During the last several months, a strange phenomenon has developed in the stock market wherein a handful of struggling publicly traded companies have seen their stocks explode higher. Perhaps you have heard of the bizarre trading activity surrounding some of these names including GameStop, AMC Entertainment, and Blackberry to name a few. So, what is going on with these so-called “meme stocks” and how does it affect ordinary investors and the overall stock market?
First, a definition is in order. A “meme stock” is a stock that has seen increased trading activity not due to a change in the underlying business but because of its popularity on social media, such as Twitter or Reddit’s popular Wall Street Bets community. With over 10 million subscribers, the Wall Street Bets forum is hosted by the social media website Reddit.com and allows users to discuss trading ideas, share screenshots of their gains (and often substantial losses), and post generally offensive material poking fun at both themselves and the companies whose stocks they trade. When many of these internet traders flock to the same stock, thereby drastically increasing the trading activity, a “meme stock” is born. With the arrival of the COVID-19 pandemic lockdowns, new speculators and gamblers were driven to the markets by way of these online forums as a combination of boredom, stimulus checks, zero commission trading at major brokerages, and an absence of sports games to bet on fostered an environment ripe for stock speculation.
The first target of these speculators were the stocks of companies that had declined sharply due to the pandemic, such as airlines, cruise operators, and even bankrupt rental car agency Hertz. It is not uncommon for risk-tolerant investors to step in during a selloff and place wagers that everything will ultimately be okay. If they are right, the stocks they acquired will return to their pre-crisis levels, netting the investors huge gains. Many of these new internet speculators saw their risky trades pay off as the Federal Reserve sparked a massive rally in stocks last spring after announcing that they would do “whatever it takes” to keep the economy from collapsing.
Emboldened by their initial gains on beaten-up leisure companies, these traders spent much of the remaining part of 2020 focused on technology and growth names such as Tesla. By the new year, however, the speculative behavior took a strange turn as these internet traders banded together to send shares of video game store operator GameStop from $20 to as high as $400.
Most recently, we’ve seen shares of movie theater chain AMC Entertainment climb from $10 to over $70, far surpassing its pre-pandemic valuation. The explosive rally in AMC shares has been so disconnected from the reality of AMC’s underlying business conditions that AMC itself declared its own stock to be overvalued and announced the issuance of millions of new shares in an effort to shore up its balance sheet. In a plot twist worthy of the big screen, these traders may have helped save the struggling movie theater chain by allowing them to raise capital when they needed it most. Below is a chart of the performance of GameStop and AMC stock year-to-date. (And yes, those returns are both over 1,000%.)
So, why did these traders decide to send the shares of these struggling companies into the stratosphere? This community of internet traders appears to enjoy proving seasoned market veterans wrong, as was the motivation for targeting GameStop where many supposedly sophisticated hedge funds that had sizable bets placed against the stock took large losses amid the rally. Furthering the rally, though, are the same underlying motivations of greed and the fear of missing out that have been present throughout market history, whether it was the Dutch Tulip Mania bubble in 1636 or the dot-com technology stock bubble of 20 years ago.
What makes this moment in market history different than previous ones is the use of the internet and the accessibility of digital communities. It has never been easier to join a movement and feel like part of the cause, regardless of its merit. Internet traders see that someone else online made a big profit trading one of these stocks and think they can replicate it, all while feeling a sense of comradery as though they’re part of a team crusading against what they deem to be an arrogant class of elitist professional investors. While we can’t know with certainty how this speculative mania will end, if it’s anything like past bubbles, the result may leave a lot of people poorer than when they started.
What does this all mean for clients of FSA? There have been times in which some funds we have owned for client portfolios contained at least one of the stocks that have been targeted by these internet traders. These funds own many other stocks in addition to any of these “meme stocks,” so the likelihood of any one single stock affecting client portfolios in a noticeable way is low. We monitor each fund closely to ensure that the fund is performing as expected. For now, this “meme stock” phenomenon is just an odd and interesting sideshow. As always, the FSA Safety Nets® are applied to each fund we hold which will shift money out of any fund that falls below the exit price, regardless of the underlying reasons for a selloff.
Portfolio Update: Markets posted mixed results for the month of May, with the S&P 500 returning a 0.7% gain and the technology-heavy NASDAQ 100 slipping -1.2%. We trimmed some of our growth-oriented funds and added to more value-oriented funds while remaining fully invested. We are entering the summer months, which have historically been a weak period of the year. If we do experience a sell-off in the markets this summer, we will follow our exit process until the uptrend resumes. Until then, we are content to let the portfolios continue to ride the wave higher.
Disclosures are available at https://fsainvest.com/disclosures/market-update/.