Tesla’s Monster Musk Incentive. Plus, Deutsche Bank’s Jim Reid on Stocks | Barron's Streetwise

Key Concepts

• Long-Term Investing: Strategies focused on holding assets for extended periods to benefit from compounding returns and market growth.
• Inflation Hedge: Assets that are expected to maintain or increase their value during periods of inflation.
• Valuation: The process of determining the current worth of an asset or company.
• AI (Artificial Intelligence): Technology that enables machines to perform tasks typically requiring human intelligence.
• Robo Taxis: Autonomous vehicles designed for ride-sharing services.
• Humanoid Robots: Robots designed to resemble humans in form and function.
• Story Stock: A stock whose valuation is primarily driven by future growth potential and narrative rather than current fundamentals.
• IBITA (Interest, Taxes, Depreciation, and Amortization): A measure of a company's operating performance.
• Weighted Average Cost of Capital (WACC): The average rate at which a company is expected to pay to finance its assets.
• Emerging Markets: Countries with developing economies that offer high growth potential but also higher risk.
• Developed Markets: Countries with mature economies and stable financial systems.
• Fiat Money System: A monetary system where the value of currency is not backed by a physical commodity like gold, but by the government that issued it.
• Modern Monetary Theory (MMT): An economic theory that suggests governments that issue their own currency can spend freely without being constrained by deficits.
• Real Assets: Tangible assets such as real estate, commodities, and precious metals.

Tesla and Elon Musk's Trillion-Dollar Incentive Package

The discussion begins with the upcoming vote on Elon Musk's trillion-dollar incentive package at Tesla. While the package is widely expected to pass, its implications are complex.

Musk's Political Involvement and Tesla's Brand

• Doge and Political Backlash: Elon Musk's involvement with the Department of Government Efficiency (Doge) and his perceived rightward political shift led to investor concerns. A report from Dan Ives at Wedbush Securities highlighted a "code red situation" for Tesla, suggesting brand damage and potential demand destruction due to Musk's association with the Trump administration.
• Impact on Sales: Tesla historically appealed to environmentally conscious customers, giving its base a "leftward tilt." Musk's political moves were feared to alienate this demographic and hurt sales.
• Post-Doge Performance: Despite these concerns, Tesla's stock has outperformed the S&P 500 since Musk stepped down from Doge.

Tesla's Financial Performance and Future Potential

• Recent Results: Tesla's latest quarterly results were solid, largely due to a rush of customers taking advantage of an expiring EV tax credit. However, JD Power estimates a significant year-over-year decline in EV sales for the following month.
• The "Story Stock" Aspect: Tesla is not just a car manufacturer but also positioned as a "physical AI company." Its stock market value is heavily influenced by the potential of its nascent AI businesses, such as robo taxis and humanoid helper robots, which currently contribute little to income. Estimates suggest the car business accounts for only about 12% of Tesla's market value.
• Musk's Role as "Storyteller": As a "story stock," Tesla relies on Elon Musk, the "storyteller-in-chief," to articulate its future vision and maintain investor confidence.

The Incentive Package and its Rationale

• Musk's Motivation: Musk has stated that the new pay package is necessary to ensure he has sufficient voting control to build his "robot army" at Tesla without fear of being ousted. He emphasizes that the money is not for personal spending but to secure his influence over future AI initiatives.
• Shareholder Approval: The package is expected to pass due to historical shareholder support for Musk's compensation and the significant portion of Tesla's current stock price tied to the future potential of its AI ventures. A previous 2018 package was overturned by a Delaware court, but shareholders voted to replace it.
• Package Details: If fully earned, the package would increase Musk's ownership from 13% to around 25%. It includes milestones related to market capitalization growth, operational achievements (e.g., a million robo taxi or humanoid robot deliveries), and levels of IBITA.

