Originally posted on our newsletter: https://www.overlookedalpha.com
It was obvious in the fourth quarter of 2020 and the first quarter of 2021 that retail-favorite growth stocks had become disconnected from reality and valuation. In retrospect, it might have been the official announcement on Feb. 23, 2021 of the merger between Churchill Capital IV and Lucid Motors (LCID) that marked the top. The rally in what was then CCIV stock, which followed accurate reporting on the merger valuation, was best explained, and likely only explained, by the fact that buyers that day literally didn’t understand how SPAC mergers worked.
In some respects, the bubble that started in Q4 2020 has popped. In many others, it’s still going. The fundamental errors across the market (to be fair, hardly limited to retail investors) stem from rather garden-variety bubble behavior. But the last two years have added something else — a staggering sense of arrogance and importance. Investors in the 1999 equity market or the 2005 real estate market thought making money was easy — but not necessarily that they were smarter than the professionals. (To be fair, in both cases many of the professionals were egging them on.)
To coin a phrase, this time has been different. A struggling, unprofitable movie theater chain has roughly 4 million retail shareholders based on a conspiracy theory that is insane by the standards of conspiracy theories. Assume that base is roughly two-thirds US (and the figure is probably higher); that means that more than 2% of US households own AMC stock despite there being literally zero fundamental case of any kind. So committed are the ‘apes’ that AMC is now renting out its meme-ness.
There are, still, thousands of Twitter accounts dedicated to "trading" the market, based on at best a perfunctory understanding of that market. Combined, those accounts have probably three years of professional experience, $3 million in total bankroll, and somehow millions of unique followers. Reddit’s investing forums are a staggering cesspool of ignorance and groupthink (the platform’s algorithms literally keep contrarian views out), yet those forums have become so powerful that institutions actually are tracking them.
Crypto enthusiasts and Tesla ‘stans’ aren't just content to make money. They need to claim to be a part of a world-changing mission at the same time. NFTs are the apotheosis of the "greater fool theory," and almost proudly so. Web3 not only is looking to normalize Ponzi schemes, but to turn customers into owners.
Across the board, there is a staggering sense of entitlement. Early adopter of an online platform? Well, not only should you get to enjoy the service you've found, but you should get paid for your time (and your ‘likes’). Read about Bitcoin on a Reddit forum? You're set to profit.
Your stock goes up? Tell your Twitter followers you're a genius. It goes down? Must have been hedge fund manipulation. After all, whether it's equities, crypto, options, or just using a product, the profits should be easy.
It was obvious in the fourth quarter of 2020 and the first quarter of 2021 that retail-favorite growth stocks had become disconnected from reality and valuation. In retrospect, it might have been the official announcement on Feb. 23, 2021 of the merger between Churchill Capital IV and Lucid Motors (LCID) that marked the top. The rally in what was then CCIV stock, which followed accurate reporting on the merger valuation, was best explained, and likely only explained, by the fact that buyers that day literally didn’t understand how SPAC mergers worked.
In some respects, the bubble that started in Q4 2020 has popped. In many others, it’s still going. The fundamental errors across the market (to be fair, hardly limited to retail investors) stem from rather garden-variety bubble behavior. But the last two years have added something else — a staggering sense of arrogance and importance. Investors in the 1999 equity market or the 2005 real estate market thought making money was easy — but not necessarily that they were smarter than the professionals. (To be fair, in both cases many of the professionals were egging them on.)
To coin a phrase, this time has been different. A struggling, unprofitable movie theater chain has roughly 4 million retail shareholders based on a conspiracy theory that is insane by the standards of conspiracy theories. Assume that base is roughly two-thirds US (and the figure is probably higher); that means that more than 2% of US households own AMC stock despite there being literally zero fundamental case of any kind. So committed are the ‘apes’ that AMC is now renting out its meme-ness.
There are, still, thousands of Twitter accounts dedicated to "trading" the market, based on at best a perfunctory understanding of that market. Combined, those accounts have probably three years of professional experience, $3 million in total bankroll, and somehow millions of unique followers. Reddit’s investing forums are a staggering cesspool of ignorance and groupthink (the platform’s algorithms literally keep contrarian views out), yet those forums have become so powerful that institutions actually are tracking them.
