Since when did bankruptcy become bullish?

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When referring to retail investors, I occasionally call them "Robinhood traders" as a slang term

Here's the podcast episode for this post

Tim Mossholder from Pexels

The past few weeks have been interesting. Since the day that Hertz declared bankruptcy, it's stock went up over 600%. It's very absurd considering that most companies that go into bankruptcy never make it out. 

Then the story gets crazier. 

Since last week, companies that have filed for bankruptcy like JCPenny, Chesapeake Energy, Whiting Petroleum, and Pier 1 have skyrocketed from its bankruptcy lows. 

Today, I notice an article that CNBC that confirmed my suspicions about the price movements in those bankrupt companies. The title, which says "The hot new things to make your stock pop: Go bankrupt" seems appropriate to say considering the price action of many of those companies reflects it. This type of behavior by investors looks euphoric.

Imagine reading an article that said:

"Hertz, Whiting Petroleum, Pier 1 and J.C. Penney, which all declared bankruptcy amid the pandemic, saw their shares surging at least 70% each in Monday’s trading alone, some of which more than doubling."

Sounds crazy, right? While some might say that its short-sellers covering their short positions, according to data from Robintrack, it can be attributed to retail investors rushing to buy shares of the company. This type of behavior looks common from my experience of studying trends on Robintrack. 

Tailored Brands, which said that they were considering bankruptcy, had a huge uptick in ownership by Robinhood when news of it came out. Meanwhile, you can notice how more people bought Tailored Brands (NYSE: TLRD) as the stock price continues to decline. 

Despite the low oil prices and experiencing failure in their turnaround efforts, investors continued to buy more shares of Chesapeake Energy. Interestingly, even when the company conducted its last share dilution and reverse split, the shares of the company continue to get gobbled up by retail investors. 

Interestingly, the stock skyrockets at one point, and the rate of change of ownership for Chesapeake Energy shares increased from there. Investors were not only buying the dip on Chesapeake Energy (NYSE: CHK) but also chasing the stock price higher. 

For Whiling Petroleum, it's interesting that investors were slow to buy the dips on the company's shares as it was trending downwards. Once its stock price reached near the single-digit dollar values, that's when many Robinhood investors started acquiring shares of Whiling Petroleum (NYSE: WLL) aggressively. 

And finally, we have Hertz. Around the time that they were rumored of filing for bankruptcy, Robinhood users started acquiring shares of the company at a more aggressive pace. Then, once they declared bankruptcy, the number of users that owned Hertz shares skyrocketed. Once Hertz started rebounding above its share price during the day that they declared bankruptcy, Robinhood users started chasing the stock's upward momentum. 

Interestingly, during the time when Hertz's bankruptcy was news to everyone, I asked on social media on why people were buying Hertz. It's interesting to see that many are optimistic about the company and see them being able to come out of bankruptcy alive and stronger. Plus, the fact that Chapter 11 allowed companies to continue operating during bankruptcy proceedings is what attracted people to a potential contrarian opportunity originally. 

There were bigger signs of euphoria in the market. In the article, there were mentions of penny stocks skyrocketed to where their share prices were worth more than a dollar:

"Imminent bankruptcy filers Chesapeake Energy and California Resources also skyrocketed from a few pennies to a couple of dollars in a matter of days."

This type of price action is quite intriguing. While some companies going into bankruptcy had large floats, others probably had smaller floats. Maybe that's why they experienced that price action from the rush of buyers from the retail side. That's my best guess. 

Form the Robinhood data, people might imply that the rampant buying by Robinhood investors is what creates these violent upward movements. From the article, it mentions that:

"The rally in bankrupt and distressed names in part was boosted by retail investors on stock trading apps like millennial-favored Robinhood."

CNBC seems to be agreeing with the consensus that the buying mania by Robinhood investors' and other retail investors are what caused these violent price movements. 

Some might be wondering why all of this price action is happening around the world of penny stocks and bankruptcy land. There is one possible explanation for it:

"The wild moves in bankrupt names came as the market rallies aggressively with each new sign of economic recovery and the coronavirus easing"

These high expectations are what fueled this euphoria. Many (including me) had the assumption that once everything reopens, everything goes back to normal. Like a light bulb. So far, economic data and social media are telling a variety of images. Casinos being flooded with people and having long lines on the highways give us the impression of a strong recovery. Meanwhile, you have restaurants that are still receiving meager business and airports being ghost towns. These sightings give the impression that the economic recovery will take a lot longer than many assume. 

These mixed sightings in the US and around the world are still giving bullish sentiment for investors. Because of that, many investors are having a higher risk appetite. Here's something you might want to note:

"With the economic conditions improving suddenly, investors are betting these bankrupt companies are now in better shape than when they limped into Chapter 11."

I'll admit, betting that a company can get out of bankruptcy during an economic activity does help put the odds in your favor, a bit. General Motors (NYSE: GM) was able to get out of bankruptcy alive during the economic recovery in 2010. By the end of 2012 to 2013, American Airlines (NASDAQ: AAL) has been able to get out of bankruptcy and fly the skies again during the end of the economic recovery and into normal times. 

At the same time, because we won't know how long it would take for the economy to recover, this makes investing in bankrupt companies a really speculative investment. Plus, there are other things that are in play when betting on companies that are going bankrupt like the amount of money they owe to creditors and other people. 

With the rapid rise in ownership of bankrupt companies on Robinhood, it seems like investors are forgetting that:

"Equity holders technically are last in line for payout and typically get wiped out in bankruptcy."

This is why the odds are usually against equity investors when betting on a turnaround during Chapter 11 bankruptcy proceedings.

These types of price movements remind us of the mania that happens before crashes. This type of speculative behavior has been common during the internet bubble according to the article.

Overall, we shouldn't get bullish over companies that are in the middle of a bankruptcy proceeding even if the economy gets better. The odds are against the equity holders. Especially with the bull market lasting for more than a decade, many have the mindset that the bull rally will never end. Because of that, many seem to have adopted the buy the dip mentality easily. It's interesting to see many investors having the guts to buy the dip. I'll admit, it was difficult adopting that mentality when I first started investing. 

But the urgency to buy shares of companies that are undergoing a bankruptcy is irrational. 

As a bonus, here's how Robinhood users reacted when Luckin Coffee (NASDAQ: LK) was found to have committed fraud by faking sales

It's quite interesting to see that on the day that Luckin Coffee collapsed by a huge percentage, the amount of Robinhood users owning Luckin Coffee skyrocketed and that number continues to grow. 

All of the screenshots from Robintrack show how prevalent the buy the dip mentality has been among many retail investors. 

Investors today seem to take advantage of any dip they can find.