MEME stocks are back, with retail investor speculation igniting the July market frenzy and raising concerns about a stock market bubble. However, analysts believe the spillover effect of this round of speculation on the overall market is relatively limited.
Analysts argue that unlike the MEME stock craze led by GameStop and AMC Entertainment in 2021, the current speculative activity is mainly concentrated in small-cap and low-priced stocks, with minimal impact on major indices like the S&P 500.
Despite the risk of capital misallocation, historical experience shows that such speculative bubbles usually do not affect the broader market.
Low-Priced Stocks Become New Speculative Darling, Trading Volume Reaches Record High
The most notable feature of the July market is the crazy chase for low-priced stocks. Data shows that the bottom tenth of stocks by initial price saw a median increase of 16% on July 23rd when the new round of MEME stocks peaked, far exceeding the 1.4% gain of the highest-priced stocks. The starting stock price became the best predictor of performance that month.
This investment logic based on stock price rather than company fundamentals seems absurd to institutional investors. Companies can easily change their stock price through simple stock splits or reverse splits without affecting shareholders' actual ownership proportion or profit sharing. Unless the stock price is long-term below $1 and faces delisting risk, the absolute stock price itself is meaningless.
However, many retail investors either do not understand this basic principle or choose to ignore it. In the frenzied trading of July, their strategy indeed worked, while professional investors' rational analysis failed. When the speculative fever reversed at the end of the month, the cheapest stocks also fell the most, by 6%.
Capital Allocation Concerns Emerge, Historical Lessons Worth Heeding
Excessive speculation can lead to improper capital allocation, as the MEME stock craze of 2021 clearly demonstrated.
At the time, companies like GameStop and AMC issued billions of dollars in new shares when their stock prices were high, but their stock prices subsequently plummeted. GameStop and AMC have currently fallen 74% and 99% from their peaks, respectively.
Economist Keynes warned in 1936 that when "business becomes the bubble on a speculative whirlpool," capital will flow to the wrong companies, damaging growth and employment. This concern is equally applicable in the current environment, especially when speculative funds flood into companies with weak fundamentals.
However, the impact of current speculative activities is relatively limited.
There are no low-priced stocks in the S&P 500, and cheaper stocks among large companies did not show a clear performance pattern in July. When retail investors pushed up bubbles in green stocks, SPACs, and loss-making tech stocks in 2021, the bursting of these bubbles also had minimal impact on the broader market.
Market Sentiment Tends Towards Rationality, Overall Risk Controllable
Long-term sentiment surveys from the American Association of Individual Investors and Investors Intelligence show that while current investor sentiment is more positive than at the beginning of the year, it has not reached an overly optimistic level. Futures traders tend to be bullish on options, but not to the extent seen in 2021.
Analysts estimate that retail investors may have boosted the S&P 500 through bottom-fishing since April, but their influence was relatively limited in July.
The current round of MEME stocks, dubbed DORK stocks (derived from company codes of Krispy Kreme, Opendoor Technologies, Rocket, and Kohl's), is just the public manifestation of private traders' summer speculative frenzy.
Although investors have reasons to worry about high stock prices, tariffs' impact on profits, potential economic weaknesses, and excessive AI enthusiasm, the boom and bust of MEME stocks and low-priced stocks have a very limited spillover effect on the rest of the market. Historical experience shows that such speculative activities are more of a marginal market phenomenon, rather than a significant source of systemic risk.
