Reflexivity. It's a term coined by world famous investor George
Soros who argues that different principles apply in markets
depending on whether they are in a "near to equilibrium" or a "far
from equilibrium" state. Soros argues that when markets are rising
or falling rapidly, they're typically marked by disequilibrium
rather than equilibrium, and that the conventional economic theory
of the market (the "
efficient market hypothesis
") does not apply in these situations. Markets are irrational and
If you want to put it into a very simple nutshell, markets are
always wrong and tend to overshoot to the downside and upside. The
main reason is that markets are traded by people, and people tend
to get overzealous in either direction. They get excited about a
market or trend, think that the current situation in that market or
trend will continue forever, and push a stock or market too far in
The classic example are bubbles, such as the Internet bubble in the
late '90s or the housing bubble. In these cases the markets went up
too far, then "reflexed" to the downside.
This, of course, can also pertain to undervalued sectors which
then, in turn, overshoot to the down side then reflex to the
upside. The 2002 and 2008 bottoms were examples. During those
periods the markets had reflexed from their highs then overshot to
the downside, especially in the case of the March 2009
S&P 500 Index
Armageddon had been priced into the markets as they overshot to the
downside. They promptly began to rally and more than doubled in the
following four years.
This can often happen in a stock as well. In the '90s there was a
company called Iomega which made technology for external hard
drives -- a big thing at the time as most computers did not have a
huge amount of memory. The stock soared thousands of percentage
points and then crashed to almost nothing as the company priced in
future growth that was just not there. The history of the market is
filled with flash-in-the-pan stories such as this.
I think a stock that is increasingly looking like it's overvalued
). Electric cars are going to gain market share in the coming
years. However, they are still in their very early stages of
development. Recently, Tesla has been on a tear. After trading as
low as $26 per share last year, the stock has skyrocketed to as
high as $173 per share this year. Sales of the car are beginning to
increase. Year to date, more than 4,700 cars have been sold in
California -- meaning Tesla outsold Jaguar, Land Rover and Porsche
in the Golden State. However, the problem is that number is still
minuscule on a long-term basis. For example, the two largest
sellers of cars in California are
), which have sold 157,000 and 100,000 cars, respectively, year to
Now, there are all sorts of questions you can ask when it comes to
Tesla: How big is the market for $80,000 electric cars? Where is
the input infrastructure (such as pumps at service stations) for
these cars? However it seems no one likes to ask common sense
questions like these while a stock is hot.
With a price of $167 per share, Tesla has a market cap of nearly
$20 billion. For comparison, Ford has a market cap of $62 billion,
) has a market cap of $45 billion,
(OTCMKTS:FIATY) has market cap of just over $9 billion, and India's
) -- which owns the Jaguar and Land Rover brands -- has a market
cap of $14 billion.
Do you really think that Tesla, at the moment, is worth one-third
of Ford, one-half of GM, or nearly Tata and Fiat combined?
The stock has discounted huge growth. It has to fire on all
cylinders to meet expectations of its current inflated price.
The company has been a short seller's nightmare, climbing to new
high after new high. However, I think that a prudent investor in
the coming weeks and months would look to buy some long-dated
out-of-the-money LEAP put options to play a potential downturn in
the company's stock price, which may return to more realistic