Crypto enthusiasts and Tesla ‘stans’ aren't just content to make money. They need to claim to be a part of a world-changing mission at the same time. NFTs are the apotheosis of the "greater fool theory," and almost proudly so. Web3 not only is looking to normalize Ponzi schemes, but to turn customers into owners.
Across the board, there is a staggering sense of entitlement. Early adopter of an online platform? Well, not only should you get to enjoy the service you've found, but you should get paid for your time (and your ‘likes’). Read about Bitcoin on a Reddit forum? You're set to profit.
Your stock goes up? Tell your Twitter followers you're a genius. It goes down? Must have been hedge fund manipulation. After all, whether it's equities, crypto, options, or just using a product, the profits should be easy.
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NewsTranscript
00:00 I don't believe the market can be consistently timed, but the market can be occasionally
00:07 timed. At ultimate peaks the insanity is obvious. Anyone in 1999 with any sort of training or
00:15 experience knew the end was near. What catalyzed it for me personally was a conversation with
00:22 a relative on Christmas Eve 1999 in which he told me he'd purchased a material amount
00:27 of stock in a supposed internet company called BigHub.com. Although I didn't know that BigHub
00:34 was a penny stock promotion, taking advantage of precisely this kind of investor, it was
00:39 clear at that point that there was literally no one left to buy internet stocks. It was
00:46 clear, certainly in my North Carolina town that in 2006-2007 the housing market had gone
00:52 nuts. Houses were being resold for 30% or 40% profit within months and house flipping
00:59 was a national obsession. In mid 2006 a group of awful condos built around the corner from
01:06 our house went for more than our house was purchased for. Once again there seemed to
01:12 be no possible buyers left, at least at the price points being asked. And it was obvious
01:18 in the fourth quarter of 2020 and the first quarter of 2021 that retail favourite growth
01:24 stocks had become disconnected from reality and valuations. In retrospect it might have
01:31 been the official announcement on February 23rd of the merger between Churchill Capital
01:36 and Lucid Motors that marked the top. The rally in what was then CCIV stock which followed
01:43 accurate reporting on the merger valuation was best explained and likely only explained
01:48 by the fact that buyers literally didn't understand how SPAC mergers worked. In some respects
01:55 the bubble that started in Q4 2020 has popped, but in many other areas it's still going.
02:03 We're seeing an insane amount of graft in this market certainly, but that's not a surprise
02:09 in a bull market, and on the sheer lack of anything to do for much of 2020, and depending
02:14 on your persuasion, interest rates at zero, it's not surprising that scammers are feasting.
02:20 But it might be more true that what many of us, again myself included, have not quite
02:24 appreciated is the unbelievable amount of stupidity that has dominated this market,
02:30 particularly over the last 25 months.
02:34 Dogecoin created as a joke hit and peak market capitalisation of $100 billion. The very idea
02:41 that a crypto has a market capitalisation itself could be questioned. The SPAC bubble
02:47 was littered with ideas that made no logical sense, with lottery.com being one of my favourite
02:53 examples. Long story short, lottery pitched itself as a play on the growth of online lottery
02:58 services when in fact it simply resells lottery tickets online at massive markups to customers,
03:04 and customers are attracted through an enormous affiliate network. In a wonderful echo of
03:10 the 1990s, lottery bought a domain name to supposedly take advantage of online sports
03:15 betting growth as well. The stock peaked at $16 post-close, but it remains overvalued
03:21 at $3.50.
03:25 Retail investors didn't care to understand the economics of sports betting, the nature
03:29 of the electric vehicle market, or the multi-decade history of failure that green energy plays
03:34 like plug power and fuel cell energy. During the meme stock craze they piled into not just
03:40 weak but ridiculous businesses. Failing chains, an Australian laundry concerned because its
03:47 ticker was naked, a micro-cap headphone manufacturer. The fundamental errors across the market,
03:54 to be fair hardly limited to retail investors, stem from rather garden variety bubble behaviour.
04:01 But the last two years have added something else, a staggering sense of arrogance and
04:06 importance. Investors in the 1999 equity market or the 2005 real estate market thought making
04:13 money was easy, but not necessarily that they were smarter than the professionals. To coin
04:20 a phrase this time has been different. A struggling unprofitable movie theatre chain has roughly
04:25 4 million retail shareholders based on a conspiracy theory that is insane by the standards of
04:31 conspiracy theories. Assume that base is roughly 2/3 US and the figure is probably higher.
