Party like it’s 1929! Buying into bankrupt companies is insane. It’s dot-com bubble x 10mn, and it’s doomed to fail

The US Federal Reserve does not understand the moral hazard caused by reckless ‘money-printing’ policies, or the difference between liquidity and solvency. These policies have duped retail and small investors, who are now victims.

Amid all the gloom of Covid-19 and the Black Lives Matters protests, June 8, 2020 was a busy day for the financial markets. The Business Cycle Dating Committee of The National Bureau of Economic Research (NBER) determined that the US economy peaked in February 2020, marking the longest business expansion since business-cycle records began in 1854. An impressive 128-month run from June 2009, before entering into a lockdown-induced recession in February 2020.

Stock markets gleefully rejoiced at the grim news. Alan Greenspan, Ben Bernanke, Janet Yellen and Jerome Powell, please take a bow. Mission accomplished. These Federal Reserve ex-chairs and current chairman are responsible for breaking the law, distorting price discovery and inflating the most grotesque asset bubbles in history. Bravo! Never mind the virus or the riots, it’s buy, buy, buy!

After the Federal Reserve announced they would offer bailouts to small, main-street businesses that banks would not touch with a barge pole, the Dow Jones Industrial Average surged nearly 500 points, adding to the almost 1,000-point gain of last Friday. And the NASDAQ rocketed to all-time new highs, closing up at a record 9,924. The NASDAQ will bubble over 10,000 and keep going until it doesn’t. Just party like it’s 1929!

The Federal Reserve has no legal authority to monetize debt or to create extraordinary amounts of leverage, putting the taxpayers on the hook for their fiscal profligacy. The fundamental problem is the Fed does not understand the difference between liquidity and solvency.

In capitalism, bankruptcy is a mechanism used to deal with poorly run businesses that are unprofitable. By providing liquidity to these poorly run businesses, the Fed is not creating solutions. It is creating more debt and a world filled with profitless zombie corporations that eventually go bankrupt – only with much more debt.

Unlimited Federal Reserve bailouts have created an “illusion” for retail investors, that stocks can never go down and that corporations do not need profits, earnings or a sustainable business model, because “the Fed has your back.”

Let’s take one example of what happens when the market's ability to price risk and accurately determine valuations is undermined by reckless snake oil salespeople masquerading as omnipotent oracles? Take the case of Chesapeake Energy.

It is the biggest shale oil producer in America, and its shares, CHK, had a very wild ride indeed today. Here is my overview of a few of the CHK headlines that rolled off my ticker late today during post-market trading:

June 08, 2020

1:16 pm ET

Chesapeake Energy Corp. (CHK) halted due to volatility.

1:21 pm ET

Chesapeake Energy Corp. (CHK) resumed trading.

2:14 pm ET

Crude prices drop but oil stocks are rising. Here's what's behind it.

2:16 pm ET

Chesapeake Energy up over 140%, on pace for record percent increase.

4:27 pm ET

UPDATE: Chesapeake Energy's stock nearly triples, trading up at $84 after 22 trading halts.

5:11 pm ET

Chesapeake Energy shares are trading lower after it was reported the company will prepare a Chapter 11 filing, giving lenders control.

I have been extremely bearish on oil prices since 2018 (here) and, in the first week of April 2020, I predicted that we would see oil at $10 a barrel, which would bankrupt many of the highly leveraged shale oil and gas producers (here). The Federal Reserve has promised “unlimited bailouts,” but how will they bail out the oil and gas sector, and all the other zombies?

The leader in the US shale fracking oil and gas revolution, Chesapeake Energy Corp., like many of the zombie corporations on life support thanks to the Federal Reserve’s policy of low-interest rates and moral hazard, has been on the brink of insolvency for years.

The collapse in oil prices from March-May has pushed Chesapeake over the edge. One week ago, CHK was trading at $12.82 per share. In last night’s after-market, CHK traded up at $84.75 per share; that’s an increase of 563 percent in only a week. At 17:11 on June 8, CHK announced that it was preparing Chapter 11 bankruptcy filing papers and the stock crashed over 50 percent in only a few hours after its meteoric rise – a jump that occurred for no reason except for momentum traders (MOMO) buying for fear of missing out (FOMO).

CHK’s stock movement illustrates a textbook “irrational exuberance” and indicates that retail is all-in as markets become even more irrational. Greater fools buy at any price because some other fool in the Fed will bail them out. The bad news is that in Chapter 11 bankruptcy filings, all the equity (stocks) becomes worthless and its price falls to zero.

Chesapeake Energy Corp. has a massive debt problem, owing nine billion dollars with a debt payment due on June 15. Should CHK default on this payment or file Chapter 11 bankruptcy, CHK will likely cause a tsunami of industry shale oil and fracking defaults that may spark the next phase of our crisis.

On the other hand, Hertz Global Holdings Inc, the large international car rental company, declared bankruptcy two weeks ago, and its shares traded as low as 40 cents. Today, these shares traded at $6.90 per share, or an increase of 1,623 percent in around 10 days.

Federal Reserve policies have empowered retail investors on trading sites like Robinhood to believe what a millennial told me last week: “Trading is easy; anyone can become a millionaire because the Federal Reserve’s job is to ensure that stocks only go up.”

Delusion or reality? Only time will tell. But I know what I think, after a few decades of working on Wall Street. I’m not a buyer of these zombie companies like Hertz and CHK at the best of times, let alone now.

These zombies are dead companies with no chance of survival and which only burn cash. No real investor would buy these: only a drunken, no-hoper gambler would – they are dead ends.

So in June 2020, in the midst of all that’s ravaging our world and 40 million unemployed Americans, stocks are trading at the highest valuations in history, not just in the bankrupt companies. Those sorts of extreme heights normally imply a humming economy with high GDP, full employment and the economy roaring along in tip-top shape, not an economy suffering from a full-blown economic depression featuring the greatest wealth inequality in history. This is just a crazy BUBBLE inflated by the Fed's money printing.

And while no one can predict how high it will go, we do know, like Chesapeake shares, that it’s all going to end in a lot of tears.

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