04 February 2024

Economics, Earnings, and Tesla

By Matthew McKee, CFA, CFP®

February 4, 2024

More than 100 companies reported earnings this week, with the focus on five of the Magnificent Seven. Layered on was a Fed meeting and a slew of economic reports.

The prior week, Tesla’s earnings disappointed investors, further exacerbating recent declines. The stock has lost nearly a quarter of its value since the beginning of the year, and over 50% from its previous peak in 2021.

Here we’ll discuss the current economic and corporate earnings environment. We pay attention to these developments not only to inform investment positioning, but to stay attuned to unique risks our clients are exposed to.

In the third section, we’ll share a story about how we helped a client avoid a potentially disastrous outcome in a concentrated Tesla stock position.

Taking it top-down: the economics

US GDP grew 3.3% annualized in the fourth quarter, above consensus expectations and higher than what the Fed projected in their mid-December meeting. It came as little surprise to most when Fed officials decided to hold rates steady on Wednesday.

As we noted in our 2024 outlook, the market’s expectation of six rate cuts seemed optimistic in one sense. In our opinion, such a pathway for rates would foretell substantial economic weakening. Expectations for the speed of depth of rate cuts have moderated, especially following a strong jobs report on Friday morning.

The market continues to reward companies with strong balance sheets and current profitability, more so than in prior years when rates were near zero. The question is if companies may further accelerate layoffs to cut costs and meet earnings expectations.

Let’s get to earnings…

This week was an important one for earnings, with more than 100 companies reporting, including five of the Magnificent Seven – Microsoft, Alphabet, Apple, Meta, and Amazon. Nvidia reports on the 22nd.

As we also noted in our outlook, we believe there may be greater upside to be had outside of the Magnificent Seven over the medium term. Investors often center the attention on a handful of the largest companies, but the reality is that company leadership evolves continuously through time. Today’s juggernauts will give way to tomorrow’s.

Going into this week, aggregate earnings across the market were below expectations. 69% of companies had beaten estimates. While this may seem good, companies typically guide to achievable results, and this figure is below the five-year average of 77%. Furthermore, aggregate earnings were 5.3% below expectations, versus a five-year average of 8.5% above.

On Tuesday, Alphabet and Microsoft reported earnings that generally met or beat published consensus estimates. However, the market was expecting more. Shares of MSFT and GOOG fell -2.7% and -7.4% the following day.

Later in the week, Apple, Meta, and Amazon delivered their earnings calls.

Apple has been hit with a patent infringement for their watches, slowing sales in China, and an antitrust investigation. Despite posting its first quarter of growth in a year, Apple shares traded down 3% after the call.

Meta jumped after announcing a dividend and Amazon also increased following a strong holiday season.

Yet, in sum, four of the first six to report failed to meet investors’ lofty expectations.

The most dramatic drop among the Mag7 was from the week prior, and it’s a company that we have been doing extensive work on with a client.

A case study in managing taxes and risk

In 2023 we began working with a client with almost all their wealth in Tesla stock.

As a long-time employee, this client got in early with options compensation. The stock’s meteoric rise created meaningful wealth, but also a tax liability and a poignant risk.

An outright sale would not only mean a gargantuan tax bill, but also an identity crisis. This client still believes deeply in Tesla, so the advice was not just to “sell it all immediately”. On the flip side, they realized the Elon Musk Investment Plan (almost all TSLA stock) was not suitable, and they needed to do something.

So, what to do?

The first step was to get to know the client personally and understand their purpose for the wealth held in Tesla stock. Since decisions involve trade-offs, linking back to the client’s core values is more than just a platitude; it is necessary to do our job properly.

We spent many hours poring over the rat’s nest of historical options and stock grants held in their account. One of our CPA partners helped us measure thrice to cut once on surgical share sales, engineered to raise just enough cash to cover exercise costs and tax liabilities for a pool of expiring options.

For the shares that remained, we initiated a program of options-based strategies that delivered a couple specific benefits:

1. We earned income on shares, to be earmarked for future taxes. The tradeoff was that we effectively sold away some upside in a portion of the portfolio. But that’s ok. Plenty of upside exposure remained.

2. We swapped a significant portion of the single-stock risk to gain exposure in a more diversified stock index, without realizing capital gains.

Given what has since happened to Tesla’s share price, these critical moves have preserved wealth and allowed the client to sleep better at night.

As we often say in these newsletters, the story here barely scratches the surface of this deep and detailed client engagement.

We have several tools in our kit to attack problems like these from many angles. We encourage those in similar circumstances to reach out for a consultation.