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Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors.
Before trading, please ensure that you fully understand the risks involved
Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors. Before trading, please ensure that you fully understand the risks involved

Tuesday, August 23, 2022

The National - Why the meme-stock craze is making a comeback

By Century Financial in Century in News

The National - Why the meme-stock craze is...
Vijay Valecha, Special to The National August 23, 2022

You can’t keep a bad investor down. Last year, Generation Z and millennial investors piled into meme stocks, looking to make a quick killing by ramping up the prices of burnt-out companies, such as video game retailer GameStop and movie theatre chain AMC Entertainment.

Day traders lost their minds — and money — chasing instant online gratification, egging each other on through Reddit subgroups and WallStreetBets.

Some even kidded themselves that they were doing social good by sticking it to Wall Street hedge funds that have been cynically shorting these companies to profit when their shares turned to dust.

It was classic late bull market madness, fuelled by cheap money, high hopes and a fear of missing out, and ended in an entirely predictable fashion.

The GameStop share price fell from a peak of $81 in January 2021 to $10 in a month, turning virtual fun into real paper losses.

Free trading app Robinhood, which was at the heart of the action, saw its active user base drop from a high of 22 million in 2021 to about 14 million in June this year as investors ran for cover.

Many assumed the madness was over for good when this year’s bear market struck. But they were wrong.

Meme stocks are back. Investors, it seems, have learnt nothing. All it took was a flash of positive market sentiment and they whipped out their mobiles and started trading.

GameStop and AMC Entertainment once again find themselves in the centre of the storm, joined by another troubled retailer, Bed Bath & Beyond.

Traditional investors like to buy good companies with bright prospects. Meme investors do the opposite, but they have hit on one truth. Any asset is only worth what people are willing to pay for it.

Meme stocks are totally speculative but maybe that’s the point, with Bed, Bath & Beyond rocketing 500 per cent since the beginning of August, David Morrison, senior market analyst at Trade Nation, says.

“Why worry much about trying to make 1 per cent or 2 per cent a month by trading big established companies, when you can double your money in a day if you get lucky?

“And if you’re unlucky and lose money, you can always post copies of your trading statements on WallStreetBets and watch the ‘witty’ comments roll in.”

Meme stocks flew back into fashion at the same time as wider investor sentiment picked up.

“We’ve seen a sharp rally in US equities since mid-June following the protracted sell-off since the beginning of the year. There’s a growing feeling that the bottom is in and the only way is up,” Mr Morrison says.

Investors are working on the assumption that inflation has peaked and the US Federal Reserve can slow the pace of interest rate hikes, then start cutting in 2023 as the economy slows.

They should not get too comfortable with that concept, Mr Morrison warns.

Yes, inflation may have peaked, at least in the US, but the Fed funds rate is still likely to climb higher from today’s range of 2.25 per cent to 2.5 per cent.

In the UK, analysts are warning that rates could peak at 6 per cent, bringing everyone into a very different world.

US stock markets now look overbought, Mr Morrison warns. “If we get a significant pullback, the bears will be out in force again. It’s going to be a volatile end to the year.”

This summer’s meme stock revival is based on “herd sentiment and excess speculation”, just like the original, so approach with caution, Vijay Valecha, chief investment officer at Century Financial in Dubai, says.

We have entered a new era of higher interest rates with reduced global liquidity as central banks turn the taps off and this demands a different strategy.

“Markets are likely to reward only those products and stocks that provide actual value and use case options in the real world,” he adds.

Now is not the time to pursue a get-rich-quick strategy as it could end up making you poorer at an even faster rate.

“Whatever you do, don’t bet your life savings, although, unfortunately, that’s exactly what many meme-fuelled traders have been doing,” Mr Valecha says.

The summer stock rebound looks more like a bear market rally than something more substantial, Chaddy Kirbaj, vice director at Swissquote Bank, says.

Investors have been buying the dip, encouraged by the drop in US inflation in July to 8.5 per cent, down from 9.1 per cent in June.

They want to get in before the Fed starts easing in earnest and markets rocket, but Mr Kirbaj urges caution. Wall Street may be buzzing, but the real economy is in trouble.

“The underlying risks of recession, global trade disruptions, higher costs of production and increased mortgage rates are intact, so investors should be more cautious than excited about the recent market rally,” he adds.

Mr Kirbaj notes that the 2008 crisis didn’t happen overnight, but took months to materialise. The same could happen again and even slowing the pace of rate hikes may not be enough to revive a struggling economy.

Younger investors aged between 18 and 30 are the driving force behind the meme stocks trade, Philippe Ghanem, founder of global investment gateway SquaredFinancial, says.

That is certainly the case with his company’s younger clients, who are quick to return when the sentiment picks up — and just as quick to stop trading when it falls.

This more “aggressive” investment strategy does not work in the long run, Mr Ghanem says.

“Our clients aged between 40 and 65 are much more conservative and enjoy a notably higher return on investment as a result.”

He believes “sticky” inflation will grind the life out of meme stocks.

“I believe higher inflation is now structural due to factors such as the energy transition, demographics and the cost of building resilience, and will settle around 4 per cent to 5 per cent. If this happens, the craziness should not return,” Mr Ghanem adds.

Others are not so sure, including Walid Koudmani, chief market analyst at financial brokerage XTB.

He says the recent Bitcoin rally shows that investor optimism is hard to crush.

“We could see a significant reaction if Bitcoin broke past $25,000, as returning investors may see that as a potential sign of better things to come,” he says.

The next few months could be tough, but once things ease, it seems highly likely that meme stock madness will return.

Markets have priced in further monetary tightening and are now looking ahead to when the Fed will start to reverse rate cuts to boost the slowing economy, Mr Morrison says.

“This could lead to a rally in all risk assets going into 2023,” he adds.

The current GameStop, AMC and Bed Bath & Beyond bunfight may soon be taking a time out as uncertainty returns, but we could be in for a third round of this nonsense next year. You have been warned.

The National