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What are ‘meme’ stocks and is this new trend hinting at the next market crash or the opposite? Image Credit: Pexels

Dubai: A new market trend coined ‘meme’ stocks has been on the rise, but it is has been causing widespread concern among experts and analysts as to whether it is indicative of a potential market bubble or an imminent crash.

When a stock that has seen an increase in trading volume not because of the company’s performance, but rather because of hype on social media and online forums like Reddit, it’s referred to as a ‘meme stock’ – and an increasing number of such stocks have been spotted in recent months.

Additionally, there has already been a lot of chatter about whether stock markets worldwide are in a ‘bubble’ state and numerous market and industry experts have in the last weeks put out an alarming number of convincing statistics and arguments.

So with ‘meme stocks’ and other unrealistically priced assets currently in the market and new indicators pointing towards a possible market crash, investment risk and related investor uncertainty has spiked markedly.

What is a stock market bubble?
A stock market bubble – also known as an asset bubble or a speculative bubble – is when prices for a stock or an asset rise exponentially over a period of time, well in excess of its intrinsic value.

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Although there are multiple definitions of what a ‘bubble’ is, the essence of them all is that stock prices have gotten to an unsustainably high level, driven by unreasonably positive investor expectations – and when those expectations change, prices will revert to normal, dropping a lot in the process.

After a record rebound from a pandemic-induced market crash last March, stock benchmarks worldwide have raced past a series of record highs in the first six months of 2021. As stocks hit record highs, top banks are getting an increasing number of inquiries on whether the boom, which has some parallels to the dotcom crash, will result in a similar bust.

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How did meme stocks come about?

Meme stocks initially came on to the scene in late January 2021. Namely, this was and is still thanks to retail investors on the social media platform, Reddit.

Particularly, these investors banded together by pooling resources and pumping them into the most shorted stocks at the time. As a result, said stocks saw their values skyrocket overnight.

Now, some four months after the initial phase of this trading frenzy, meme stocks appear to be making a comeback. Along with several of the classic names, retail investors appear to have a growing meme stocks list to choose from.

For instance, US-based plant-based meat substitute producer Beyond Meat and US-based headphone manufacturer Koss Corporation are joining the madness. Beyond Meat stock is up by over 40 per cent in the past two weeks. More impressively, Koss stock is looking at year-to-date gains of over 1,100 per cent.

While the current meme stock saga unfolds, analysts evaluate that more adventurous investors could be keen to jump on the meme train. However, meme stocks and meme cryptocurrencies (link to Hanna’s Dogecoin story) are dominating headlines amid resurfacing fears of a possible market crash.

Meme frenzy grabs headlines

Some strategists fear the meme frenzy as a sign of a bubble building in the stock market. Two most notable recent examples include US-based video game company GameStop and cinema chain AMC Entertainment.

Shares of AMC have skyrocketed more than 2,000 per cent this year. That's more than 20 times more than the best-performing stock in the S&P 500, US-based energy firm Marathon Oil.

Other meme stocks have similarly held on to their Reddit-fueled gains, with GameStop up 1,400 per cent and BlackBerry 120 per cent.

Steve Massocca, managing director at US-based investment firm Wedbush Securities, noted that the trading in names like GameStop is one of the things that has made him more cautious about the market.

He said the high valuations on the meme names are unlikely to last. “It’s going to be around as long as cicadas are,” he said, referring to the insect that lives just a few short weeks above ground after spending as many as 17 years underground.

What signs point towards a crash?

What signs point towards a crash?

Analysis shows that one of the biggest red flags can be seen on the valuation front.

On a key stock market benchmark, the S&P 500 in the US, which is tracked by stock indices worldwide, the price-to-earnings (P/E) ratio – a measure of inflation-adjusted earnings over the previous 10 years – closed this past week at 37.28.

For reference, that's more than double the average S&P 500 P/E dating back to 1870.

The concern is that in the previous four instances where the S&P 500's P/E ratio topped and sustained 30, the index went on to lose at least 20 per cent not long thereafter. Precedent suggests that premium valuations like we're seeing now aren't well-tolerated for long periods of time.

History also sheds light on how the markets typically respond following a bear market bottom (when a market experiences prolonged price declines and bottoms at a record low).

