FINANCIAL MARKET UPDATE 6.8.2021

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

THE RETURN OF MEME STOCK MAYHEM

A handful of companies that had previously garnered a devoted following of individual investors are once again making headlines. Back in January, these ‘Meme Stocks’ saw their share prices rocket to dizzying heights. By early February, many of the highest flyers had given up much of their gains. In recent weeks, some of these same companies have again launched higher. While these stocks have been generating significant buzz, are they actually worth your attention?

Let’s start with some background. The term ‘meme stock’ generally refers to a company whose shares are exhibiting significantly higher than normal volume as a result of the stock being hyped on social media. Prominent examples include GameStop, AMC Entertainment and Blackberry.  Reddit’s WallStreetBets forum, which has grown to over ten million users, is generally considered the launchpad for the meme stock phenomenon. Individual investors using this platform have been able to coordinate enough buying power to move the share price of certain small stocks significantly higher. This activity garnered significant attention in late January but later fizzled out to a degree. Over the last few weeks there has been a resurgence in some meme stocks. As of Monday’s close, the year-to-date gain on GameStop and AMC had risen to approximately 1,400% and 2,500%, respectively.

After observing such massive share price gains, the fear of missing out (FOMO) can easily take hold. In fact, FOMO supplies much of the fuel required for share prices to blast off the way they have. A virtuous cycle can be created after the initial share price gain attracts attention, enticing more buyers, which increases demand, elevating prices further, drawing in additional buyers, resulting in ever-increasing prices. While this may appear to be an easy path to riches, it is important to understand that there are significant risks.

Perhaps the largest risk is the stretched valuations. Many of the meme stocks were negatively impacted by the pandemic lockdowns. AMC Entertainment, the nation’s largest chain of movie theaters, was nearly forced into bankruptcy late last year. As the economy reopens, it would seem reasonable that these companies and their share prices would recover. According to YCharts, the value (market cap) of AMC’s business was about $752 million at the end of 2019. As of yesterday’s close, the business was valued at $27.6 billion. You would be hard-pressed to justify such a massive increase in AMC’s value over its pre-pandemic level. The stock’s price has completely detached from fundamentals, with its share price being driven by a massive supply and demand imbalance.

The fear of missing out can be replaced by the ‘fear of losing everything’ in the blink of an eye. A small price decline can push a few investors to the exits, and their selling causes the price to fall further, spreading the fear and creating more sellers, which pushes the price even lower. The once virtuous cycle becomes a vicious one that destroys wealth as fast as it was created. This type of abrupt sentiment reversal was on full display during a roughly two-week span ending February 9th. During that time, AMC lost over 70% of its value, while GameStop lost over 85%.

Share dilution is another major issue that meme stock owners should be concerned about. When there is significant demand, the market is extremely efficient at providing supply. With the massive rally in meme stocks, largely a function of coordinated investor demand, it shouldn’t be a surprise that some of these companies have taken advantage and issued new shares. While this is a great deal for the issuing company, it’s generally a bad deal for their investors. The ownership interest of existing shareholders declines as the number of shares issued increases (unless a shareholder purchases additional shares).

AMC again provides us a great example of this. The company’s shares outstanding increased late last year and has more than doubled in 2021. While this proved to be a useful lifeline to help the company get through a challenging period, it left its existing shareholders with a significantly lower ownership interest in the business.

Some buyers of meme stocks fully understand that the prices they are paying are astronomical. To the extent that their main goal is to profit from the trade, they believe the momentum can continue and that they can hop along for the ride. There are several issues with this.

For starters, to the extent that the momentum does not last long, a successful sale will incur a high short-term capital gains tax. This means a good chunk of the benefit from taking a substantial risk will go to Uncle Sam rather than remain in the investor’s brokerage account. Even doing that assumes the investor will know when the right time to sell arrives. The problem, of course, is nobody knows for certain, and many will be wrong. For every investor that sells near the top, there must be a buyer on the other side. For those poor souls that ultimately do buy at the top, I am sorry. After quick gains of 1,000%-2,000% (or maybe more), it’s an awfully long way back down to earth.

WEEK IN REVIEW

  • Last week the BLS published the jobs report, which generally disappointed. The economy added 559k jobs during May, while Forecasters surveyed by MarketWatch were anticipating a gain of 670k jobs. The unemployment rate declined from 6.1% to 5.8%, while the participation rate (share of adults working or looking for work) declined to 61.6% versus 63.3% pre-pandemic. Additionally, updated data published last week from both the services and manufacturing sectors showed activity continues to grow at an accelerating pace.
  • Over the weekend, the G-7 announced a (non-binding) agreement to update the global-corporate tax system. Before the agreement can be implemented, each member country will have to pass their own local laws in order to actually implement the agreement (no easy task). There are two main pillars to the agreement. The first would change the longstanding principle that profits should be taxed where value is created, which generally meant where the company was located. This was easily implemented when it came to factory production but is more challenging now, given the increased importance of intellectual property. The updated framework would allow at least a portion of profits to be taxed where the goods and services are consumed. The second component would be a 15% minimum tax on the global income of multinationals.
  • All eyes will be on the May CPI data to be published this Thursday. A high reading on the April inflation report generated some volatility as the market questioned the Fed’s view that the accelerating pace of price increases is transitory. Recent Fed speakers have begun to signal there will likely be a discussion about how/when to begin tapering the asset purchase program at the FOMC meeting next week. A surprise in the inflation data would likely dominate the headlines and weigh on those discussions.

HOT READS

Markets

  • The Fed is in Early Stages of a Campaign to Prepare Markets for Tapering Its Asset Purchases (CNBC)
  • Higher Interest Rates Would Be Good for the Country, Treasury Secretary Yellen Says (CNBC)
  • Is There a Labor Shortage? What the May Jobs Report Tells Us (CNBC)

Investing

  • How To Do Long Term (Morgan Housel)
  • Crypto Frauds Target Investors Hoping to Cash in on Bitcoin Boom (WSJ)
  • The Stock Market vs. Earnings Growth (Ben Carlson)

Other

  • Rampant Pitch-Doctoring in MLB is Pumping Pitchers and Deflating Offenses (SI)
  • What Can You Do to Lower Your Risk of Alzheimer’s Disease (WSJ)
  • Normandy Commemorates D-Day with Small Crowds, but Big Heart (Military.com)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

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JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 12+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. He is also responsible for portfolio trading, research and thought leadership as well as analytics and operational efficiency for the Firm's Financial division. He lives in Omaha, NE.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

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