DRIV: The Electric Vehicle Bubble Is Bursting

Summary

• Electric vehicles are the future, but that does not make EV stocks good investments.
• EV stocks have risen largely due to massive "hobby investing" growth which has fueled an alarming increase in those borrowing money to buy stocks.
• While the surge in new entrants is good, it has pushed many electric vehicle (and related) stocks up to unreasonable levels.
• As we reach the one-year mark from the beginning of 'the bubble,' many may soon look to take profits on major winners for tax purposes.
• ETFs with high exposure to the "EV Bubble" such as Global X's DRIV may be a great short opportunity as the speculative rally becomes a bust.

One of the major market forces in 2020 was the ascendance of the electric vehicle industry. While many EV stocks had a strong performance record for years before 2020, last year saw incredible gains in the industry. Record gains were seen not only in Tesla (TSLA) but also in its smaller new competitors such as Nio (NIO), Nikola (NKLA), and XPeng (XPEV). While many are still rising, it seems the EV market passed its peak momentum around November 2020. See below:

Data by YCharts

Without a doubt, the strong performance of electric vehicle stocks is slowing. Companies such as Nikola have been shown to have made misleading statements, giving many investors a sense that firms are making excessive efforts to capitalize on EV's popularity. While my overall bearish view on EV stocks has yet to come to fruition, I did warn investors about Nikola in July when it was trading at its peak.

Most electric vehicle stocks have slowed dramatically following Nikola's bust and TSLA's ascendence to the S&P 500. While I believe that electric vehicles will become increasingly popular, EV equities seem to be universally overvalued - making them potentially deadly investments today.

Last year's financial market was awash with liquidity due to the substantial rise in personal savings rates (due to reduced spending and increased fiscal stimulus). Even more, many individuals had extra time which encouraged some to pick up trading and investing as a hobby. There was record retail brokerage account growth, however many of these new traders do not know basic investing knowledge. This is demonstrated by FINRA's study that showed new investors, on average, could only answer 1.4 out of 5 basic investment knowledge questions correctly.

While it is good that new entrants have joined the investing community, this situation has created extreme valuation imbalances. Importantly, Tesla and NIO are currently the 2nd and 3rd most popular investments on Robinhood (which is the go-to broker for many new investors). This is yet another sign that EV stocks are rising due to their popularity and not fundamentals.

As recently explained in-depth in "VGT: There Have Never Been These Many Bearish Catalysts," most individual investors no longer have excess cash and, with margin debt at an extreme all-time-high, many are likely borrowing money to buy stocks like Tesla. While stimulus checks may shore up some cash, the growing lack of liquidity among retail investors may be catalyzing a potentially large crash. Such a crash would impact all equities, but electric vehicle stocks have perhaps the most downside risk due to their extreme valuation and heavy ownership concentration among new retail investors.

The Best Way to Bet Against Electric Vehicles

Recent history has shown that it is dangerous to bet against electric vehicle stocks individually. Many are prone to short-squeezes and manic buying which have a tendency to cause rapid upward moves. One could create a large basket of EV stocks, however, that would be impractical for most. Thus, I believe one of the best ways for investors and traders to make the bet against EV stocks is through an ETF.

Fortunately, there already is an electric vehicle fund, the Global X Autonomous & Electric Vehicles ETF which trades under the ticker (NASDAQ:DRIV). DRIV invests in companies involved in the development of both electric and autonomous vehicle technology. This includes not only companies like TSLA and NIO, but also research companies, battery metal companies, and other secondary benefactors of the "EV boom".

DRIV's top holdings today include Google (GOOGL) (GOOG), Intel (INTC), and Microsoft (MSFT) so it is largely a "technology" ETF. About 34% of holdings are in technology while 33% are in consumer discretionary. This is mainly auto companies like Tesla and NIO but also older firms like Toyota (TM). DRIV also includes semiconductor stocks like Nvidia (NVDA), and AMD (AMD) which have particularly high exposure to the growing global chip shortage (as do all automobile firms).

