Anatomy of a Mini-Bubble

Earlier today Briefing.com posted their thoughts on how these “momentum themes” (mini-bubbles) develop year after year:

We mentioned numerous times over the past 48 hours the Micro-cap Energy momentum theme that has sent some previously unknown energy names skyrocketing, and all you have to do is check the percentage gainers list today to see that — for this morning at least — it’s still in effect (the top percentage gainers today in order are all micro-cap energy: SSN +75%, FPP +41%, BDCO +38%, MXC +29%, PDO +21%, LEI +17%… see 11:14). Rather than recap the specific circumstances that drove these names, we’d like to discuss in general terms how these momentum “themes” develop. It seems that maybe once or twice a year these mini-bubbles suddenly pop up out of nowhere, and they typically last anywhere from a few days to a few weeks. Right now it’s micro-cap energy, but last year it was small-cap China stocks, and a number of years ago we saw brief, huge rallies in bird flu plays, stem cell stocks, Tsunami plays, homeland security stocks, etc… In terms of identifying these themes in their early stages, they all form out of different circumstances, but they do tend to have a few characteristics in common early on:

  1. a sudden macro catalyst,
  2. a co-specific news event that leads to a huge percentage gain in a previously unknown microcap stock, and
  3. a broadening out where other related stocks rally and hold onto their gains (as opposed to seeing the usual intraday sympathy play chop-down)…

So for example, the current craze in micro-cap energy stocks is ultimately being driven by the accelerating rally in the price of oil during the past week (point #1). Normally, this might not be enough to move the often low-quality micro-caps, but then you had an extremely bullish earnings report by PDO last Thursday (point #2), which not only led to an attention-getting 60% gain for the stock that day, but induced momentum traders to scramble to find other sympathy plays. The broadening out phase (point #3) occurred when we saw a succession of positive press releases by other, similar US-based energy co’s (MXC, CLR, SSN), while the backdrop of new highs in crude oil continued to make headlines each day…

So in short, while past momentum themes all had different origins, they all required a definable macro event, and were followed by a quick succession of co-specific news items (for example the above-mentioned themes had macro backdrops respectively of a bubble in the Shangai index, high-profile stem cell legislation, the Indonesian tsunami, 9/11 — and were followed by a number of positive company news items that kept gapping up the microcaps involved)…

So how do they end? They tend to peter out when the macro catalyst stops making headlines, and when the stocks themselves have seen 3-5 days of successive gaps higher. We’re not going to hazard a prediction as to when the current micro-cap energy craze ends, but we just wanted to point out some of the similarities between the current theme with those that have occurred in the past.

Good stuff to keep in mind when trying to ride future manias.

Comments

  1. Posted by Dr. Duru on May 21, 2008 at 8:38 pm

    Great commentary. Definitely one for the archives.

  2. Posted by brandon on May 21, 2008 at 9:04 pm

    Thank you for posting this. I will bookmark this page.

  3. Posted by Joe Drake on May 21, 2008 at 9:27 pm

    I frequent your site for the excellent charts, but fail to see much value in trying to identify a”phenomenon” that occurs perhaps twice a year, with so many contingencies. Intersting to learn, but hard to turn into cash.

  4. Posted by Michael on May 21, 2008 at 9:35 pm

    I hear you Joe. I think the most practical use of info like this is to know when to sell — assuming one had the ‘nads to play these kind of stocks in the first place. These kind of stocks are usually to thin for my liking but others may find it helpful.

  5. Posted by TraderMD on May 21, 2008 at 9:55 pm

    Great post. Thanks.

    I definitely missed that on briefing.com today.

  6. Posted by Andrew on May 22, 2008 at 11:50 am

    Thanks for the post, interesting observations.

  7. Posted by Bill aka NO DooDahs! on May 22, 2008 at 1:37 pm

    They forget ethanol stocks on their list. Here’s a 3-year chart of PEIX.

    http://stockcharts.com/h-sc/ui?s=PEIX&p=D&yr=3&mn=0&dy=0&id=p27918115536

  8. Posted by Michael on May 22, 2008 at 2:45 pm

    That’s one bubblicious chart!

  9. Posted by Bill aka NO DooDahs! on May 22, 2008 at 2:58 pm

    Yeah, I remember making some comments at Seeking Alfalfa when PEIX was in the $40s, and basically getting laughed at. They really thought I was crapping in their cornflakes.

    Everybody in ethanol stocks thought they were sustainable businesses, good startups, etc. Just like the dot-bomb, only more recent, and quicker to blow up.

    The interesting thing is how the corn craze crept (that’s a lot of alliteration) into chicken, wrecking stocks like SAFM and IBA (sic?) for the better part of two years. Nice to see themes intertwine.

    Smaller bubbles include the “hype” and “fad” stocks like Crocs, Heelies, Jones Soda, etc. I think the best money is made by riding the bubbles, but I’ve been burned doing that on occasion.