Never Hertz to Ask
Obviously we’re going to talk about this today:
Ok, so. Up until this year, I would’ve told you that there are two general kinds of financial bubbles.
The first kind of bubble is where everyone believes the future will be like the present. Think credit bubbles and real estate; think 2007-2008, where the fundamental belief that drove the bubble forward and into ruin was “We’ve figured this out. We can’t lose. The risk has all been worked out. Lever up, cowboy. We will never die.”
There are two reflexive feedback loops at work here. The first is the positive feedback cycle between that belief, “We have the future figured out”, and rising asset prices – which confirm the invincible mentality and drive it forward. The second loop is that rising asset prices translate to lower cost of capital. In a mindset like this, we get excessively comfortable with investing that low-cost capital into businesses and investments that generate predictable future earnings, or the illusion of predictable. That cheap capital can then meaningfully contribute to those earnings actually materializing, on schedule. Bubbles can genuinely be self-fulfilling prophecies; to a point. Past that point it’s bad.
The second kind of bubble is where everyone believes the future will be different from the present. Think equity bubbles, startups, and crypto; think 1999, where the fundamental belief that drove the bubble forward and into ruin was “It’s a new economy. All the rules are different. The upside is unlimited. If you get in now, you’ll be rich. We’re going to live forever.”
As before, there are reflexive feedback loops at work here too. The first loop is the positive feedback cycle between that belief, “I’ve seen the future, and I believe”, and rising asset prices – which confirm the bubble mentality, and bring on the FOMO. The second loop, as before, is that rising asset prices actually do something useful here. It means we can fund cool startups! Wacky, speculative ventures, which under normal circumstances could never raise any money, are able to access capital at attractive valuations. Sometimes they do, in fact, build the future. These kinds of bubbles can be actually good.
Unlike before, where we rewarded predictable earnings (or, the perception of them) with low cost of capital, here it’s the opposite. We’re looking for unpredictable earnings; specifically, the prospect of unknowable but infinitely high upside. These bubbles can also become self-fulfilling prophecies (dot com speculation got us Amazon, and a whole lot of broadband cable), but they blow up when expectations get too detached from reality.
There are certainly sub-categories and variations on these two themes. For instance, one driving factor you often see associated with bubbles is new financial instruments that give the retail buying public better access (or more aggressive leverage) to the object of speculation. Crypto is an obvious recent example, but this goes all the way back to the Mississippi Company and South Sea manias, with the invention of the joint stock company and the bubbles that resulted. Other stuff matters too, like economic cycles and political narratives. But in general, up until this year, I would’ve told you that these are the two basic kinds of bubbles.
I was wrong. There is a third kind of bubble, and it’s happening spectacularly right now. If the first kind of bubble is “everyone thinks the future will be the same”, and the second kind is “everyone thinks the future will be different”, the third kind is “everyone thinks the future doesn’t matter.”
If you remember, the 1999 bubble had a lot to do with technology and the future, sure, but also had something to do with boomers and early Gen Xers having all of this disposable money right as online brokerages became a thing. Right now, there’s a similar thing going on. Millennials have real paychecks to spend, and stock trading fees have all gone to zero. Trading has become gaming.
Crypto gave us a taste of the wild a few years ago, for that brief autumn where random people from your past would message you about how much Filecoin to buy. But now that itch has hit the mainstream. The stock picking day traders are having their cultural moment, led by Dave Portnoy and an army of shitposters.
Portnoy’s “Davey Day Trader Global” escapades are hilarious and well-known, and he’s brilliantly playing the heel; credit to him for absolutely getting how it works, Barstool not withstanding. But the bigger story here is Wallstreetbets. I’m sure most of you have heard of the Wallstreetbets subreddit by now; if you haven’t, the best way I know how to explain it is that it’s like “multiplayer Jackass for the stock market.”
Wallstreetbets started as a bunch of random internet yahoos bragging about crazy YOLO trades they’d make (and would actually follow through on!), and what enormous percentages of their net worth they’d win or lose spectacularly. I really do think that Jackass is a good comparison here. Yes, these people are trying to get rich; but more importantly, they’re trying to provoke reactions. It’s a game of who can be the most shocking. There’s really not much difference between reading some of these WSB posts and watching an old Jackass sketch. You’ll laugh until you can’t breathe, and then keep laughing when you realize someone actually got kicked in the crotch that hard.
But as it got more popular, some actually sophisticated (and supremely aggressive) traders are getting in on the fun, and it got highly competitive and weird. It’s the newest version of “the stock market as full-contact sports with legal gambling”, and it’s a lot of fun. No one here cares about valuation or fundamentals. It is explicitly a casino. Everyone is here to get in and out of a position in the most shocking way possible. And, astoundingly, there’s enough AUM getting accumulated behind these bets that it can actually start to move individual stocks in weird ways.
The groundwork for this strange show has been built up over a few years, but when the pandemic hit, all hell broke loose. A perfect storm of events come together: first, generational volatility in the stock market as everyone tried to get in front of (and then out from) a global pandemic; second, everyone getting quarantined at home and desperate to feel something, and third: no sports.
Enter Hertz. Hertz was in trouble anyway; it’s carrying around a ton of debt to pay for a fleet of cars that no one wants to drive, because we have Uber now. When the pandemic hit, they got called on their debt, couldn’t make it work, so they had to declare bankruptcy and start a restructuring process.
But then weird things started to happen. Hertz’s stock, which is literally worthless, starts to go up. And up. And up. It gets bid up a whole 500% over a 3-day period last week. What is going on?