04:38 That means that more than 2% of US households own AMC stock despite there being literally
04:44 zero fundamental case of any kind. So committed are the apes that AMC is now renting out its
04:50 meme lists. There are still thousands of twitter accounts dedicated to trading the market based
04:57 on at best a perfunctory understanding of that market. Combined those accounts have
05:02 probably 3 years of professional experience, $3 million in total bankroll and somehow millions
05:08 of unique followers. Reddit's investing forums are a staggering cesspool of ignorance and
05:14 groupthink. The platform's algorithms literally keep contrarian views out. Yet those forums
05:20 have become so powerful that institutions are tracking them.
05:25 Also enthusiasts and Tesla stans aren't just content to make money, they need to claim
05:31 to be part of a world changing mission at the same time. NFTs are the apophysis of the
05:36 greater fool theory and almost proudly so. Web3 not only is looking to normalise Ponzi
05:43 schemes but to turn customers into web owners. Across the board there is a staggering sense
05:50 of entitlement. Early adopter of an online platform? Well not only should you get to
05:56 enjoy the service you found but you should get paid for your time and your likes. Read
06:01 about bitcoin on a reddit forum? You're set to profit. Your stock goes up? Tell your twitter
06:08 followers you're a genius. It goes down? It must have been hedge fund manipulation.
06:13 After all, whether it's equities, crypto, options or just using a product, the profits
06:18 should be easy.
06:22 Admittedly this may just be an old man yelling at the cloud, after all there were message
06:26 boards full of nonsense in 1999 too. But there does seem to be a layer on top of the usual
06:32 bubbly behaviour and that can't be ignored right now. After all, market history teaches
06:38 us two lessons. The first is that a bottom can't be reached until the novices are run
06:44 off, properly chastened. Yes that's an incredibly condescending point and an unfortunate one
06:50 as well, I stand by it regardless.
06:54 Housing didn't bottom until the house flipping shows were off television. Gold didn't bottom
06:59 last decade until the we buy gold sign spinners left their corners and the constant drumbeat
07:05 of TV ads petered out. After the plunge of the 2000 Nasdaq top, equities didn't reverse
07:11 until CNBC ratings hit the lows and stocks peaked again when those ratings did the same
07:17 in 2007.
07:21 Right now the novices aren't gone, they sure as hell aren't properly chastened. They're
07:25 still on twitter and in AMC and GameStop and hodling their innate cryptos. Indeed, Robin
07:32 Hood is expanding trading hours to capture precisely this demand. On the announcement
07:38 Hood stock gained 24% on Tuesday adding $2.6 billion in market cap in the process. That
07:45 rally itself shows how much power novices retain. The news shouldn't have resulted
07:51 in any gains, given that Robin Hood said in late January that expanded hours were on the
07:56 way this quarter.
07:59 The second lesson is that it's exceptionally difficult to avoid the impact of those novices.
08:04 The stocks they favour will bring down the rest of the market. The S&P 500 was almost
08:09 exactly half from its March 2000 high to its 2002 low. That's despite the fact that the
08:16 poster children for the late 1990s bull run were not in that index. And if we're close
08:21 to a top it could be a long way down. Before falling 50% the S&P 500 rose 582% from the
08:29 October 1987 low to the March 2000 high, a time span of 12 and a half years. From the
08:36 March 2009 bottom to the January 2022 high the S&P climbed 609% in just under 13 years.
08:45 History has essentially repeated on the way up and it will be ugly if it does so again
08:49 on the way down.
08:50 In short, I don't believe this market is at a bottom, or even ready to bottom. Like
08:57 many experienced investors I see a real risk of a sharp plunge over the next 12 to 24 months.
09:03 I'm actually far more sanguine than most about the obvious risks. There's some kind
09:07 of transitory effect upon underpinning scary inflation numbers. The 10 year treasury has
09:13 moved sharply but still yields just 2.5%, roughly where it was before the pandemic.
09:19 Russia is losing and elevated mid-term oil prices rely on discipline from drillers, something
09:24 history tells us simply won't last. But those risks certainly are real. The lessons
09:30 of history, at least in my opinion, are scarier.
