The 2020s have brought us some interesting times. For the financial markets, perhaps one of the strangest phenomena to arise this decade so far has been the birth of ‘meme stocks’. In fact, some have declared this the meme stock era! In a financial world that’s certainly less predictable than anyone could have guessed, what is this upstart new phenomenon, and do you need to pay attention? Let’s take a look at the world of meme stocks.
Taking the meme into the financial world
Like them or loathe them, memes are now part of our daily landscape. Boosted into iconic pop cult history by the spread of social media, they’re a ubiquitous part of the modern social landscape.
How did they infect the stock market, however?
In the broader framework of things, the arrival of commission-free trading and online investment groups provided the birthplace for the meme stock. Apps like Robinhood give the man on the street easy access to investing in the stock markets. It was inevitable the investing landscape would change. This has created a world where anyone can trade easily. It was inevitable that social media groups dedicated to investment would arise. Reddit is one, with subreddits like r/stocks and r/investing booming, while Stocktwits, a kind of Twitter dedicated to stocks, holds its own share of the social market. Not to neglect the now-infamous r/wallstreetbets in that list!
While these people are not all well-schooled in financial arenas, they now hold some significant clout in molding market sentiment. Nor is it all fun and games. AMC entertainment and Gamestop, the original meme stocks, became a trendy investment because a group of Redditors became aware that hedge fund buyers intended to short these stocks to boost their own growth. They mobilized to buy it to stop this, forcing them to cover their shorts, in a ‘stock takeover’ that’s come to be known as Gamestonk.
Whether you see this as a valiant attempt to stop the ‘rich’ from bullying the struggling at perhaps the worst time in history to be a movie theatre chain or gaming electronics retailer, stopping them from destroying livelihoods to fund their next vacation, or simply a bunch of silly young people who didn’t know what they were doing in the stock market buying on ‘feels’ rather than strong indicators. One thing is for certain- the meme stock is here to stay. Like it or loathe it, the amateur investor has turned out to have a lot of power over the US and UK stock markets on the back of this phenomenon.
The power of the Gamma Squeeze
So, how did a few angry individuals turn a stock’s fortune around? They used what’s known as a gamma squeeze. When a stock price undergoes a rapid, unexpected, shift it can force investors to behave off pattern in an attempt to minimize loss. Gamma squeeze represents the extreme of this when a stock price rockets upward.
Short squeezes happen when a sharp increase in stock price forces people who shorted the stock to repurchase their shares to minimize their own losses. In other words, people who ‘bet’ that the stock will go down are forced into losses by an unexpected turnaround and must act to mitigate them. It can temporarily drive a stock price up. Gamma squeeze sees widespread purchases of short-dated call options on a stock, spiraling that upward boom into a cascade where call buying raises the stock price, so more call buying and more price inflation occurs.
So, what are meme stocks?
Unlike a growth or a value stock, a meme stock is not easy to define. In fact, we’d say you will never see a ‘meme stock’ category listed anywhere. All the same, ignoring them could be an expensive mistake.
What characterizes a meme stock? They can be overpriced, and will definitely have seen spikes of rapid growth in a short period of time. They’re defined as popular amongst Gen-Z and maybe the cooler millennial, and the valuations that give them such high volatility are based on potential, not their financial broadsheet. Gamestop, the original meme stock, wasn’t even bought on potential, but merely to ‘play the system’ and stop some stock market ‘bullying’.
Strict book valuation is low on the list, and the sentiment instead revolves around future problems the stock can solve and the potential of the company. And, it has to be said, FOMO is part of what’s driving the purchase. Of course, this means panic-selling at normal market dips and bumps is also common, adding to the overall volatility of a meme stock. It is sometimes even called a “bro-ey” sentiment by finance professionals which implies that mostly men do it as a leisure time activity rather than a real investment. In short, there’s a lot of hype not always backed by logic.
Should I buy meme stocks?
Just because they’re the product of online hype doesn’t mean meme stocks are bad. AMC, for example, has used the unexpected share price boost to make solid restructuring that could well pay off in the long run. Just because online hype is around, doesn’t mean a company will affect its day-to-day operations. Just be aware that buying a meme stock means you’re entering pretty late in the stock cycle when ‘mainstream’ awareness is well underway, and you will pay a premium for it. Also, don’t lose sight of the volatility inherent to meme stocks. As always, you will need to do your due diligence and separate the worthy from the worthwhile.
The meme stock phenomenon is certainly an interesting one. While it’s tempting to dismiss it purely for its social media fad-ness, there is potential in some of the stocks. Likewise, where there’s market disruption there’s always space for savvy investors to do their best work. Will the meme stock phenomenon peter out, or is it set to stay? While we can’t say at present, it’s worth making sure you don’t get caught in the hype, and keep your investor sentiments grounded in your long-term financial plan.