SA Interview: Macro And Equity Investing With Atlas Research

23.72K Followers

Summary

Atlas Research is an individual investor and former buyside analyst who brings institutional quality research and investment strategies to the retail audience.
The importance of analyzing the top down macro landscape, their take on Tesla and misconceptions in the electric vehicle movement are topics discussed.
Atlas Research explains why holding cash is the best investment today - and how it provides optionality in a future buyer’s market.

Feature interview

Atlas Research is an individual investor and former buyside analyst who brings institutional quality research and investment strategies to the retail audience. We discussed the mania in the broader U.S. stock market (and how to play it), why for most investors the only way to win the short squeeze game is by not playing and why the market is making a mistake pricing in a full recovery from the Coronavirus.

Seeking Alpha: Walk us through your investment decision making process. What area of the market do you focus on and what strategies do you employ?

Atlas Research: In a nutshell, I’m looking for compelling single stock ideas wherever they can be found – whether it's consumer or commodity companies, or anything in between. But my process always starts with analyzing the top down macro landscape as a risk management overlay.

For a brief bit of background, I got started in finance working for a macro fund that traded commodities, currencies, fixed income, and equities all around the world. After following every major global market each trading day for several years, it became clear how the macro backdrop plays a huge role in shaping returns nearly across every asset class. As one example, the 2014 – 2016 U.S. Dollar spike that crashed commodities prices across the board showed that, if you’re buying into a commodity producer, you’d better have a strong view on the U.S. Dollar.

For a more recent example, the current spike in global interest rates is threatening to pop what I view as a massively inflated equity bubble, particularly in the tech sector. My hunch is that very few tech investors factor in the sovereign bond market into their investment process. But we’re starting to see how rising bond yields could exert some tremendous headwinds to the record valuations across much of the tech sector. In particular, the fast growing, but unprofitable cohort - which includes many of the best performing stocks in recent years.

Cheap financing has allowed investors to overlook the lack of profitability in pursuit of growth for much of the last decade. Should financing costs start increasing via higher interest rates, this entire dynamic suddenly changes. We’ve just seen a preview of that in the last few weeks, and the 10-Year Treasury yield is only at 1.5%. If this trend continues, all bets are off on how fast valuations can compress on the long duration bets implicit in the fast-growing, but unprofitable “disruptors” in today’s market.

SA: What type of reader should follow your work?

Atlas Research: Investors interested in high conviction ideas, with a top down focus. I’ll also occasionally post idiosyncratic ideas that can perform regardless of the macro environment, but those don’t come along often. One example that comes to mind include previous work on tobacco maker Altria (MO) - a company that I still believe offers tremendous value and will likely perform well regardless of the macro backdrop.

SA: In your opinion, who is right on Tesla (TSLA) – the bulls or bears? What is the other side missing about this trade and what is going to change their mind so the stock re-rates to your price target? What is the best way to express this view if not a simple buy or short?

Atlas Research: If we simply use the stock price as the measuring stick, there’s no denying that the bulls have been right so far. Of course, you could have said the same thing about countless Dot Com stocks in the late 90s... and we know how that story ended. Ultimately, price momentum and narratives only go so far. At some point, Tesla’s stock price will converge with the fundamental earnings power of the business. When that happens, there’s no justification for a $100 billion valuation, let alone the current $800 billion valuation (using the fully diluted market cap).

If I were to summarize the bullish side of the trade in one sentence, it would be the willingness to suspend all disbelief, and buy the stock based on fantastic visions of future profitability. Perhaps the best example is the belief in the much-hyped Tesla “Robotaxi” business. CEO Elon Musk has promised the imminent release of Level 5 full self-driving autonomy since 2016. In theory, Tesla could “flip the switch” via an over-the-air update and unleash the world’s first autonomous Robotaxi network. Elon Musk has talked up the prospect of windfall profits from this nonexistent Robotaxi business, for both Tesla customers and the company. However, virtually every autonomous expert in the field will tell you that Level 5 autonomy will most likely never happen with the current hardware in Tesla vehicles. Since 2016, these experts have been right, while Elon Musk and the bulls have been wrong.

In short, the biggest thing the bulls are missing is that Tesla’s stock is simply an artifact of the broader mania in today’s financial markets. During a speculative frenzy, there’s no limit to how far stock prices can depart from the basic reality in the financial statements. That’s why it’s foolish to try and short Tesla - anything can happen in the short run. But when the tide goes out, we’re not talking about a minor 20-30% correction… I believe Tesla will lose at least 90% of its value during the next bear market. That’s why put options are my preferred vehicle to express a negative view on Tesla - they offer a mechanism for capturing this asymmetry, without the risk of going bankrupt in the process.

SA: To follow up, what are the best ways to play the electric vehicles ("EV") market from the long or short side? Do you see any misconceptions from the bulls or the bears about the EV market in general, its near or long-term projected growth or impact on related industries?

Atlas Research: I see many misconceptions in the EV movement, which I’ll broadly classify into two components:

EVs are not economically competitive with internal combustion engine ("ICE") vehicles, without government coercion through various tax/regulatory schemes. Even if EVs do become cost competitive, that still doesn’t mean EV makers will enjoy any better profit margins than current automotive companies.
There’s no compelling data or evidence indicating that EVs actually help the environment.

