Tesla and the S&P 500

Tesla is being included in the S&P 500 index at what can safely be described as elevated valuations. With a Price / Earnings ratio above 1000, and the economic outlook for the consumer less than rosy, it's hard to see how this kind of valuation can be maintained. Furthermore, there has of late been a dramatic drop in bank lending, indicating an imminent drop in prices for speculative assets. The price of Tesla shares is for these reasons alone likely to drop. However, market dynamics surrounding the inclusion of this company in the S&P 500 are likely to cause the drop to be even worse than it already seems likely to be.

The inclusion of Tesla in the S&P 500 has forced the hand of index fund managers who've had no choice but to buy this stock at its all time high. As a consequence, this stock is now owned by many more people than would otherwise have been the case. Most of its owners are so out of necessity rather than enthusiasm. The stock has had a fantastic run, despite its mediocre earnings. It's as speculative a bet as any, and far more likely to go down than up. Which begs the question, who's still interested in buying it?

Making this even more perilous is the fact that S&P 500 is itself at an all time high, making it likely to be an early casualty of the current drop in bank lending. Going forward, those selling shares in the S&P 500 will be sellers of Tesla, and with an outsized allocation to Tesla due to the price bubble its currently in, there will be a need to sell large stakes in Tesla to cover withdrawals.

But those still holding speculative positions in Tesla will likely front run index managers, going from long to short at the very moment S&P 500 indexes have fully loaded up on this stock. With the P/E ratio above 1000, there will be nothing holding this stock up as it comes crashing down. Even a 99% drop in its price will still keep the P/E ratio above 10. A further 50% drop may be required in order to make it attractive to conservative value investors, which means that Tesla may fall as much as 99.5% before hitting a bottom.

A further consequence of this is that S&P 500 will greatly underperform indexes that do not include Tesla, making it all the more attractive to short the S&P 500. The result of this will be a rotation from speculative to conservative position, making the inclusion of Tesla in the S&P 500 likely to go down in history as the pin that pricked the current bubble in speculative assets.

By Vauxford - Own work, CC BY-SA 4.0, Link