There’s no way to describe it other than, this is a Jackass sketch taking place. It started out as these internet YOLO traders playing an increasingly stupid game of chicken. But then it… caught on? Other people started to get in on this too. Hey, obviously the stock in the long run is worth zero. Everyone knows that. But it’s going up, and tomorrow it might go up more. If this were just some dumb penny stock with a cool story attached to it, that’d be old news. This is different.
When you see a stock getting bid up like this, the only conclusion you can draw is “The future does not matter, because in between now and then, this is explicitly just spinning a roulette wheel. The stock could go up or down, who knows, but at least you know it has nothing to do with the underlying value of the stock (which we all know is zero!), and everything to do with other gamblers.
So Hertz sees this happening, and they’re like, well, if there’s demand for our stock, we should go sell some! I mean, it’s a ridiculous kind of demand, and it’s not “real” demand, but hey, maybe it’s real enough. So Hertz files, and is granted, an emergency request to their bankruptcy judge to issue a billion dollars worth of new stock in order to take advantage of whatever this is. Tom Lauria, one of the attorneys representing Hertz, had an all-timer line: “New platforms for day traders may be facilitating this. There are forces at work that us non-financial people, that we can only observe.” The SEC, presumably between gasps of laughter, declined to weigh in on whether the transaction was legal, saying “it is up to the company to comply with securities law.”
Just to restate how funny this is: Hertz is granted permission, by their own bankruptcy judge, to sell stock in their company which has already declared bankruptcy, because due to weird mojo in the universe, there’s a small army of reddit trolls playing chicken with each other and it just might save the company. Financial Twitter goes crazy, and (of course!) people start bidding up stocks of other bankrupt companies. It was a great day to be online. (Matt Levine, as usual, has the best writeup.)
(By the way, here’s a hilarious aside: Business Insider reports on this, and says, “oh, by the way, Hertz share price fell on the news, which makes sense, as shareholders will face dilution” hahahahaha)
So how can we think of these events as a third model in our taxonomy of bubbles? We’ve got all three pieces of our reflexive loop at work. The first is a deep belief: not that the future will be the same, or will be different, but that it’s totally irrelevant. As Hertz’s stock price rises, it confirms this temporary suspension of reality, and furthermore, it confirms that the other people you’re trading against are also idiots, so there’s an opportunity to make money here.
The second half of this reflexivity loop is even weirder. Unlike in a normal bubble, where it’s the perception of stability that drives an earnings multiple, or in an equity bubble, where it’s the perception of high upside that drives an earnings multiple, here there are no earnings. The future earnings here are presumed to be zero. But if everyone knows that, and everyone is okay with it, then everyone around the table can look at everyone else around the table in the eye, and know that they don’t care about earnings either. They only care about winning this YOLO trade, and Hertz is issuing new shares to fulfill that demand, and it could conceivably, theoretically, save the company! Aah! I can’t even.
And so long as everyone thinks that, then the only limiting factor to how violent this bubble can be is how much cash you have, and how quickly the traders can find each other. The answer seems to be “lots”, and “fast”.
I really do think that this deserves its own place on the financial tree of the life. It’s a genuinely unique form of financial dadaism that’s distinct from the other two kind of bubbles. And we’re going to see it again. Not exactly like this, but the genie’s out of the bottle now. There is enough AUM dedicated to these kind of stunts, and the internet has dropped the cost and latency of communication among these day trading Johnny Knoxvilles down to zero.
This generation of day traders is hooked on harder drugs than in the 90s, and the internet is absolutely why. There are mimetic forces at work here. But it used to be that you experienced this pressure as “my idiot coworker got rich, I want to be successful like that, let me try this day trading thing.” Now, it’s something more extreme. I have insecure friends who feel pressure to do these Davey Day Trader-inspired stunts with their trading accounts, because that’s how they affirm their own manhood or sense of self. (By the way, in case you were wondering how many people are acutally making money on this, Robinhood trading is fully taxed. I wonder how many people don’t realize this.)
Even after this stunt phase mellows out, there is a whole generation of retail investor out there whose introductory experience in the markets was 2020. I can really understand how the formative message you’d absorb here is “no one knows anything!” I really do! After the last few months, I can really understand how your fundamental attitude towards the stock market would be: “What the market thinks will happen ten years from now is totally irrelevant. We don’t even know what’s going to happen tomorrow!”
These are the raw ingredients you need for a different kind of bubble than the first two, that I bet we’ll see a lot of going forward. There’s enough AUM, who demands a certain kind of “investment” (and enough momentum traders looking to capitalize retail idiocy) that you’ve gotta be thinking like Hertz here! How can we take advantage of this? The market wants a product. So let’s give it to em!
The Hertz story is an exceptional situation. I do not think it’s likely to ever happen again. But you know what kind of public companies have zero earnings for years at a time, and where future earnings are so far away that it’s already understood by everyone to be a day-to-day game of chicken, just like this? Biotech companies. And you know what kind of companies are going to be really interesting in the aftermath of Covid? Biotech companies.
At the end of last year in my Ten Predictions for the 2020s post, I threw out a take: “There will be a major speculative bubble in biotech companies.” I mean, I didn’t have this in mind, but you know what, this makes me feel pretty good about that prediction. One of the catalysts, I wrote, would be “A new kind of financial innovation that becomes the instrument of speculation. These aren’t a necessary component of bubbles, but they sure help. In this case, I bet there’s going to be some new clever financial product that bundles and securitizes the highly speculative IP of biotech companies, in a way that legally lets retail investors buy them through an ETF or something.” I’ll admit, at the time, I didn’t foresee the “new, creative instrument of financial speculation” being “the equity of bankrupt companies.” But why not!
Anyway, in summary, ha ha ha ha ha. What a week.
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