Bubble Begone
Two years ago I wrote a Viewpoint entitled A Bad Idea Bubble in which I warned that prices for speculative stocks were coming unglued from reality. I named three specific examples of marginal businesses whose stock prices were being bid up to spectacular heights in a raucous market. In retrospect, I was awfully early in my warning, too early to be useful, like a tornado siren going off days or weeks before the actual twister. After a brief Covid-induced lull in early 2020, the bubble continued to expand.
In early 2021 I checked back in on those three companies in a follow-up Viewpoint called Bubble Fatigue. All three had continued to rise. The party just raged on and on. My theme in Bubble Fatigue was the emotional exhaustion of watching people hypnotized by greed and fantasy throw more and more money after whatever dumb themes happened to be working and, in the process, screw up the game for the rest of us. There is a saying, “price is truth,” which emphasizes that successful investing is buying assets that go up, not having elegant, rational arguments why the assets you own deserve to go up. In a crazy market, insisting that price is truth becomes like gaslighting—a form of psychological abuse in which the abuser stubbornly denies fundamental truth and eventually causes the victim to doubt their own sanity.
Now finally in early 2022 the bubble I first complained about two years ago seems to be ending. I don’t want to call the end too emphatically right at this moment. There could easily be a couple dead cat bounces left in it, but reclaiming old highs seems unlikely at this point. I think this will be the third and final piece in what has now accidentally become my “Bubble Trilogy.” As I write this, the S&P 500 is down about 10% from its all-time highs. It is also up more than 30% since I wrote A Bad Idea Bubble two years ago. The market also remains up about 10% since I wrote Bubble Fatigue last year. The broad averages have enjoyed strong returns. In contrast, two of my three original bubble examples, Virgin Galactic (NYSE: SPCE) and Beyond Meat (NASDAQ: BYND) have lost more than half their value in two years and are down by at least two-thirds from their peaks. The third, Carvana (NYSE: CVNA), was a big beneficiary of consumer stimulus and the shift to online-only shopping during lockdowns. Carvana’s stock has actually beaten the market modestly in the last two years, but it is down two-thirds from its peak, and it would not take much further weakness to wipe out the last remnants of its pandemic-era success.
Let me tell you the story of another market darling from the last two years which was not featured in my first bubble Viewpoint—it did not get hot until later on—but which encapsulates the past two years better than any other single stock I can think of. The company is called Ontrak (NASDAQ: OTRK), having recently changed its name from Catasys. The old Ontrak was a marginal player on the fringes of telemedicine. The company always claimed to be on the verge of big things, but something funny always happened on the way to the bank, so to speak. They never quite got where they were going. Before the pandemic (and the name change), shares had long traded in a range between about $5 and $20. As Provident’s healthcare analyst, I had researched the company a little but had dismissed it because the story management spun never aligned with reality.
Well, if there’s ever a time for a telehealth company to suddenly shine, it’s a pandemic. Even a very marginal business should be able to succeed if it happens to be in exactly the right place at exactly the right time. Early in the pandemic the market bid up Ontrak shares to $30, about double their pre-pandemic range. Justified or not, the bullish move was easy to explain.
Then the fraud allegations came. A short-selling outfit called Culper Research laid out in good detail how Ontrak (then still called Catasys) was being fired by its health plan sponsor customers and lying to investors about it. I read the report and was thoroughly convinced because it explained the questions that had lingered after I previously peeked into the company and failed to square its claims with reality. Shares fell back to $20 after the report, hardly a very severe punishment considering the heft of the allegations, but directionally the response you would expect.
The company’s financial results continued to stagnate. The pandemic clearly wasn’t helping them like the bulls hoped. Despite that fact, and despite the credible fraud allegations, the stock zoomed higher between June 2020 and February 2021, ultimately reaching nearly $100 per share—about five times its pre-pandemic high! That was the price buyers paid for, at best, a total cipher of a company that was failing despite falling backwards into what should have been a boomtime. At worst, the company could be called a proven fraud. Well, the stock momentum eventually broke, and it broke spectacularly. Shares have gone almost straight down over the last year and currently trade at $2.49, probably about where they should have been all along. What an embarrassment for everybody involved!
So what happened? In retrospect it looks like Ontrak shares reached those obscene heights not despite allegations of fraud but because of those allegations. At some point during the bubble, speculators started herding into highly-shorted companies on the theory that their collective buying effort could squeeze out short sellers and force them to cover at ever-high prices. This strategy was famously successful in Gamestop and AMC, at least to the extent that some short sellers experienced real pain. It’s not clear how many of the herding buyers actually escaped with profits. I think it was mostly company insiders who got out at the highs. A few fast-money speculators must have escaped with profits, but I bet they turned around and blew them in the next big lemming rush. Greed isn’t very smart. It repeats the same simple tricks until those tricks inevitably stop working.
Fun and games aside, the deeper problem is that short sellers tend to identify worthy targets, so by targeting short sellers the buyers were herding themselves into some of the worst companies in the market. Their intention was to punish short sellers, but the effect was to reward potential frauds and failures. How perverse! When a claim of fraud becomes a reason to buy a stock, the market is standing on its head. In the last two years, we’ve seen just that.
I can’t say what started this whole bubble, nor what finally ended it, assuming it is indeed over. Some blame lax monetary policy. Others blame social media or zero-commission stock trading. If I ever think I’ve figured out what happened then maybe there will be a fourth installment in this series, but I doubt that will happen. We have all found the last two years exhausting in many ways. I just hope the financial history books save a little room for this bubble period because there are lessons to learn, bubble or none. For me, the greatest lesson is that quaint ideas about market efficiency aside, investors can lose their collective minds. They aren’t quickly or easily coaxed back to reality, but reality always prevails in the end.
Miles Putnam, CFA