Memomania is back: how retail traders rocked the market

The US stock market is repeating the euphoria of four years ago associated with meme stocks. In 2021, the most famous of them were the securities of GameStop, a chain of video game stores, and AMC Entertainment movie theaters. Their quotations retail traders, negotiating in social networks, inflated dozens of times, depriving hedge funds of billions of dollars. But this was a prelude to a market crash in 2022. Memomania raises similar concerns now.

Over the past couple of weeks, shares of a number of companies have soared by tens or even hundreds of percent for no reason. The most notable example was the securities of Opendoor Technologies, a platform for the rapid resale of residential homes. In 2021, when interest rates were zero, people were quarantined because of a pandemic, and real estate prices were rising rapidly, its shares were worth a peak of $35.88. In June of this year, however, they were trading at only slightly more than 50 cents. But within about a week in mid-July, their value soared to $3.21.

The growth was fueled by retail traders, who began calling for concerted action on online forums to support Opendoor's stock. "$OPEN is all wrapped up in the GameStop atmosphere," quotes The Wall Street Journal post on X by user SkipTradeless. - WE WILL NOT STOP AT $82 [per share]." (Author's spelling and punctuation retained).

Another user with the nickname Hot-Ticket9440 wrote on a Reddit forum about retailer Kohl's, whose revenues have been declining for years due to the migration of shoppers to online shopping, "Let's go!!!! Let's hit the shorts buy every recession. Together we are strength." 

Shares of Kohl's, which have been trading around $10 lately, jumped to $17.4 on July 22. It ended trading up 37.6% at $14.34. Since then, the price has fluctuated between about $12 and $14, sometimes jumping 10% in a day. 

Meme stocks are securities that are supported by communities of traders who play for the upside and share popular pictures or sayings related to them on social networks. The current story is reminiscent of the events of 2021, when the phenomenon was born. It gained popularity during the pandemic, when the stock market rose rapidly - it was supported after the initial collapse by the Federal Reserve, which cut interest rates to zero, and the government, which, quarantining people, began handing out money to companies and consumers. 

Social media users buy those stocks that hedge funds are actively shorting - playing down, selling borrowed securities in the hope of buying them back at a profit after a fall. The desire to humiliate professional investors by forcing them to bear losses was one of the privateers' primary motivations. As they band together to buy up stocks, they start driving quotes up, and hedge funds have to close their positions to limit losses by buying shares, which further stimulates the price growth;

In January 2021, Melvin Capital, a fund that shorted GameStop shares, lost $6.8 billion of the just over $12 billion it had on hand. A year later, the fund closed.

Lately, too, there has been what Steve Sosnick, chief strategist at Interactive Brokers, described as "buying the stuff." He said the U.S. stock market rally, which began in April after the collapse that followed Donald Trump's announcement of "retaliatory" import duties, was largely fueled by individual investors buying up large-company stocks and index funds. As a result, indexes experienced the fastest recovery in history and set new all-time highs in late June. "This prompted many people to get into riskier types of investments," Sosnick says. 

Stocks continued to rise in July, thanks to a resilient economy, inflation not yet evident after duty hikes, and strong corporate earnings. "We're seeing all the signs that this has turned into a full-blown meme," adds Brent Kochuba, founder of SpotGamma, which collects derivatives market data.

For no apparent reason, shares of mobile video camera maker GoPro, trading below $0.9, jumped 75% to $1.54 on July 21 - 23, and coffee and doughnut chain Krispy Kreme jumped 32% to $4.32. 

In July, quotes for QuantumScape, which develops solid-state batteries, soared more than 100% in 10 days. Social media speculated that a partnership with QuantumScape could be announced by Tesla, the WSJ noted. 

These stories fit into the typical stock-meme approach of private traders, points out Jon Treacy, publisher of Fuller Treacy Money, an investment newsletter. They raid companies whose stocks have large short positions. For example, Treacy calculated, QuantumScape has 38.4% of its shares in free float, Krispy Kreme has 30%, and another meme participant, Beyond Meat, the world's largest producer of plant-based meat substitutes, whose shares were up 30% on July 21, has 39.3%.

Another indication, says Treacy, is name recognition: "There are several biotech companies on the list with the largest short positions, but they are unlikely to become meme stocks because few people have heard of them." 

Individual investors now play a significant role in the US stock market. Their share has grown significantly since the late 2010s, when trading apps for smartphones appeared, many brokers canceled commissions for stock trades, and then the pandemic made its contribution. Private equity traders now account for 20.5% of total trading turnover, and more than 26% in stocks under $5, according to data from Jefferies Electronic Trading Solutions.

