Rob Arnott Warns Tesla Stock Is Showing Signs of a Bubble — and Indexers Are About to Buy High

Shares of Elon Musk’s electric-car maker will probably lag the S&P 500 in the year after its looming entry to the index, the Research Affiliates founder said.

Chris Ratcliffe/Bloomberg

Chris Ratcliffe/Bloomberg

Tesla’s soaring shares may start heading downhill after the electric-car maker joins the Standard & Poor’s 500 stock index next week, with funds tracking the index poised to buy high, according to Research Affiliates.

“Tesla is entering the S&P 500 with a stupendously high valuation,” Research Affiliates founder Rob Arnott and the firm’s Vitali Kalesnik and Lillian Wu said in a paper released Thursday. “Given all the classical signs of a bubble in Tesla’s stock, and the evidence of 31 years of S&P additions and deletions, December 21–22 likely marks the beginning of a reversal in Tesla’s share price.”

The electric-car maker has skyrocketed 684 percent this year through December 17, including a large jump in stock price since the index division of S&P Global announced a month ago that Tesla would join the S&P 500 next week. Tesla’s shares rose about 5 percent on Thursday to close at about $656 each, valuing the company at more than $600 billion.

“Traditional cap-weighted indices, such as the S&P 500, are structured to buy high and sell low — and Tesla is a prime example of this maxim,” Arnott, Kalesnik, and Wu said. “By the close of trading on December 21, index funds, ETFs, and other index-tracking strategies will have purchased Tesla shares valued at nearly $220 billion.”

Research Affiliates assumes hedge fund managers and “other liquidity suppliers have already stockpiled” most of that $220 billion worth of Tesla shares — and are ready to offer them to index funds under the “largest single trade in history” when the company enters the S&P 500. Based on their research, Arnott and his co-authors said Tesla will probably lag the index in the year after its entry.

“The odds are against its remaining a top-dog stock,” they wrote.

By contrast, the company that Tesla is bumping from the S&P 500 — Apartment Investment and Management Co.— looks like a winning a bet for investors to consider, according to the paper.

Aimco, which develops apartment communities in the U.S., had been lagging the index in the 12 months before its pending removal from the S&P was announced this month. The company’s drop in stock price over the past year was likely a “key reason” the S&P index committee decided to remove it, said Arnott, Kalesnik, and Wu.

“Both Tesla and Aimco followed the familiar pattern: Tesla’s share price surged, while Aimco’s share price plummeted before the index adjustment date,” they said. “If history is a guide, the prospects for each of these stocks may substantially reverse over the next year, with Tesla underperforming and Aimco recovering nicely.”

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Tesla, an electric-car and clean-energy company, will be the largest stock ever to enter the S&P 500, according to Research Affiliates. While the firm described Tesla an “impressive” company that has pioneered its industry under visionary leader Elon Musk, the authors warned that it has entered bubble territory partly because marginal buyers of its stock are investing based on the narrative of its “great future success,” rather than conventional valuation models.

Tesla’s lofty valuation is roughly equal to the market capitalization of the next top nine auto groups combined: Toyota Motor Corp, Volkswagen, General Motors Co., Honda Motor Co., SAIC Motor Corp., Hyundai-Kia, Ford Motor Co., Fiat Chrysler Automobiles, and Renault and Nissan Motor Co., which trade as two separate companies but belong to the same corporate group, the paper shows.

“A partial driver of Tesla’s eightfold increase in price since its most recent March low was the crowd of Covid-19 locked-down gamblers who, having to forego Las Vegas or Monte Carlo, turned their attention to hot stocks instead,” Arnott and his co-authors said. “Tesla will not remain unchallenged as the EV industry leader for long.”

In the meantime, should Tesla’s share price remain unchanged on December 21, “should we believe that the index funds did not move the price?” the authors asked in the paper.

“Based on this highly deceptive scenario, the trade would not appear to have an impact,” they said. “But prior to the trade, hedge funds and other liquidity providers had pushed up the share price — by 700 percent since the March lows — accumulating the shares they needed to offer the indexers on December 21.”