The Missing Ingredient
"In a roaring bull market, knowledge is superfluous and experience is a handicap.” -- Benjamin Graham July 6, 2020
From CBC News on June 17:
“Sherrie Hardy, a 33-year-old airport security worker in Muskegon, Michigan, said she used her and her fiancee’s stimulus checks to invest in Hertz and have no plans to sell. ‘I invested not only in a sense of capitalizing, but actually want to be a supporter of Hertz. I’ve always had good business with them and their community efforts. So it’s something that I would like to see to stay around for years to come,’ Hardy said.”
Where to start with this one… The purpose of the stimulus checks was to help tide people over due to temporary or permanent job loss as a result of a forced government shutdown. If you’re using that money to buy stocks, I’m guessing your job was safe, you were fine making rent, and you were already fully stocked up on canned beans and toilet paper. Still, we should give Sherrie a break, since the real “stimulus” abuse was bailing out Wall Street and the top 1% yet again. If Wall Street is getting trillions, Sherrie and her fiancé can enjoy their $1,200 each, and they’re welcome to spend it on food, gas, bills, or bankrupt stocks.
Wait…what? Buckle up. The story quoting Sherrie was run on June 17th, four weeks AFTER Hertz filed bankruptcy. Sherrie and her fiancée thought the best use of their “windfall” was to drop the entire wad on a company that filed for bankruptcy four weeks earlier. Why in the world would anyone admit that to a good friend or their priest, let alone a national news publication which will memorialize it for posterity? Has she ruled out ever having children? Does she hate her parents?
Ok. Sherrie likes Hertz. She’s “always had good business” with them, whatever that means. She likes their community efforts. Who cares if they’re insolvent so long as they sponsor a local 5K race. It’s all so amusing. Imagine being asked by a reporter to name a company you admire and would like to support as a shareholder. I get Apple, Disney, Starbucks, Costco, Tesla, and Berkshire Hathaway. But Hertz? A rental car company? Really? Did anyone fact check to make sure Sherrie Hardy is a real human?
So, Sherrie has a soft spot for Hertz and would like to support them and see the company “stay around for years to come.” In order to support the company, Sherrie decided to buy some shares. Apparently, I’ve been naively assuming that people have some basic knowledge of how the stock market works, the difference between buying shares from a company versus secondary shares on a stock exchange, the basics of capital structure, and what bankruptcy entails.
Sherrie bought her shares of Hertz (HTZ) through her brokerage account. She was impressed with their community efforts and wanted to buy some shares. Lucky for her, some Joe Blow wanted to sell his shares. They were matched up on a stock exchange and the trade was executed. Hertz didn’t sell those shares to Sherrie. Hertz didn’t get Sherrie’s stimulus check. Joe Blow did. If Sherrie really wanted to help Hertz out, she would have had a greater impact by starting a GoFundMe campaign for the company, asking people to help support this victim of systemic Uber and debt abuse.
Sherrie does know what bankruptcy means, right? A company files bankruptcy when its liabilities (debts) exceed its assets, it can’t raise new money from investors, and it can’t pay its bills. You know…when it’s broke and can’t raise new money. Public companies have shareholders and often creditors. The creditors have extended debt/credit to the company and are in the front of the line to recover the money owed to them if a company goes bankrupt. The more senior or secured the debt, the more likely that creditor gets paid back. Equity is the lowest rung of the capital ladder, so shareholders are last in line when it comes to recovery in a bankruptcy. Sherrie must know this, right? RIGHT!?
There are two types of corporate bankruptcy, as Sherrie must know. One is Chapter 7, in which company assets are sold off, creditors are paid off to the extent possible (partially), and the company ceases to exist. Shareholders only get some cash if all the prior claimants are made whole, which is almost never.
The other type of bankruptcy is Chapter 11, and this is referred to as a reorganization. The goal of Chapter 11 is to restructure a company so that it can continue operating. This is what Hertz is doing. Hertz isn’t likely to disappear, at least for a while. The creditors are lawyering up and will have to reach an agreement with the court on how much of a loss each will take. We have no idea how long the bankruptcy process will last, whether the attempted reorganization will fail, how much debt the company will have afterward or the terms, what the cost structure of the company will look like, or whether new equity will be issued as a part of the bankruptcy process. These issues are critical in determining what, if any, value HTZ stock might have. Can you picture Sherrie and her fiancée sitting in the drive-through of Arby’s discussing how the terms of Hertz’s asset backed securities might impact a successful reorganization? Me neither.
I bet Sherrie also doesn’t know who Carl Icahn is. Billionaire Carl Icahn had invested $2.3 billion in Hertz and owned nearly 39% of the shares on May 25th. He sold that entire stake the next day for $40 million. That leaves a mark. Billionaire investors aren’t infallible. Most of them have some big losers. Nevertheless, Carl is no dummy, and I doubt there is anyone out there who knows Hertz better than Carl or has as much experience with the corporate bankruptcy process. If you’re buying or holding a stock that he’s dumping, you’d better have a really good reason for it…something better than, “I’ve always had good business with them and their community efforts.”
But what if hordes of Sherries and fiancées combined their $1,200 government checks and drove the share price of HTZ much higher!? Wouldn’t that help the company continue to have good business with customers and continue their community efforts? This is where the story takes another humorous turn. Check out the chart above. As you might expect, HTZ was dumped immediately after it announced it was filing for bankruptcy on May 22. The stock dropped 80% that day. No surprise. The next day, however, it jumped 131%. No news. It then fell about 40% over the next week before jumping 570% over the following three days. It then collapsed 77% over the next two weeks.