Analyst Views and Valuation

• Divided Opinions: Wall Street analysts are divided on Tesla's stock, with 43% recommending "buy," 35% "hold," and the rest "sell."
• Valuation Concerns: Despite a recent price target increase by Wedbush Securities to $471, the valuation is considered "stretched." The target is based on a sum-of-the-parts analysis, including a discounted cash flow analysis extending to 2040 for theoretical robots.
• Breakdown of Value: Estimates attribute Tesla's value as follows: car business (12%), robo taxi hopes (45%), FSD services (17%), energy generation and storage (6%), and humanoid robots (19%).
• Optimist Valuation: Wedbush Securities uses an 11.7% weighted average cost of capital for "optimists" (humanoid robots), assuming a 40% long-term penetration rate in US manufacturing and 20% in US households.

The Future of Autonomous Driving and Robotics

• Whimo Experience: The transcript highlights the experience of seeing "Whimos" (autonomous vehicles) operating without drivers, particularly in Phoenix, as a stunning and potentially transformative event.
• Profound Shift: This shift towards autonomous driving is compared to the advent of engine-powered vehicles, suggesting a profound change in transportation.
• Uncertainty: While the trend towards autonomous driving and robotics is acknowledged, the timeline, cost, and competitive landscape remain uncertain.

The Ultimate Guide to Long-Term Investing with Jim Reed

The conversation shifts to long-term investing with Jim Reed, Global Head of Macro and Thematic Investing at the Deutsche Bank Research Institute. His study, "The Ultimate Guide to Long-Term Investing," draws insights from hundreds of years of market returns.

Historical Returns and Current Market Trends

• US Market Performance: Investors have been pleased with the rising US stock market. However, non-US developed markets have outperformed the US this year for the first time in a long time.
• Valuation Concerns in the US: Based on historical data, Reed suggests that returns in highly valued markets like the US are likely to be below their long-term trend.
• AI's Potential Impact: While acknowledging the potential for AI to boost productivity, Reed notes that current US valuations seem to anticipate an even greater step-up in earnings than historically observed, even with AI advancements.

The Importance of Valuations and Diversification

• "Buy Low, Sell High": Reed emphasizes that the core principle of long-term investing is to buy fundamentally cheap markets and hold them. This strategy, while not always effective in the short term, "spectacularly works over the long term."
• Global Diversification: With 56 countries in his report's data set, Reed highlights that there are many countries with less "onerous" valuations that can offer decent returns, especially if investors are concerned about high valuations in the US.

Intervention and the Financial System

• Authority Intervention: Reed believes that authorities have little incentive to let markets find their natural equilibrium and will intervene early to prevent significant pain by expanding money supply and fiscal spending.
• Comfort and Worry: This intervention can be comforting as it suggests policymakers will prevent complete market collapse. However, it also raises concerns about the long-term consequences of ongoing intervention.
• Historical Examples of Failure: While acknowledging that individual countries can experience severe market downturns (mostly in bonds due to wars), Reed notes that equities are rarely wiped out completely.

Attractive Investment Opportunities

• Emerging Markets: Reed identifies emerging markets as having the best risk-reward profile when combining valuations, demographics, and debt levels. Developed markets, in contrast, face high debt, poor demographics, and relatively expensive markets.
• Bonds: The starting yield is a crucial determinant of bond returns. While bond yields have normalized, they remain mostly below their long-term average. Reed expects very small positive real returns from developed market global bonds.
• Gold: Reed has a "soft spot for gold" due to his belief in the inflationary bias of the current fiat money system. However, he notes that current valuations for gold, despite its significant gains this year, might make a globally diversified equity portfolio a superior investment from a return perspective.

Conclusion

The discussion underscores the importance of a long-term perspective in investing, emphasizing the historical significance of valuations and diversification. While acknowledging the potential of new technologies like AI and robotics, the transcript also highlights the uncertainties and the role of investor psychology and market narratives, particularly in the case of Tesla. The insights from Jim Reed's research suggest a cautious approach to highly valued markets and a potential tilt towards emerging markets for long-term growth, while also recognizing the ongoing influence of policy intervention on financial markets.