Meme Stocks: The Sequel

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One of the hallmarks of a horror movie franchise is that each time we think the anti-hero has been vanquished, he arises once again to wreak mayhem. The same can be said of meme-style stock trading, which has re-emerged with a vengeance in recent days.

It is no coincidence that the timing roughly coincided with Reddit’s (RDDT) recent IPO. Reddit, specifically its r/wallstreetbets forum, was the incubator for the meme-stock phenomenon in the first place, so it is unsurprising that its own stock would exhibit that type of behavior once it became listed.RDDT rose about 30% yesterday, fueled somewhat by the inauguration of options trading on the newly listed shares. 

If the enthusiasm was limited to RDDT, one could reasonably assert that the stock’s rally was simply residual enthusiasm for an IPO. But when its 30% rise was accompanied by a similar rise in Digital World Acquisition Corp (DWAC, DJT), the SPAC that just completed its merger with the former president’s Truth Social platform; a 15% rise in GameStop (GME), the “OG” meme stock, ahead of this afternoon’s earnings report; and a 7.5% jump in bitcoin, along with a 22% jump in MicroStrategy (MSTR), a company that is essentially a leveraged bitcoin holding company, and it hardly seems unreasonable to consider that a broader trend might be afoot. We’ve been in a highly momentum-driven market environment, and it is clear that some of that momentum has morphed into wild enthusiasm for a range of highly speculative investments.

Since the phrase and phenomenon burst onto the scene in early 2021, I’ve been searching for a rubric for what separates meme-style investing from mere speculation. Here are some of my thoughts:

  1. Quasi-religious Fervor. A key element that fueled the original meme stock rally was an “us versus them” mentality that was fermented on social media.“Them” was the short sellers who were perceived to be rooting for the demise of the chatroom denizens’ favorite stocks. But what fueled that zeal? At the time, with the help of my son, I attributed it to nostalgia:

“The short-squeezed WSB [Wall Street Bets] stocks all have one thing in common besides being short-squeezed. They’re all things a 20-something person would be nostalgic for.GameStop, AMC, Nokia, Build-a-Bear – things that would make you sad to hear are failing business because it means that you’re old.”

Nostalgia was simply the catalyst – more prosaic motivations like greed and fear took hold and morphed into an exuberant zeal for a select group of stocks. Cryptocurrency enthusiasts have a similar type of belief in the future for those assets. And in the case of DJT, there are political motivations driving the stock.I have always believed that the company’s most devoted investors viewed it as a call option on the MAGA movement, which of course has its own highly devoted proponents. It is hardly unreasonable to expect that many of those devotees would vote for their preferred candidate with their wallets.

  1. Disregard for Fundamentals.If one’s investment decisions are based primarily upon emotions, then it is hardly a surprise that standard valuation metrics will be cast aside. True believers don’t really care about prosaic concerns like P/E ratios and the like. They’re not doing detailed calculations about the discounted future cash flows of their favorite stocks. Many commentators noted that DJT’s $6 billion (now $9 bn) valuation seemed rather excessive considering that its sales are minimal and profits are essentially non-existent. But its situation is not unique. Even though GME is far from its all-time highs, its valuation remains stratospheric. It sports a P/E above 600 along with a triple-digit forward P/E.None of these can be remotely considered value stocks, and few can be honestly considered demonstrable growth stocks. Thus, the unique “meme-stock” classification.
  2. High Short Interest. Stratospheric valuations attract short sellers. Those investors are indeed concerned with valuation metrics and borrow shares to sell with the hope of selling high and buying low. There is often a moral judgment placed upon short sellers, but legal short selling (the vast majority of short sellers and brokers who facilitate their activities follow the copious rules that govern that activity) is a hallmark of an efficient market. Shorts need to be borrowed, sometimes at exorbitant rates, and eventually need to be covered. If the short seller is wrong, they expose themselves to massive, potentially unlimited losses. Remember, a stock can rise infinitely, but it can’t go below zero. Thus, the short seller knows his maximum profit when he enters the trade, but losses can mount if either the stock or its borrowing cost rises. As we saw in 2021, this can be a powerful catalyst for a meme-stock rally.

None of this can happen of course unless monetary conditions allow for high levels of speculation. It is no coincidence that the phenomenon arose during the ferocious post-Covid monetary expansion. While monetary conditions are hardly as loose right now, it is nonetheless apparent that we have been in a market that has been driven by momentum. It shouldn’t be a huge shock that some of that momentum has spilled away from companies with demonstrable recent growth, like Nvidia (NVDA) or Meta Platforms (META), into those whose bottom-line growth is far from assured. And, by the way, if we’re in an environment that supports rampant speculation in a wide range of risky assets, do we really need rate cuts?

More By This Author:

Why Do We Need Rate Cuts?
Don’t Sleep On Global Stocks
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Disclosure: The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the ...

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