The 2020 lockdown mania — our term for the ripping rally off the March lows, which went completely off the rails in the end — was the worst kind of bubble.
It was born of greed and hubris, with little of value left behind. It was powered by ill-considered government stimulus, adding weight to a deficit topping $26 trillion. And it set up the markets, and the economy, for greater pain in its aftermath.
Note we say the lockdown mania “was” the worst kind of bubble — speaking in the past tense. That is because, after the events of this week, chances are high the bubble has burst.
It’s possible there is more to come. But signs of “the end” abound:
- COVID-19 outbreaks roared back to the forefront of investor consciousness.
- The Nasdaq touched 10,000 — just barely — and then plummeted.
- The S&P 500 registered a rare “island top” in the space of four trading days.
- Volatility and volume have expanded, balloon-like, to the downside.
In addition to the above, Federal Reserve Chairman Jerome Powell gave a stunningly bearish policy update on Wednesday, June 10. Whatever the exact opposite of a “V-recovery” forecast is for the U.S. economy, that is what Powell communicated.
The Federal Reserve sees an economy that will be struggling to get a foothold, in need of ongoing fiscal and monetary stimulus just to hold things together, for years upon end.
In his June 10 remarks, Powell sounded like a bedside doctor tending to an ICU patient in critical condition, promising to do everything possible over the next 24 to 36 months just to keep the patient alive. V-shaped recovery? The way Powell portrayed it, we have a touch-and-go situation with respect to having any kind of recovery at all.
Meanwhile, by the time it reached peak levels, the 2020 lockdown mania had become a parody of itself. We caught some of the silliness in our catalog of warning signs earlier this week, but by no means all.
Here are some more highlights:
- Dave Portnoy, a famous sports-gambler-turned-day-trader with a social media following of millions, declared on Twitter on June 5, “I’m being modest when I say I’m the world’s greatest day trader. My unlimited money has upgraded to infinity money.”
- On June 8, Portnoy delivered the following highlights via the end-of-day comment to his mass following: “Buffett is an idiot… All I do is make money, this game is f—easy… Literally the easiest game I’ve ever played. All I do is print money… I should be up a billion dollars.”
- On June 9, Twitter user Joseph Mauro reported: “My son just told me that he can only play @FortniteGame in the evening… because half his squad started trading. He is 10. @RobinhoodApp #TrueStory”
- “Stocks trading below $1 per share have an average gain of nearly 80% in the past week,” CNBC reported on June 10, “according to a note from the Institutional Equity Derivatives team at Citadel Securities obtained by CNBC.”
So, let’s recap, shall we?
Sports gamblers who have only been trading since March, due a lack of sports to bet on, calling Warren Buffett an idiot and declaring that they print money. Ten-year-olds giving up their video game time so they can trade with their friends on Robinhood. Penny stocks seeing an average gain of 80% in a week.
And all of it was powered by stimulus checks — a kind of “helicopter drop” for the stock market — backstopped by the Fed’s assurance of moral hazard to infinity. Both amplified a wild denial of reality in which a refusal to acknowledge the dangers of the pandemic morphed into a feverish kind of take-no-prisoners, “YOLO” (you only live once) optimism, with high-frequency trading programs likely amplifying the signal further.
This all came to a head immediately prior to the Nasdaq touching the 10,000 level, just barely — not unlike the brief, bare touch of the 5,000 level that marked the March 2000 top — in the same week that the U.S. federal deficit topped $26 trillion, adding a whopping $2 trillion in a little more than two months.
From a trading perspective, it is what it is. For TradeSmith Decoder, we bought SPY puts on Thursday, in response to the S&P’s rare “island top” formation. We expect the position to do well.
But the demise of this mania — and that is what it was, and what it still remains if the mania is not dead — is nothing to celebrate, because a lot of pain and destruction is likely to come of it.
All bubbles do short-term damage when they burst. But there are good bubbles and bad bubbles, and the measure of a bubble is what gets left in its wake.
Take the dot-com bubble of the late 1990s, which ended in the year 2000, for example.
The bursting of the dot-com bubble was a destructive event, but the economic destruction was mostly contained — and we got Amazon, Google, and Netflix as a result, along with tens of millions of miles of fiber optic cable.
Most of that fiber optic cable, rolled out in an explosion of overcapacity and speculative excess — lay dormant and dark for a number of years after the bust. But all of it eventually lit up and added to the nation’s productivity. (In the past decade, a great deal more has been installed.)
Or take the railroad mania of the mid-19th century, in which speculators and financiers paid for tens of thousands of miles’ worth of railroad track in the space of a few short years. The excess track was far more than the country needed at the time, and the bubble’s bursting brought economic pain in its wake — but America also saw significant long-run benefits, as the track was eventually used.
The point here is that bubbles based on a real concept, even if enthusiasm for the concept gets way out of hand, tend to leave behind some kind of useful infrastructure, or new technology, or both, which later becomes a highly productive asset. Then, too, when the bursting of a bubble wipes out hundreds of companies, a handful of juggernauts (like a new Amazon or Google) are sometimes left behind.
In this sense, investors and speculators who lose their heads and overcommit their capital, and then go bust in doing so, wind up doing a long-run service for the economic greater good.
But bubbles based on “greater fool theory” — when the objective is 100% cynical, and there is no actual investment thesis at all, other than selling out to the greater fool, which is whoever buys next — leave only destruction when they burst, with no redeeming value whatsoever.
The example of investors using the Robinhood platform deliberately chasing after bankruptcy names — “this company is worth nothing, but if I buy it at 40 cents, I can sell it to someone for 80 cents,” and so on — is an almost perfect example of destructive and pointless hubris, marking the worst kind of bubble.
It is the total transformation of investing or trading as a productive economic activity. Instead of using knowledge to facilitate price discovery (which traders do) or providing capital to a growing enterprise (which investors do), the greed-and-hubris approach turns markets into a kind of smartphone casino.
If our annoyance shows through, it is because destructive manias tend to hurt a lot of people in the end, including many who can’t really afford to get hurt. Such episodes also contribute to the wider risk of a deflationary bust. The financial and psychological damage created by an asset-price collapse can worsen the prospects for recovery, with the level of damage proportional to the frenzy.
