Despite the risk of capital misallocation, historical experience shows that the bursting of such speculative bubbles typically does not affect the broader market.
Written by: Bu Shuqing, Wall Street Insights
Meme stocks have made a comeback, igniting retail investor enthusiasm and leading to a market frenzy in July, which has raised concerns about a stock market bubble. However, analysts believe that the spillover effects of this round of speculation on the overall market are relatively limited.
Analysts note that, unlike the 2021 meme stock craze dominated by GameStop and AMC Entertainment, the current speculative activity is mainly concentrated in small-cap and low-priced stocks, having minimal impact on major indices like the S&P 500.
Despite the risk of capital misallocation, historical experience indicates that the bursting of such speculative bubbles usually does not affect the broader market.
Low-priced stocks become the new favorites for speculation, with trading volumes reaching record highs
The most notable feature of the July market was the frenzied pursuit of low-priced stocks. Data shows that the median price increase of the bottom decile of stocks, which had the lowest prices at the beginning of the month, reached 16% by July 23, when the latest round of meme stocks peaked, far exceeding the 1.4% increase of the highest-priced stocks. The initial stock price has become the best predictor of performance for the month.
This investment logic, based on stock price rather than company fundamentals, seems quite absurd to institutional investors. Companies can easily change their stock prices through simple stock splits or reverse splits without affecting shareholders' actual ownership or profit-sharing. Unless a stock price remains below $1 for an extended period and faces delisting risks, the absolute stock price itself holds no real significance.
However, a large number of retail investors either do not understand this basic principle or choose to ignore it. During the frenzied trading in July, these investors' strategies did indeed work, while the rational analysis of professional investors faltered. When the speculative frenzy reversed at the end of the month, the cheapest stocks also saw the largest declines, reaching 6%.
Concerns about capital allocation arise, and historical lessons warrant caution
Excessive speculation can lead to improper capital allocation, and the meme stock craze of 2021 has provided a clear example.
At that time, companies like GameStop and AMC took advantage of high stock prices to issue billions of dollars in new shares, but their stock prices subsequently fell sharply. GameStop and AMC are currently down 74% and 99% from their peaks, respectively.
Economist John Maynard Keynes warned in 1936 that when "real enterprises become bubbles in the whirlpool of speculation," capital will flow to the wrong companies, harming growth and employment. This concern is equally applicable in the current environment, especially when speculative funds flood into companies with weak fundamentals.
However, the scope of current speculative activity is relatively limited.
There are no low-priced stocks in the S&P 500 index, and cheaper stocks among large companies did not show significant performance patterns in July. When retail investors drove up green stocks, SPACs, and loss-making tech stock bubbles in 2021, the bursting of these bubbles also had minimal impact on the broader market.
Market sentiment is becoming more rational, and overall risks are 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 yet reached overly optimistic levels. Futures traders tend to favor call options, but to a much lesser extent than in 2021.
Analysts estimate that retail investors may have driven up the S&P 500 index through buying on dips since April, but their impact in July was relatively limited.
The current round of meme stocks, referred to as DORK stocks (derived from the ticker symbols of companies like Krispy Kreme, Opendoor Technologies, Rocket, and Kohl's), is merely a public manifestation of private traders' summer speculation frenzy.
While investors have reasons to be concerned about high stock prices, the impact of tariffs on profits, potential economic weaknesses, and excessive enthusiasm for artificial intelligence, the boom and bust of meme stocks and low-priced stocks have relatively limited spillover effects on the rest of the market. Historical experience shows that such speculative activities are more of a marginal phenomenon in the market rather than a significant source of systemic risk.
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