On July 21, trades in 1.9 billion shares of Opendoor took place, accounting for nearly 10% of all trading volume in the U.S. stock market that day. And the number of trades in options on its stock topped 3.4 million contracts - more than the record number of options on GameStop in 2021, notes Bloomberg. 

And more than with Nvidia stock options, adds the WSJ, citing exchange data from CBOE Global Markets. Meanwhile, Opendoor has a market capitalization of about $2 billion, while Nvidia has a market capitalization of more than $4 trillion, notes Andrew Hiesinger, founder of options platform QuantData. 

"It's just unheard of," he told the newspaper. - And this jump in trading was definitely not related to fundamentals. It was speculation."

Playing the stock-meme game is not for the faint-hearted: quote jumps over several days, or even one day, can amount to dozens of percent. Thus, at the opening of trading on July 23, Krispy Kreme shares jumped by 39%, but closed with a growth of only 4.6%. A day earlier, Opendoor securities fell in price by 10%.

Or the other way around - it could be just a game for those who don't think much about it. This was the sentiment among retail traders in 2021: the government, in the fight against the pandemic, supported payments to people who were locked out of their homes and gambled away their ill-gotten gains in the stock market.

Now the situation is different, but employment remains high, the economy is strong, the stock market is setting record after record, and other risky asset markets are euphoric: bitcoin has doubled in price in less than a year and is hovering around $120,000;

"In the meme stock business, the approach is more like this: follow the crowd, follow people you trust on social media, jump into the stock and hope for the best," said Max Gohman, associate chief investment officer at Franklin Templeton Investment Solutions (quote via Bloomberg). - It's a bit like buying a lottery ticket for a roller coaster ride."

Memomania may even affect the companies' actual businesses: in 2021, GameStop and AMC Entertainment, after their shares skyrocketed, made additional share issues, raising funds they would otherwise have had trouble raising. Or maybe not: Bed Bath & Beyond, whose stock was also a meme at the time, has since gone bankrupt. 

In the end, fundamentals trump the bursts of enthusiasm. GameStop's stock has fallen more than 70% from its peak in January 2021 to now, and AMC's stock has fallen nearly 99% from its peak in June 2021.

Memomania may be evidence of an overheating market. "New highs are fueling fear of underperformance" on the upside and an influx of new money, said Michael Arone, chief investment officer at State Street Investment Management (quoted by Bloomberg): "There are certainly decent amounts of liquidity being injected into the market." 

"Investors are grabbing all the goodies available in the market and are not too concerned about rising risks," laments Mike Bailey, analyst director at FBB Capital Partners. The current market sentiment is "a path to irrational euphoria," he says, using a phrase from former Fed Chairman Alan Greenspan, who characterized the market's rise during the 1990s tech bubble.

In some respects, the market is even more overheated now than at the peak of the tech and mortgage bubbles, which ended in full-blown crashes and crises, analysts at Deutsche Bank have drawn attention;

Margin debt (funds that investors borrow from brokers to buy leveraged securities) rose 18.5% on the New York Stock Exchange in the two months through June 30. This is the fastest growth in leveraged funds raised to buy U.S. stocks since late 1999 and mid-2007, according to a Deutsche Bank report.

After that, the U.S. stock market reached the peak of the bubble in March 2000 and in October 2007.

The euphoria could continue for some time if import duties end up being less than market participants anticipate or the Fed softens its monetary policy stance more than expected, Deutsche Bank notes. But it also notes that brokers issued more than $1 trillion in loans to investors and traders in June;

This mark has been reached for the first time in history. Meanwhile, lending rates are much higher now than they were during the 2021 memo, when the Fed had a prime rate near zero. It's now 4.25 to 4.5%, meaning borrowers are spending more to service marginal debt. They may lose the ability to bear those costs if they are no longer covered by rising stock prices and start selling stocks to get rid of leverage. 

The margin debt figure "comes ever closer to the point at which market euphoria becomes too hot to handle," Deutsche Bank noted.

Even if the market is not expecting a repeat of the events of 2000-2022 and 2008, when the bubbles burst, the drawdown could be significant. The 2021 memomania was a kind of precursor to the severe market decline in 2022, when the S&P 500 lost 19% and the Nasdaq Composite lost 33%.

This article was AI-translated and verified by a human editor