The Bear’s Lair: Half-inflated bubbles are a Buy

If you had bought South Sea Company shares 300 years ago today, on February 17, 1720, you would have paid the inflated price of about £175 per share. If you had sold those shares at any time before the end of September 1720, you would have made a fine profit, more than five times your money if you had sold at the top of £1,000 in July. Today as then, it remains true: half-inflated bubbles are a thoroughly unsound investment, but potentially a very lucrative one.

By February 1720 you would already be worried about your investment if you had bought shares in the French contemporary bubble, the Mississippi Company, which was by then looking shaky, but at least you’d be better off than if you had bought the bank-notes of its companion Banque Royale, which ended up worthless. The South Sea Company, on the other hand, was partly bailed out and from the end of 1720 traded as a reliable income stock, its price fluctuating around £100 until its eventual winding-up in 1853. Your speculative investment 300 years ago today would thus not have been a complete loss and would have paid you 133 years of dividends.

The backlash from the South Sea Company’s misadventures was severe and prevented any further speculative bubble of that size for over a century. For the next bubble, in 1825, we can get a participant’s view from the diary of the junior minister’s wife Mrs. Harriet Arbuthnot, in a diary entry of March 16, 1825, when it was nearing its peak: “There is a railway going to be made between Liverpool and Manchester which promises to answer immensely. We have 10 shares in it for which we gave £3 a piece and which are now worth above £58 each and they are expected to be worth above £100. I am very fond of these speculations and should gamble greatly in them if I could, but Mr. Arbuthnot does not like them, and will not allow me to have any of the American ones as their value depends on political events and he thinks in his official situation it would be improper.”

Mr. Arbuthnot was right, even if impropriety was just an excuse – shares and bonds at this time were issued with £10 paid on a £100 share or bond, so when their Latin American bonds proved worthless, the Arbuthnots would still have been liable to make a further subscription of ten times their initial investment into a dead speculation. As for the Liverpool and Manchester Railway, as the world’s first substantial passenger railway, it was the most important public company investment of the Industrial Revolution. Finding the right half-inflated bubble in a period prolific of such, Mrs. Arbuthnot got in on the ground floor, though she doubtless later blessed her husband’s admirable caution with respect to Latin American securities.

Bubbles, in which one can invest as they inflate, are fairly rare in Gold Standard economies, like those of 1825 or (technically bimetallic) 1720. Real interest rates are too high and there is not normally enough money creation to power the surges of enthusiasm that produce such bubbles. After 1825, there were several speculative surges in the 19th Century, but mostly on a fairly small scale. The next such surge to cause major disruption was that of 1929, after the catastrophe of World War I and the catastrophic policy of the Federal Reserve System had inserted money management mechanisms into a system that should have been self-regulating. The lax monetary policy of the late 1920s caused the speculative excesses of 1929, though it should be noted that even those excesses were quite limited in scope compared with those of the late 1960s that followed the freely-created-money years after World War II.

Negative real interest rates, whether due to the inflation of the late 1960s or the infinitesimal nominal interest rates of recent years, generate far more bubbles than were possible under the Gold Standard, because they make leverage cheap and easily obtainable. What’s more, the mechanism causing the bubbles to burst is far less strong than in 1720; with leverage so freely available, it can be used to prop up the shakiest and most heavily loss-making structure.

Given today’s sky-high market and over-expansionary monetary policy, investing in half-inflated bubbles may be especially attractive for at least a modest portion of one’s funds. Eventually, the market will crash, but that has been true now for over a decade, and avoiding the market, given ultra-low interest rates, means a constant drip of losses in real terms.

Some of the bubbles will turn out to be scams, and others will turn out to rest on business models that make no sense (like Uber (NYSE:UBER) and the abortive WeWork IPO) but that has always been the case. Uber and WeWork demonstrate another thing: as investors we are much better off when the bubble’s inflation happens in the public markets, rather than through private valuations, the benefits of which go to private equity companies and insiders, with the company being unloaded on the public at the peak of the bubble at an utterly exorbitant valuation.

By investing in half-inflated bubbles, we are relying on two eternal investment truths. First, stock markets are leptokurtic; in other words their trends last longer than would be supposed by random-walk theory, so in a strong uptrend it can make sense to buy the stocks with the greatest momentum, as they are the most likely to continue upwards. Second, in a strong bull market, as a bubble investor you are relying on the “greater fool theory” that there will be somebody, a greater fool than you, who will buy the stock off you at an even more exorbitant valuation. But if the current long market uptrend has shown us anything, it is that there is no shortage of fools; indeed easy money generates them in massive profusion. Finally, when investing in half-inflated bubbles we are relying on our ability to distinguish half-inflated bubbles from bubbles that have reached their maximum size and are about to burst: needless to say, that is the most difficult question.

I am quite certain there are no hidden Liverpool and Manchester Railways among today’s half-inflated bubbles, and equally certain that if you hold on too long to most of them, you will lose your entire investment. Still, here are some half-inflated bubbles that may provide a few thrills:

  • Beyond Meat Inc. (Nasdaq:BYND) Why anyone would want to go beyond meat is beyond me, but apparently people do. Market capitalization $6.7 billion, lossmaking, stock up 50% this year. Makes plant-based meat substitutes, which apparently taste more like the real thing than previous versions; so far focused on beef but testing Beyond Chicken with KFC. Given Millennials’ extraordinary ideas on diet, this could head for a $50 billion market capitalization, so there is room for BYND to inflate further.
  • Peleton Interactive Inc. (Nasdaq:PTON). Makes interactive fitness products, cleverly advertised and costing a huge premium to regular ones. Market capitalization $8.1 billion, makes steady losses. Charging a huge premium for some fancy gimmicks can work well, but the stock hasn’t been exciting in the past year. Still, while the company continues making $200 million annual losses (so cannot be valued by conventional means), there’s hope.
  • Gilead Sciences Inc. (Nasdaq:GILD). Pharmaceutical company, market capitalization $82 billion, P/E ratio of only 15 (boring!) However, it has an experimental drug against coronavirus, so if that disease turned into the Black Death, GILD would presumably prosper and be inversely correlated to the S&P 500. Getting in on the ground floor with this one!
  • Luckin Coffee Inc. (Nasdaq:LK) Chinese coffee shop chain, equivalent of Starbucks. $9.7 billion market capitalization, heavily loss-making, but stock doubled in last 3 months. Short-selling broker Muddy Waters recently branded it a fraud, but its declared losses are so large that fraud is surely unlikely! Anyway, frauds do well in inflating bubbles also; the rising tide lifts all boats.
  • Diamond Eagle Acquisition Corp. (Nasdaq:DEAC) This is a SPAC (special-purpose acquisition corporation) with no current business whose price has almost doubled in the last 2 months because it is proposing a merger with the private fantasy sports betting company DraftKings. Since Americans are fanatic fantasy sports players and Internet sports betting has recently been legalized at the federal level in the United States, this looks like a potential gold-mine. With DEAC having market capitalization below $1 billion, it has perhaps the greatest upside of any opportunity here.
  • Virgin Galactic Holdings Inc. (NYSE:SPCE) develops space flight for private individuals; has been described as the “Tesla of Space.” $5 billion market capitalization; no revenues, let alone profits. Personally I would not buy a used car off Richard Branson, SPCE’s British founder, but then I would not have bought Tesla Inc. (Nasdaq:TSLA) shares either, so what do I know?

To sum up: in a well-ordered world, investing in half-inflated bubbles would be a poor strategy, because there would be too few bubbles and they would burst too quickly. But we do not live in such a world. However, gold, and gold mining companies, remain a safer alternative.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)