Bankrupt Companies: Retail’s Façade

Institutional investors and algorithms that provide a massive amount of capital, and therefore volume, have driven markets since roughly the turn of the century.  Hedge funds and investment banks simply have an immense amount of capital compared to individual investors.  As of late, the weight of market players shifted.  Federal stimulus recipients and even sports gamblers were introduced to the market recently, and provided an unprecedented result.  Over the past year many online brokerages became commission-free, causing households to start trading outside their 401ks.  According to the Wall Street Journal, TD Ameritrade’s daily average client trades before they became commission free was about 870,000.  After they became commission-free, that number soared to almost 3,000,000.  The increased volume has sparked a brisk recovery from March lows and volatility in bankrupt and near-bankrupt companies, creating a façade.  

Investopedia provides insight on a certain type of trader for which the quantity on the market is surging: “Retail traders, often referred to as individual traders, buy or sell securities for personal accounts”.  Retail traders are generally regarded as uninformed, novice traders who trade for a combination of hobby and income.   Contrary to retail traders, there are institutional investors.  Institutional investors are professional money managers who trade large pools of capital for....  Institutional trading is a multilayered business, including departments of analysts, traders, and researchers.  Needless to say, institutional money management is far more informed than retail investors.  Regardless of credibility, retail trading can have a large effect on the market when millions of retail, or “Main Street”, investors choose to deploy capital.  Generally speaking, institutional money managers have a much greater effect on the market because of the size of their individual trades.  In roughly the last six weeks, the quantity of Main Street investors swelled tremendously.  

On the surface, it seems unlikely that an increase in disposable income is present given the economic conditions.  At a second glance, however, the idea seems much more feasible.  In some cases, stimulus money combined with savings from commutes, entertainment, food, and some other general living expenses led the charge for excess disposable income poured into the stock market.  The Federal Reserve and Congress implemented extreme measures in terms of financial handouts.  Finance experts are attributing the surge in retail to federal stimulus programs.  Just about everyone received some sort of stimulus, whether it was a one-time $1200 payment, or the additional $600 per week in unemployment.  Arguably, not everyone that received the money needed it, as reflected in the markets by the surge of capital deployed by Main Street.  Additionally, some investors awaited a downturn in the market for months, as depicted by Bloomberg, “more than 2 million new accounts in the first quarter, exceeding the number of new users at Charles Schwab Corp., TD Ameritrade Holding Corp. and E*trade Financial Corp. combined during that period”.  That’s 2 million new users to just Robinhood alone, and before much fiscal stimulus was awarded..  Smarter retail investors predicted that after a 30% return from the S&P 500 in 2019, along with an inverted yield curve, a downfall must have been near.  This increase in trading volume led the charge for fundamentally poor companies to produce high returns, turning the S&P 500 into a poor economic health indicator.  

These investors are having a unique effect on markets.  There are so many retail dollars on the market that they are forcing some sectors of the market in a positive, misleading direction.  A study was conducted in Taiwan 50 Index on the relationship between price and volume.  The study concluded, “As for the trading volume at market open and close, the [Daily Trading Volume] (sic) have significantly positive effects on [Daily Stock Returns] (sic)”  ). (Huang, 2020) This proves that an increase in volume provides positive movement regarding price action.

Most retail investors are simply “trend trading”.  They can quickly toggle the length of the chart on the most popular novice trading app, Robinhood, and buy companies that they believe will bounce back based on the company’s chart.  Many retail investors are known to say something along the lines of, “If it was trading at price ‘A’ last month, it must return to this level.”  The sheer quantity of investing with this mindset has artificially forced prices up.  This provides a misleading message within markets.  The overall market is largely pushed more and more positive because of the increase in buying these stocks, many of which are penny stocks.  

If it were not for this surge in volume, markets probably would not be climbing to this extent, given the level of uncertainty.  Just one example of this occurred with Hertz.  In February, Hertz traded close to $20 per share.  Amid the pandemic, the companies’ bankruptcy forced the share price down to a mere penny stock.  The company spent most of its time since April trading in the $2-4 range.  Hertz recognized retail investors rushing to buy their stock amid the crash.  The price of their stock artificially (not driven by natural positive news/ earnings growth) doubled.  Buying Hertz stock amid bankruptcy is particularly foolish because in some cases the stock is worth $0.  Holding shares of common stock is the worst place to be in bankruptcy because the bond holders and creditors receive the company’s assets first, whereas equity holders are paid last, if there is anything left over.  Retail investors that buy ownership of a bankrupt company either have fundamental misconceptions of equities, or they place extremely preposterous confidence in the idea of the company not going entirely bankrupt. They decided to issue $500M to fund their bankruptcy due to the surge in volume from retail.  In other words, they used novice, uneducated investors money to pay off debt.  Wall Street Journal’s podcast describes, “Hertz, a bankrupt company was one of the best performing companies on Wall Street”.  This proves the façade that retail investors managed to create.  Hertz, along with several other fundamentally poor companies like Chesapeake Energy, led a charge of climbing charts.  The podcast details one specific trader who poured $50,000 into Hertz while standing in line at Starbucks.  

Retail is clearly contributing a significant amount of price movement in markets, creating a façade.  It appears that markets are signaling a recovering economy, when in reality the increased volume within markets provides increased returns.  The companies that are the most fundamentally depressed are the most attractive for these investors.  Some investors have no idea what they are buying, and simply trend trade.  Excess government stimulus certainly contributes to this camouflage, but there are other classifications of people such as gamblers who entered markets in hopes of chasing their lockdown-delayed thrill from casinos and sports betting.  Regardless of the person’s background, Main Street is having an unprecedented effect on the markets and it is contributing to false images of the economy.    

Works Cited:

Huang, Pao-Yu, et al. “The Microstructure of the Price-Volume Relationship of the Constituent Stocks of the Taiwan 50 Index.” Emerging Markets Finance & Trade, vol. 48, 2012, pp. 153–168., www.jstor.org/stable/41739223. Accessed 21 June 2020.