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 everyo…

Obviously were going to talk about this today:
Ok, so. Up until this year, I wouldve 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 Weve figured this out. We cant 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 its 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 Its a new economy. All the rules are different. The upside is unlimited. If you get in now, youll be rich. Were 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, Ive 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 its the opposite. Were 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 wouldve told you that these are the two basic kinds of bubbles. 
I was wrong. There is a third kind of bubble, and its 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 doesnt 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, theres 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. 
Barstool Sports Dave Portnoy is leading an army of day traders | Sophie Alexander & Katherine Greifeld, Bloomberg
Portnoys Davey Day Trader Global escapades are hilarious and well-known, and hes brilliantly playing the heel; credit to him for absolutely getting how it works, Barstool not withstanding. But the bigger story here is Wallstreetbets. Im sure most of you have heard of the Wallstreetbets subreddit by now; if you havent, the best way I know how to explain it is that its like multiplayer Jackass for the stock market.”
Wallstreetbets started as a bunch of random internet yahoos bragging about crazy YOLO trades theyd make (and would actually follow through on!), and what enormous percentages of their net worth theyd 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, theyre trying to provoke reactions. Its a game of who can be the most shocking. Theres really not much difference between reading some of these WSB posts and watching an old Jackass sketch. Youll laugh until you cant 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. Its the newest version of the stock market as full-contact sports with legal gambling, and its 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, theres enough AUM getting accumulated behind these bets that it can actually start to move individual stocks inweird ways. 
Reddits profane, greedy traders are shaking up the stock market | Luke Kawa, Bloomberg Businessweek
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; its 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, couldnt make it work, so they had to declare bankruptcy and start a restructuring process. 
But then weird things started to happen. Hertzs 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?
Theres 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 its going up, and tomorrow it might go up more. If this were just some dumb penny stock with a cool story attached to it, thatd 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 theyre like, well, if theres demand for our stock, we should go sell some! I mean, its a ridiculous kind of demand, and its not real demand, but hey, maybe its 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, theres 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, heres 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? Weve 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 its totally irrelevant. As Hertzs stock price rises, it confirms this temporary suspension of reality, and furthermore, it confirms that the other people youre trading against are also idiots, so theres an opportunity to make money here. 
The second half of this reflexivity loop is even weirder. Unlike in a normal bubble, where its the perception of stability that drives an earnings multiple, or in an equity bubble, where its 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 dont care about earnings either. They only care about winning this YOLO trade. 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 stupidity thats distinct from the other two kind of bubbles. And were going to see it again. Not exactly like this, but the genies 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. 
The Hertz story is an exceptional situation. I do not think its 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 its 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 didnt 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 arent a necessary component of bubbles, but they sure help. In this case, I bet theres 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. Ill admit, at the time, I didnt 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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