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21 May 2024
4 min read

Meme stocks are back – what does it mean for markets?

As GameStop* and AMC* return to the headlines, we highlight why we think the 'meme stock' phenomenon shows a febrile attitude among investors that could provide a tailwind for markets, but also make them more fragile.

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The return of meme stocks highlights optimism among retail investors and demonstrates their willingness to get involved with markets. In our view, this active participation could provide a market tailwind, while the engagement in the one-day option market is potentially supportive of US equities in particular. But the surge in meme stocks could serve as a warning sign too.

Indeed, the speculative behaviour (one-day options are effectively lottery tickets) could indicate a potential bubble. While not definitive evidence, we see this as a red flag. Investor sentiment is bullish and therefore also vulnerable to change. Yet, as John Maynard Keynes famously said, “The market can stay irrational longer than you can stay solvent.” Treating the emergence of any single bubble indicator as the definitive moment close to its bursting should therefore not be advocated.

In a US election year, this feverish behaviour is a reminder of the influence of social media and of retail investors in markets. According to Pew Research, half of US adults get at least some news from social media.[1]

Remind me… how did this start?

The ‘meme stocks’ phenomenon began in late 2020 and took off into January 2021, prominently featuring stocks like GameStop* and AMC Entertainment*. In essence, it pitted a handful of Goliaths (large hedge funds) against thousands of Davids (retail investors).

The hedge funds saw the old high street favourites as vulnerable to losses in digital world and were betting on further stock declines (by shorting the stocks), while many of the retail investors had nostalgic admiration for these companies and a disdain for the hedge funds.

Through online communities, the retail investors encouraged collective action to start buying shares and drive up share prices in the same companies that big hedge funds had heavily shorted. This time round, the re-appearance of some prominent influencers on social media has whipped up a frenzy of activity around the old favourite names.


What did retail investors hope to achieve?

The goals of these retail investors were twofold:

  1. Profit: By driving up the prices of these stocks, investors who bought early enough could aim to sell their shares at higher prices
  2. Protest: Many viewed their actions as a strike against the traditional financial establishment

How big was the phenomenon?

For the affected stocks (but not the overall market), the impact was huge. GameStop’s* stock, for example, rose from under $1 in 2020 to over $100 briefly in January 2021. This huge increase in price attracted global media attention and brought in more investors hoping to make quick profits or join in the movement against Wall Street.

What’s the broader financial market impact?

However, it’s important to remember that relative to individual large cap stocks, or asset classes as a whole, this collection of viral meme stocks remained small. GameStop’s* market cap peaked just over $25 billion, AMC’s* just over $30 billion. The market cap of the S&P 500 at the time was around $35 trillion, over a thousand times larger.

In January 2021, when some meme stocks rose astronomically, the S&P 500 was down over 1%. The impact of meme stocks should therefore not be seen as a having direct impact on most portfolios, therefore (especially diversified portfolios[2]) but more for the impact on investor psychology and as a potential sign of changing market dynamics. Various studies and academic papers have shown that the meme stock craze had several broader financial market impacts:

  • Volatility: Extreme price movements of meme stocks introduced significant volatility, affecting investor confidence
  • Irrational behaviour: The ‘herd mentality’ demonstrated by retail investors was clear, with the most popular meme stocks trading at levels far exceeding their fundamental value
  • Liquidity concerns: As prices swung wildly, some trading platforms restricted trading in these stocks due to liquidity concerns and regulatory requirements, leading to debates about market fairness and transparency
  • Regulatory scrutiny: The situation caught the attention of regulators and lawmakers, leading to congressional hearings and discussions about potential changes in market regulation

In short, the meme stock phenomenon is akin to a financial uprising, with smaller investors banding together using the power of social media and collective action to take on established market players. This has introduced new factors into financial markets, demonstrating the growing influence of retail investors and how social media and technology could disrupt traditional financial market dynamics.

 

All data sourced from Bloomberg in May 2024 unless otherwise stated.

*For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.

[1] Social Media and News Fact Sheet | Pew Research Center

[2] It should be noted that diversification is no guarantee against a loss in a declining market.

 

Volatility Multi-asset Bear market Behavioural finance Bull Market
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Christopher Teschmacher

Fund Manager

Chris is something of a perfectionist which may explain the raft of automated spreadsheets ensuring charts are properly formatted to Teschmacher® standards. Having become the…

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