09:35 Admittedly this seems like terrible sentiment ahead of the launch of an investing sub-stack.
09:39 But there are some mitigating factors in terms of the forward outlook for US equities and
09:45 some reasons why it's still worth looking closely for long ideas as well as short ideas.
09:51 First it's worth noting that the market, as far as many retail investors are concerned,
09:56 has crashed. The ARK Innovation ETF is as good a proxy for those portfolios as any and
10:03 it's down 56% from last year's peak.
10:07 Dogecoin is off more than 80%. Many fad driven out altcoins have for all intents and purposes
10:13 disappeared. EV stocks, sports betting players, d-spacs, most of the retail favourites have
10:18 been significantly repriced. Some of that garbage is no doubt still too expensive, but
10:24 the bubble at the very least has significantly deflated.
10:27 Second, it's dangerous to compare this environment to anything in the past, whether it's in
10:33 terms of investments or anything else. These are unprecedented times, at least by modern
10:39 standards. Many of the novice investors are going to exit simply because they have other
10:44 things to do, offices to which to return. It's possible that the damage of the retail
10:51 bubble remains roughly contained. Indeed, the bubble has been deflating for more than
10:56 a year now, yet as I write this, the S&P 500 is up 17% over the past 12 months.
11:04 Third, this analysis admittedly isn't exactly detailed or quantitative. And let's be honest,
11:10 these kinds of things you only see at the top have been around for years. It certainly
11:14 felt like the busted IPO from WeWork in September 2019 might signal the end. There was another
11:21 18 months to go. There's a vast oversimplification in this
11:25 analysis and indeed, the same simplification can be used to underpin a contrarian case
11:32 for being bullish, simply because it's so easy to be bearish. This still feels like
11:38 a market at the top, while Ukraine and Fed and politics and whatever combine to create
11:42 a more logical, realistic case for a crash. Indeed, the snapback rally in equities over
11:49 the past two weeks seems to have been greeted with near universal scepticism and designated
11:55 as a dead cat bounce. Fourth, non-garbage stocks have been impressively
12:00 resilient. At the moment, the S&P 500 is down less than 5% from its highest, despite the
12:06 myriad short term reasons to sell. Even the Russell 2000 isn't technically in a bear
12:12 market, it's off 15% from its top. It's certainly possible that the TINA, there's
12:18 no alternative, catalyst is holding, and will until bond yields normalise. But it's also
12:24 possible that there's enough quality in US stocks, in particular from a long term perspective,
12:29 that investors are more willing to ride out short to mid term storms.
12:34 Finally, and most importantly, even in a bear market, there's value to be found. For a
12:40 few years, from a fundamental perspective, it's been legitimately difficult to even
12:44 find good ideas to start due diligence on, let alone take a position in. The best businesses
12:52 were too expensive, the cheapest stocks were usually junky companies. There are more opportunities
12:58 now without question. There are going to be a few multi-baggers undeservedly pulled down
13:03 by the wreckage in tech subsectors. There are going to be enormously profitable shorts
13:09 in energy names. And in stocks whose fair value has not yet been priced in, even by
13:15 massive declines from past highs. And there are good businesses that are 10% or 20% cheaper,
13:21 a price reduction that matters when looking to compound value over time.
13:27 Certainly, long ideas right now may well have a catalyst problem, or they may simply prove
13:32 to be too early. But from a long term perspective, being early in 2001 or in the beginning of
13:38 2008 was not a bad thing. And there are strategies, dollar cost averaging or using options that
13:45 can mitigate some of the timing risk. It's also possible to get market neutral or even
13:50 net short. It's definitely not too late to short many of the garbage names even well
13:55 off the lows. There are dozens of currently publicly traded
13:59 stocks that are going to zero, and the cooling of the meme stock short squeeze trend seems
14:03 to mitigate some of the trading risk in those names.
14:08 So personally I'm not taking my ball on going home until 2024. I don't recommend investors
14:13 do so either. But this does seem like a time to still be cautious. To nibble on quality
14:19 instead of betting aggressively on a market wide bottom. That sense is going to inform
14:24 the ideas we bring you and the strategies that we recommend. As nervous as we are about
14:29 the market, we're excited to bring you the first of these ideas on Sunday morning.
14:34 [BLANK_AUDIO]