The number of shares sold short in these and other meme stocks would suggest that a lot of people have come to the conclusion that their underlying businesses are worth zero. So, the thinking is that you short the shares and wait for the companies to go bankrupt. The problem is that stocks don’t go to zero because they are bad businesses; they go to zero because they encounter a liquidity crisis and run out of cash. (I should know as I worked at Lehman Brothers Holdings Inc. when it collapsed.) It is very difficult for a publicly traded company to run out of cash. They can borrow, issue more stock and tap a credit line, among other things. CEOs have many options at their disposal to prevent the stock from going to zero.
The issue is framed such that buying meme stocks is risky, and you shouldn’t do it. Well, it turns out that shorting meme stocks is perhaps even more risky! It doesn’t matter if you think a stock is worth zero, the reality is that it’s worth whatever someone is willing to pay. The bigger issue, though, is that the meme stocks’ prices have an abnormal and large right tail, meaning that they have the potential to explode higher at any moment. On Wall Street they call trying to profit despite this as “picking up nickels in front a steamroller.”
I have a strong suspicion that it’s not Reddit users who are powering these stocks higher. I think it’s hedge funds. The Redditors are pretty much out of ammo at this point, having burned through the government’s stimulus checks long ago and suffering big losses more recently. The shares of Robinhood Markets Inc., where many of these investors traded, are down 82% the last year on a declining user base. The only way these stocks can stage such a rally is because big investors are pushing them higher. And why not? They certainly have the means to engineer a “short squeeze.” So, the meme-stock trade today isn’t really r/wallstreetbets versus big bad hedge funds, it’s big bad hedge funds versus big bad hedge funds. Those Reddit users who are still around are simply along for the ride.
The timing couldn’t be better for meme-stock bulls. For the first time in a long time, growth stocks are back to outperforming value stocks. Cathie Wood’s bellwether ARK Innovation ETF is up almost 40% from its low this year in mid-June in a sign of rekindled animal spirits. While it’s entirely plausible that these businesses will return to fair value in the stock market, it might take much longer than the short sellers expect.
I don’t like meme stocks. I have a handful of acquaintances and family members who are unsophisticated about finance who bought meme stocks in 2021, having heard about them through various media. I said at the time that meme-stock mania was a massive wealth transfer from the unsophisticated to the sophisticated, especially for buyers of options tied to the stocks. And that has largely proven true, destroying a lot of capital belonging to people who couldn’t afford to lose it. And the longer interest in meme stocks lingers, the more capital these stocks will attract and ultimately be destroyed. The one thing I have never understood about the frenzy is that retail investors picked the worst stocks to speculate on — the ones with the poorest growth prospects and on the verge of bankruptcy. But that was the postmodern financial world of 2021 and seems to be continuing to this day.
It’s possible that going forward the stock market will have a handful of speculative footballs that hedge funds will fight over in the octagon, with a bunch of crazy cult members along for the ride. These aren’t the first meme stocks we’ve ever had — Krispy Kreme Doughnuts comes to mind from 20 years ago — but they’ve lasted the longest. What will it take stop them? Probably nothing but a long, slow denouement. People have a short attention span. They’ll move on eventually.
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Jared Dillian is the editor and publisher of the Daily Dirtnap. An investment strategist at Mauldin Economics, he is author of “All the Evil of This World.” He may have a stake in the areas he writes about.
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