Why the Latest Meme Stock Craze Won't Take Down the Overall Market

Yahoo

3 days ago

Meme stocks are back from the dead. Penny shares are soaring. Stocks that leap and crash by multiples of the market are desirable again. July in summary: wild speculation.
Should investors who don't want to gamble on daily stock moves, or three-times leveraged versions of them, worry about this?
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There are two reasons for concern. The first is that excessive gambling in the market leads to unsustainably high prices that have to crash. GameStop and AMC Entertainment Holdings, the stars of the meme-stock boom in 2021, are down 74% and 99% respectively from their peaks. If speculation has lifted the market as a whole, it will eventually sink it, too.
The second concern goes back to something the economist John Maynard Keynes wrote in 1936—that when 'enterprise becomes the bubble on the whirlpool of speculation,' capital will flow to the wrong companies, damaging growth and jobs.
Both worries are reasonable, but neither is the right reason for concern at the moment.
A lot has been written about what my colleague Spencer Jakab dubbed the DORK stocks from the tickers of Krispy Kreme, Opendoor Technologies, Rocket and Kohl's, the riders of the new meme roller coaster. They are merely the public face of a summer boom in bets by private traders.
Andrew Lapthorne, head of quantitative research at Société Générale, points to gains of 10% or so from betting on rises in the most-shorted stocks, companies with the weakest balance sheets and the highest-volatility stocks in the midst of massive trading. 'The volumes are mental,' he said.
That this is the purest of speculative gambling is most obvious in the performance of penny shares: The 10th of the market with the lowest share price at the start of July had a median gain of 16% by July 23, when the new meme stocks peaked, while the 10th with the highest price rose only 1.4%. The starting share price was by far the best predictor of performance during the month—and also of the size of losses in the last week, when the boom went into reverse and the cheapest stocks fell 6%.
Institutional investors and anyone who understands stock issuance can rightly say this is farcical. The only times the price matters is when it stays below $1 long enough to be delisted because of stock-exchange rules, or is so high that a single share is out of reach for a buyer (and even then, retail brokers now sell fractional shares). A company can double or halve the price (or more) by a simple stock split or reverse split, with no impact on the percentage of the company and implied share of the profit that any shareholder owns. The share price shouldn't matter.
A lot of private traders either don't understand this or don't care. In July, they were right, and the pros were wrong: Share price did matter, both on the way up and more recently on the way down (perhaps, as private traders took profits ready for holidays).
Such speculation can also lead to badly allocated capital, as shown when the last round of meme stocks, led by GameStop and AMC, issued billions of dollars of new shares. The stocks collapsed anyway.
Yet, this mostly passes big investors by. There aren't any penny stocks in the S&P 500, and there was no pattern showing that cheaper shares among big companies did better or worse in July. Back in 2021, private traders helped inflate full-blown bubbles in green stocks, SPACs and loss-making technology stocks alongside the meme excitement, yet the wider market was entirely unaffected when those bubbles burst.
Equally, Keynes was just wrong when he warned that Wall Street's speculative fervor worked less well at providing capital to the right parts of the economy than the more cautious British approach of investing for income.
What critics call 'casino capitalism' and a willingness to take big risks helped finance U.S. growth companies—and even the U.K. government is now trying to kindle animal spirits among voters, worrying that the City of London institutions are failing to provide speculative capital to the British economy.
Long-running sentiment surveys from the American Association of Individual Investors and Investors Intelligence are much more positive than earlier this year, but not excessively so. Futures traders are skewed toward bullish calls, but not nearly as much as they were in 2021. My guess is that retail traders helped push up the S&P when they bought the dip from April on, but that they didn't have that much impact in July.
It's reasonable to worry that stocks are too expensive, that earnings are likely to take a hit from tariffs, that the economy, while superficially strong, has many weak spots, and that excitement about artificial intelligence is overdone. But when it comes to meme stocks and penny shares, the boom and bust has little overspill to the rest of the market.
Write to James Mackintosh at [e-mail]
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