

Ted Mulholland
October 07, 2020

And how, may I ask, are electric vehicles powered if not by recharging batteries with fossil fuel generated electricity. 80 kw of charging cannot be achieved with solar.

Thomas Francis
January 28, 2021

You are right. EVs are charged by fossil fuels but electric motors are 50% more efficient than ICE and hence better for the environment.
We still need to phase out fossil fuels in next ten years, so please lobby for renewable , geothermal and nuclear energy sources. Stop supporting fossil fuels that fund Saudi Arabia and Russia.

Martin Lenard
September 24, 2020

Interesting article except for the claim that Telsla vehicles are being indirectly subsidised relative to internal combustion engine (ICE) vehicles because the former don't contribute to the Highway Trust Fund. ICE vehicles are similarly subsidised because they are not penalised for the environmental costs of their emissions.

Michael2
October 01, 2020

I believe the negative Often discussed that electric vehicle users don't pay taxes is one being sold by the lobbyists for companies such as those in oil and gas.

The trade off for better quality air in our cities and the health benefits and savings that brings is not mentioned when the nonpayment of taxes is discussed.

Even with the taxes a petrol, diesel and gas user pays, they are still being subsidised for the damage to the environment that is caused by these fossil fuels for which no one is paying except perhaps future generations

Gary M
September 24, 2020

And all those traders who shorted Tesla for the last two years are now too frightened to do it again.

 

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