Meme Stocks: How and Why?
The term “meme” refers to an idea or part of popular society that spreads and multiplies across social media. Memes gained momentum as the internet and social media grew, allowing people to rapidly spread humorous, interesting, or sarcastic thoughts through posts to others worldwide. The instantaneous and multiplicative effect of sharing such information and thoughts across internet platforms can make them go “viral.”
From the outside, the meme stock phenomenon is puzzling. Media coverage certainly didn’t understand the mechanics and sentiment that drove it and did a poor job of explaining it. Once broken down in the components that coalesced to make it happen, I think it’s far easier to digest.
Pump and Dump
The P&D has been around since the advent of capital markets, and in essence, meme stocks are a more sophisticated, orchestrated and organized pump and dump.
Nostalgia
GameStop, the first “meme” stock, holds a place in gamers’ hearts since it was many people’s introduction to gaming. As a longtime gamer, I purchased many of my consoles and many games there over the years, so while it was a failing business model – brick and mortar retail in an era where games are downloaded – it felt like a business worth saving.
In my opinion, Reddit is the lone social media service worth belonging to. It’s essentially an old-fashioned message board where you can engage on topics you find interesting and avoid some of the more mentally toxic elements of other services. It can be a truly rich source of useful information, education, and a place to weigh in with opinions on anything and everything. It has its toxic elements – trolling, group think, echo chambers, and both mis- and disinformation abound.
A sub-Reddit (or sub) is an individual board within Reddit dedicated to a single topic. r/Wallstreetbets (WSB) is a sub-Reddit dedicated to gambling on the stock market. It was a place where options trades, all-in trades on single stocks were encouraged, and victories and massive losses alike are celebrated. Information on the possibility of a GME trade had been discussed throughout 2019 while GME traded for $3-$5, and it was largely panned by the community.
Short Interest
Investors in the stock market can be both long and short. Most people are “long” the market. Being long means owning shares in a company that were purchased at a particular price with the idea that those shares will appreciate in price. Being short means that shares were loaned out at a particular price. The person borrowing those shares is betting that the price will decline and will make a profit when they can purchase those shares at a lower price in the future. Being short 100 shares that were borrowed at a stock price of $100 and purchased back at $75 in the future would net a profit of $2500 when those shares were sold back at a price of $100.
A Short Squeeze
This isn’t unique to GME. When too many people go short a company, each of those people risks losing a tremendous amount of money if the price of that stock has a sudden appreciation. In those instances, borrowers often race to “cover” their short positions, which means buying shares of that company on the open market. Their purchasing of those shares combined with the regular purchasing that drove the price higher in the first place creates a feedback loop that accelerates price appreciation. The short squeeze isn’t unique to GME. Volkswagen rose from $130 a share to $1100 over the course of 2 days in October 2008 because of the same phenomenon (this was driven by hedge funds against other hedge funds, not retail traders). Over the course of two weeks in 2021, GME rose from $2 a share to $120 a share.
\In 2020, the number of shares that had been borrowed for GME was estimated at 120%. More shares had been borrowed than had ever existed. What this meant is that there would never be enough shares available to buy back for borrowers to cover their short positions.
Social Aspect
Once the dynamics of the short squeeze were understood by the participants of Wallstreetbets, the race to force a short squeeze was on. Once the squeeze began, membership on Wallstreetbets ballooned from 1M members to 6M. Once it began, it appeared that it wouldn’t ever stop. As retail investors bought shares, forcing borrowers to buy shares, the price spiraled upward; it seemed that borrowers also understood that there weren’t enough shares to cover and the idea of a nearly infinite rise in price might actually occur.
On the peak day of price appreciation, multiple circuit breakers tripped, halting trading. Robinhood, the most popular retail broker for the retail crowd, halted all trading because they themselves in a liquidity crisis.
The hedge fund that had borrowed the most shares (who held the largest short position) was Melvin Capital. In 2021, Melvin lost an estimated $6B on its short position in GameStop. Melvin Capital closed its doors in 2022 as investors lost confidence in their management and withdrew capital. An estimated $19B was lost by hedge funds in 2021 due to short positions in GME.
Income Inequality and Liquidity
People saw GME as a way to “stick it to the man.” Stimulus checks supplied excess liquidity to retail traders to pour into the stock. Once WSB members saw the power they suddenly had to bleed hedge funds dry, the craze became a cause, and causes have staying power.
New Short Squeezes
Because of the success of the GameStop squeeze, WSB participants began looking for other short squeeze candidates. AMC Theaters, Blackberry, Nokia, and Bed Bath and Beyond. These all had brief periods where short squeezes were attempted, some successful, some not.
Summary
This won’t be the last time this happens. Short interest is tracked by WSB members and hedge funds continue to short stocks they deem to be dead businesses. Whether or not we see another squeeze with the same underlying conditions remains to be seen. With the advent of algorithmic trading, I think it’s unlikely to occur to the same degree; however, I’d also never underestimate the power of greed and the love of gambling that we possess individually and in aggregate.