Let’s first set aside the environmental angle and give the EV movement full credit for saving the planet. Even then, the bottom line is that making cars just isn’t a good business. Making cars is a highly capital-intensive affair, with razor thin margins. Should EVs become cheaper over time, the broader industry dynamics remain the same. The benefit of lower costs will flow directly to the consumers, not manufacturers. That’s simply what happens in a commoditized industry, with no competitive barriers to entry. That’s why I see no reason to invest in the auto sector in general, regardless of whether these companies produce EVs or ICE vehicles - it’s still a poor business model.

Meanwhile, until EVs become economically viable, investors face the tail-risk that the mass market consumer may not be willing to pay up to buy electric vehicles. It’s also not clear whether governments will continue subsidizing the sector indefinitely - that gets very expensive at scale. And there’s plenty of reasons why governments might change their stance on subsidizing EV sector, because it’s not clear that the movement does anything to help the environment. Let me explain why...

The first obvious problem with EVs is that electricity still mostly comes from hydrocarbons.

In the U.S., over 50% of electricity from the power grid comes from either coal or natural gas. In other key emission-producing countries, like China and India, the percentage of coal and gas powering the grid is even greater. In other words, the majority of EV buyers are merely swapping out one hydrocarbon for another (i.e. oil for coal/natural gas).

Of course, some will argue that solar and wind power could eventually displace fossil fuels as the primary sources for electricity generation, and this is the ultimate “end game” for renewable transport. But for some reason, no one ever talks about what happens to those windmill turbine blades and solar panels when they can no longer produce energy. These materials don’t get recycled; they end up getting buried in the Earth. Already, the waste from used solar panels and windmill blades is becoming a major problem for landfills around the world - despite their relatively minor role in the global electricity grid. In other words, solar and wind power merely swap out CO2 pollution in the air with the pollution from plastic and toxic metals, like lead and cadmium, into our landfills. How is that sustainable?

For these reasons and more, I have serious doubts about whether the EV movement will have staying power over the long term. But again, even if the world moves to 100% electric transport, that still doesn’t mean the companies in the space will make for good investments - as we can clearly see in Tesla’s dismal financials today.

SA: Do you think there is a bubble or mania in the broader U.S. market? Why or why not? More importantly, what is the most effective way to express this view and how do you get the timing right as calling a top is close to (if not totally) impossible?

Atlas Research: There is no doubt in my mind that we’re living through a full-blown mania in the broader U.S. stock market. I wrote an entire article detailing all of the signs, but the combination of record valuations against a backdrop of nearly 10% unemployment kind of tells the whole story in a snapshot.

Unfortunately, neither I nor anyone else has any idea when this all ends. But you don’t need perfect timing to protect yourself or to put yourself in a position to capitalize when today’s mania unwinds. For some investors, simply holding more cash than usual can pay off when bargains inevitably reappear.

For investors who like to get a little more exotic, purchasing put options can also work. Here again, you don’t need perfect timing. When you identify an options trade that can pay off 10-20x or more, you can afford to be wrong 90% of the time and still make money. Of course, options aren’t for everyone - you really need to understand the key factors that drive options prices. You also should have some process for sizing positions and managing risk before jumping into the deep end of the derivatives pool.

SA: Doing a post mortem on what happened with GameStop (and related stocks such as AMC) recently, what are the key lessons learned? Have you found any new investing strategies or resources as a result?

Atlas Research: The key lesson here is that prices can do crazy things in the short-term. Some people can play the short squeeze game and win. But for myself and probably 99% of investors out there, the only way to win that game is by not playing.

SA: Can you discuss the opportunity in special situations such as tender offers, from how you find them in the idea gen process, any capacity constraints for this strategy and how to evaluate the risk/reward?

Atlas Research: In many cases there are capacity constraints for special situations, and that’s why I don’t spend a ton of time hunting them down. In the few opportunities I’ve participated in, including the Westell write-up I discussed last year, the ideas actually came from interactions with other investors on Twitter. You can find me on Twitter @AtlasResearch, where I will occasionally post something half-way intelligent.

SA: A recurring question in this interview series is about the mispricings created by the coronavirus and its short and long-term impact – can you weigh in on this?

Atlas Research: The Coronavirus did create some tremendous bargains… for about 2 months. Now, we’ve gone full circle in the other direction. I think we will eventually move past the coronavirus and life will get back to normal, and I was a buyer last March and April on that same view. But there is still a lot of economic damage that will take years to recover from, and the market is now pricing a full recovery and then some. I think that’s a mistake, and thus the biggest mispricing I see today is too much optimism baked into current stock prices.

SA: What’s one of your highest conviction ideas right now?

Atlas Research: This is going to sound really boring, but cash. Today, virtually every stock with decent fundamentals commands at impossibly high valuation. I’m convinced that, at some point in the not distant future, we’ll once again see a buyers’ market as prices reset. Holding cash today provides optionality on this future scenario.

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Thanks to Atlas Research for the interview.

This article was written by

SA PRO Interviews

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This account publishes the weekly PRO fund manager interview, which is available only to PRO subscribers. These are interviews Seeking Alpha authors and fund managers in the industry about their investing philosophy, recent ideas they have published on Seeking Alpha and elsewhere, and their current favorite ideas. The account will also occasionally repost other interviews we have done with authors or investors.

Analyst’s Disclosure: I am/we are long TSLA PUTS. 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.

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