At no point over the past 60 years has there been a bear market that didn't correct between 10 per cent and 19.9 per cent at least once within three years of hitting a bottom. We're now more than 14 months removed from the March 2020 bottom and have yet to see a double-digit percentage retracement in the benchmark S&P 500.

Since 1950, markets have witnessed 38 double-digit declines, or one every 1.87 years, on average. Although stock markets never precisely follow averages, it does offer a reference point that declines are normal.

Since 1950, markets have witnessed 38 double-digit declines, or one every 1.87 years, on average.

US meme stocks starting to burst at seams

Shares of AMC Entertainment plummeted Thursday morning alongside a slew of other recently resurgent meme stocks after the company cautioned investors that its stock has become massively overvalued, echoing experts who've been warning of an impending correction.

AMC stock cratered as much as 40 per cent Thursday, wiping out $9 billion (Dh33 billion) in market value, after the company said it was looking to raise cash by selling nearly 11.6 million shares at market prices while also cautioning people to only buy its stock if they’re willing to risk losing all their money.

At least twice Thursday morning, the price volatility became so intense the New York Stock Exchange halted trading of AMC shares, a procedure typically exercised to prevent erratic, sentiment-fuelled market swings.

After AMC's plunge, shares of US-based retail store chain Bed, Bath & Beyond, which skyrocketed 62 per cent Wednesday, plunged as much as 26 per cent, and GameStop, the top-performing meme stock during the trading frenzy in late January, fell nearly 13 per cent.

Even shares of BlackBerry, which at one point surged nearly 15 per cent Thursday, fell 6 per cent by later in the day.

Although it is believed that the momentum of growth, witnessed during late 2020 and early 2021, will fade away, equity markets are still expected to grow for now – albeit at a much slower rate.

What to watch out for

Gary Gensler, the US Securities and Exchange Commission's recently appointed head, said the agency would release a report this summer detailing the issues raised by recent trading frenzies.

Gensler suggested regulators would crack down with new rules targeted at online brokerages like Robinhood, which he said have "gamified" investing "to get people to trade more”.

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Although it is believed that the momentum of growth, witnessed during late 2020 and early 2021, will fade away, equity markets are still expected to grow for now – albeit at a much slower rate – providing opportunities for investors to earn some profits.

However, as to the recent meme frenzy resulting in added scrutiny of markets, the trend will have to be closely watched, given indications of stock markets having limited room for significant growth.

Verdict: Should I invest in ‘meme’ stocks?

While it's possible to see substantial earnings with meme stocks, it's also important to make sure you know what you're getting into. The biggest risk is that they're unpredictable. Often, their stock prices are based more on online hype than the company's underlying business fundamentals.

The more people invest in a stock, the higher its price rises. Investors on social media can artificially inflate prices by convincing as many people as possible to invest in a particular stock. Then the more the stock price rises, the more people want in on it. That causes the price to climb even higher, and the cycle continues.

The problem arises when the price inevitably falls. When stock prices rise well beyond what's reasonable for that particular company, it's only a matter of time before the price plummets. And if you don't sell your investments at just the right moment, you could experience devastating losses.

For example, consider GameStop's first incredible rise earlier this year. The stock skyrocketed essentially overnight. But when the price began to fall, it lost close to 85 per cent of its value in the span of just over a week. If you had invested in GameStop right as it reached its peak, you would have experienced a rough fall as the stock price sank.

This doesn't mean you can't make money with meme stocks, but it's far more likely you'll lose more than you'll gain.

Investment portfolio
Meme stocks can be incredibly risky. Fortunately, though, there are much safer ways to invest your money.

Where should I invest in instead?

Meme stocks can be incredibly risky. Fortunately, though, there are much safer ways to invest your money.

One of the most effective investing strategies is to buy healthy stocks and hold them for the long term. When you invest in healthy companies with strong fundamentals, the stock price is far more predictable. These stocks likely won't experience explosive growth like meme stocks, but they're much safer and more stable.

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As you're researching long-term stocks, be sure to look at factors like the company's revenue growth and whether it has a competitive advantage in its industry. These factors set strong companies apart from the others, and these organizations are more likely to make for healthy long-term investments.

When you invest for the long term, you won't make millions of dirhams overnight. But if you're patient, you can make a lot of money over time without putting your hard-earned savings at risk.