Rob Arnott Warns of ‘Big Market Delusion’ in Electric Vehicles
(Bloomberg) -- The electric-vehicle craze is a classic sign of a “big market delusion” that has entrapped investors throughout history, according to quant pioneer Rob Arnott.
The 600% rally in a year that sent the combined value of eight manufacturers to $1 trillion is pricing every firm as a major winner in the clean-energy boom.
Yet just as the once-highly valued PalmPilot lost in the smartphone revolution, not all of them will succeed in the EV age, the Research Affiliates chairman co-wrote in a new paper.
“All of these companies are priced as if they are going to be huge winners, but they are competitors!” Arnott said alongside Lillian Wu, a researcher at RA, and Bradford Cornell, a finance professor at the University of California, Los Angeles. “They cannot all assume dominant market share in the years ahead!”
While these stocks are much more highly valued than traditional carmakers, their total sales average about 2% of the latter’s over the last three years.
Nonetheless, EVs have been a lucrative wager beloved by retail traders and tech evangelists such as Cathie Wood on the conviction that the fight against climate change will make such cars the go-to choice of the future. Led by Tesla Inc., the stock mania intensified in 2020 as the election of U.S. President Joe Biden boosted confidence the switch to clean energy will accelerate.
That rally has recently taken a breather, after rising rates caused investors to rethink the priciest parts of the stock market.
With about $157 billion tied to its strategies, RA is a pioneer in smart beta, a way of stock investing that’s based on factors, or a firm’s quantifiable characteristics. The Newport Beach, California-based firm bases its approach on long-term academic research and has often sounded the alarm over frothy valuations in recent years.
To Arnott and team, the EV sector is the latest example. While Tesla is trading at roughly 28 times its 2020 sales compared with an average 1.1 times for old-school auto stocks, Elon Musk’s firm only has a 15% market share in EV sales and its revenues are still small compared with the likes of Toyota Motor Corp. or Volkswagen AG.
Even if all the Tesla love turns out to be prescient, that will likely mean its rivals will lose some market share, making the industry-wide gains even harder to justify.
RA cites historic lessons from the evolution of the airline industry, which revolutionized travel but which “did not necessarily provide a wealth bonanza” for investors. During bad times, weak companies closed. But during good times, new competitors emerged to drive down profits.
Like the airline industry, the auto sector is also notoriously competitive and capital-intensive, which has typically depressed its equity valuations.
“In a competitive industry, market disruption benefits society at large, not necessarily the disruptors, and disruptors are often disrupted themselves in due course,” Arnott, Wu and Cornell wrote.
“We suspect that as EV competition heats up, many companies will fail, as was the case in previous industry booms -- whether autos, airlines, or technology -- and with time the total value of the industry will recede to more reasonable levels.”
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