The company certainly noticed its stock price running up 570% AFTER it filed bankruptcy and, “in a sense of capitalizing,” received permission from its bankruptcy court to sell up to $1 billion of stock in mid-June. This has never happened before. A bankrupt company in bankruptcy proceedings was attempting to sell more of its bankrupt stock to the public to raise money for its bankrupt business. That simple act might be the best summation of this entire stock market bubble. Basically, company management looked around and noticed that there were a lot of suckers investors sitting in the take-out line at Arby’s who were happy to buy their bankrupt shares. This potentially gave the company’s creditors an opportunity to raise some free money for themselves – to bail themselves out at the expense of these gullible “investors.” Fortunately, the Securities and Exchange Commission (SEC) stepped in and prevented Hertz from following through on the stock sale. This is about the only part of this story that makes sense.
This really is much bigger than Sherrie, Hertz, and Arby’s. We’ve had a tremendous bull market/bubble thanks to government debt and central bank stimulus. Things got a little shaky in late 2018 when the market fell 20%, but those losses were recouped in three months thanks to the Fed. Everything seemed fine until this past February when Covid-19 struck and asset markets cratered, but the Fed again intervened and made sure those losses were short-lived.
If you’re a Millennial, you’re probably starting to save some money. You also might have just received a stimulus check, which probably feels like free money. You’ve never invested through a real bear market, so you have no experience with losing a lot of money, unlike your parents and their parents. You’ve seen stocks levitate most of your adult life, and the two times the market did wobble you watched them roar back in no time at all. The lesson must seem clear – stocks go up, the Fed won’t let markets fall, any dips are buying opportunities, and there really isn’t much risk in stocks if you can hold on for a few months.
Enter Robinhood, the newest addition to online brokerage. It caters to the younger, less affluent crowd and offers commission-free trading and access to cryptocurrency. Robinhood is a hipper, edgier Schwab, and the company has experienced tremendous growth in the past couple of years. So, we have a “free” investment platform geared toward the younger, inexperienced crowd growing quickly at a time when their target audience is getting “free” money from the government. Vegas was locked down, and we haven’t had sporting events to bet on. People are spending more time at home with more time on their hands, and they “know” that stocks go up. It’s a perfect recipe for unhinged speculation.
You can see this playing out in the chart above. This shows the price of Hertz stock plotted against the number of Robinhood accounts that own HTZ. The number of accounts owning HTZ was climbing before HTZ filed bankruptcy, but it really exploded after, especially after the stock ran over $5/share in June. About 110,000 new accounts bought HTZ stock AFTER it spiked to $5.50 on June 8th. Those accounts are all sitting on huge losses currently. We’ve seen similar action in other stocks that either filed bankruptcy or were widely expected to, including CHK, LK, GNC, and HCR. This is not a sign of a healthy market.
The Missing Ingredient
When I went out on a limb back in early 2018 and said that it felt like the market was in a topping process, there was one missing ingredient...a mania. We had internet stocks with ridiculous business plans posting huge daily jumps back in 1999-2000 as plumbers and teachers rushed to become day traders. In 2006-2007, the rush was to borrow as much money as possible to buy as much real estate as possible at any price as plumbers and teachers rushed to flip houses.
The stock market has long been at bubble levels this cycle, but we haven’t really seen a full-on mania, until now. Today, we have unemployed and work-from-home novice investors flocking to the newest trendy online trading site to “invest” their government stimulus checks in bankrupt companies in the hopes of making a quick buck. We’re also seeing a return of the day trading phenomenon as stocks post wild daily swings based on coordinated buying through online message boards or due to the ravings of YouTube influencers. These same newbies are claiming that Warren Buffett is out of touch and doesn’t understand this brave new investment world...just as they did near the peak of the last two bubbles. I can’t say how long this current manic phase will last, but it should be pretty amusing. Unfortunately, the aftermath is going to be one hell of an education for the newest crop of investors. Look again at the Robinhood Hertz chart. The small retail investor didn’t clamor for shares until after the stock irrationally spiked to $5.50. Retail always flocks to a bubble near the end, and then they ride it down. Bubbles and manias always sucker in the most people at exactly the worst time.
The blame for this long bubble and the budding mania rests squarely at the feet of the Federal Reserve. I do have sympathy for those who are buying stocks today in the belief that the Fed won’t let them fall and stay down. I’ve believed and stated since 2002 that ever-greater Fed intervention was all but inevitable. It’s no coincidence that 2002 was also the year I first bought gold, at $250/ounce. Stocks have been attractive periodically since then, and I’ve been an aggressive buyer at times, but I have no interest in chasing any asset class that’s sitting at record high valuation levels, regardless of what the Fed is doing. Owning gold and precious metals equities over this time period has made far more sense to me, and the yellow metal has been an outstanding performer in that time.
Precious metals remains our largest holding, and we can think of it as our substitute for stock market exposure (though we do have other targeted holdings). The Fed’s actions may continue to boost the stock market (it’s really just a handful of the largest stocks), but that’s an ever-increasingly risky proposition as valuation climbs higher. At a minimum, it will make the impending collapse all the worst. Gold, on the other hand, is largely ignored in the West and remains very attractive relative to equities, real interest rates, and the money supply. It will have its pullbacks, but it still strikes me as a much better way to benefit from Fed recklessness. And just wait until these Robinhood investors discover how volatile junior precious metals stocks are! They may end up being our exit strategy if they bring their Hertz-level thinking to the miners.
Ken Bell, CFA, CFP, MBA, Community Effort Supporter
Aspera Financial, LLC
The Market Rubbernecker is associated with Aspera Financial, LLC, an investment management and financial planning firm based in the Cary, Raleigh, and Durham area of North Carolina. This and all Market Rubbernecker missives and musings (written, oral, or mimed) are subject to the disclaimers, disavowals, and hindquarter-coverings found at www.asperafinancial.com/aboutrubbernecker.