Importantly, DRIV's composition is not fixed since it is a niche thematic fund, so it invests in a wide variety of stocks. If the "EV boom" becomes an "EV bust" as I expect it will soon, then companies like TSLA likely carry more downside risk than DRIV. That said, DRIV's heavy diversification limits its upside breakout potential which makes it a safer short bet.

Even more, DRIV's extreme rise last year indicates that it could quickly decline in value. See its performance below:

Data by YCharts

DRIV has more-than doubled over the past year and has nearly tripled from its late-March 2020 low. However, the fund's performance has slowed dramatically in recent weeks. As mentioned earlier, this is likely due to a combination of a lack of "sideline cash" in most individual investor's portfolios, excessive margin leverage (margin debt is nearly 2X peak 2000 and 2007 levels), and the simple fact investors may be moving to new themes (clean energy, etc.).

Profit-Taking Could Cause 'Cascading Losses'

An additional reason DRIV may be slowing down has to do with taxes. As you likely know, investments are taxed at a significantly lower rate if they are held for over a year. Many newer and younger investors who have purchased EV stocks may not pay any tax if they hold for over a year, but have to pay a relatively large sum if they sell before then. TSLA's (and peers) boom began last March and the surge in new entrants occurred around the March-May period. This indicates that many TSLA (and peers) owners will soon be reaching that key one-year mark and maybe waiting to take profits until then. There are even articles advising TSLA owners to wait for a month or two to take profits in order to avoid short-term capital gains.

With this in mind, I believe we may soon see a significant wave in profit-taking as 'the wait' will be over for most within the coming weeks. This would have a major impact on the top-performing stocks over the past twelve months. DRIV is essentially a basket of these top-performers. If there is a small sell-off in EV (and related) stocks, we may see a cascading selling pattern as retail investors rush to take profits. While we cannot know in which stocks margin debt is concentrated, TSLA (and peers) is likely a major benefactor of the past year's extreme margin debt growth. This means many of the stocks in DRIV could also decline at a rapid speed due to margin calls if share prices decline over 25-50%.

The Bottom Line

Overall, I believe DRIV is a solid short bet today. My short thesis on DRIV is very similar to that of the Vanguard Technology ETF (VGT), however, DRIV has even greater exposure to the particular bearish catalyst abundant today. While DRIV is not a pure-play EV ETF, the reversal of the "EV boom" will impact nearly all of its constituents. The fund is extremely overvalued with a weighted-average "P/E" of 60X using 2020 weighted-average earnings.

I would like to emphasize that I am not "anti-EV" and it does seem likely that electric vehicles will become more popular over the coming decade. This will boost the sales of electric vehicle producers as well as secondary firms such as those which make up most of DRIV. That said, virtually all stocks in the EV industry are incredibly overvalued.

Many are chronically cash-flow negative. With inflation rising at such a fast pace, the Federal Reserve cannot continue to maintain market liquidity as they have over the past decade. AAII and FINRA surveys clearly shown most investors are now running low on liquidity. Without constant new liquidity, the "EV bubble" will likely pop since these firms lack the necessary cash flow. The coming expected stimulus checks may provide some respite, but with valuations and margin debt being so extreme, $1400 may only be a "drop in the bucket".

The Short Opportunity

Considering the possibility of cascading losses, it is very difficult to assess the downside risk in DRIV. A small decline could easily become a massive decline as (likely overleveraged) traders rush to take profits. That said, I would not be surprised to see DRIV lose half of its value by next year as it returns near pre-2020 levels which had more reasonable valuations. At a price of $15, DRIV would have a weighted-average "P/E" of around 30X based on 2020 earnings data which is consistent with long-term historical valuations of most growth stocks.

Following the recent short-squeezes, the number of investors betting against DRIV has declined, causing its borrowing cost to drop from nearly 20% to around 5% today which is reasonable. There is still some possibility of a continued rally so a tighter stop loss is reasonable. That said, with TSLA dropping considerably, I believe we have a strong indication that the peak is in.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.