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Picture of Christopher A. Hopkins, CFA

Christopher A. Hopkins, CFA

Meme stock redux: weapons of financial destruction

Meme: an idea, behavior, style, or usage that spreads from person to person within a culture – Merriam-Webster.com

On May 12, a cartoon drawing of a video gamer leaning forward in his chair appeared on X (formerly Twitter). No captions or explanations. But the target audience received the coded message. The next day, shares of GameStop shot 75% higher followed by an additional 100% gain the following day. Struggling theater chain AMC enjoyed a similarly unexpected and unwarranted surge, but by the end of the week both stocks had just as suddenly surrendered most of their gains. Welcome to the wild world of meme stocks.

Evolutionary biologist Richard Dawkins coined the term “meme” in 1976 from a Greek word “mimema”, something that is imitated or repeated. He was searching for a suitably descriptive term describing the rapid popular or cultural transmission of an idea or concept, analogous to how genes vigorously replicate to transmit hereditary information. The Greek root also gives us the words mime and mimic.

What Dawkins did not imagine was how his conception of viral proliferation could so markedly impact an institution like the stock market that is theoretically governed by rationality and objective data. Bubbles and manias have always been with us of course, but the internet age with the immediacy and reach of social media channels has lent a new dimension to the madness of crowds. Meme stocks like GameStop and its ilk, surging and crashing and surging again without regard to underlying fundamentals like profits or cash flows are now a non-trivial force in the market and pose a risk to individual investors who succumb to their siren song.

The meme of a video game player hunching forward conveys a particular meaning to initiates. In gamer culture, the posture signals special attention or heightened focus, suggesting that decisive action is imminent. It was the first utterance in 3 years from Roaring Kitty, the X handle for a former financial analyst named Keith Gill. The cryptic post flashed the bat signal to a tight community of traders active on blogs and bulletin boards dedicated to high-frequency, active stock trading.

Gill had been present at the creation of the earliest meme stock craze in 2021 when his posts on the Reddit thread known as WallStreetBets ignited a flurry of buying in the beleaguered and nearly worthless GameStop. Reddit is a social news exchange and forum on which members share thoughts and opinions regarding a wide variety of topics. A subset of Reddit members follows a thread (or subreddit) called WallStreetBets that shares information, gossip, and hype about specific stocks. Mr. Gill, the Roaring Kitty of X, was widely followed on Reddit under a profane username.

Fueled by irreverent viral chatter on Reddit, the share price shot sharply higher, creating a world of hurt for a cadre of professional speculators who were betting against or “shorting” the stock.

Profiting from a falling stock by short selling requires the investor to borrow shares from another holder and then sell those shares with the expectation of buying them back at a lower price to return to the lender. Gill had observed an extraordinary level of short selling in GameStop, at one point reaching 140% of the outstanding shares (meaning even some shorted shares were re-lent and shorted again, an unsustainable condition).

Short selling is notably risky. If the bet sours and the stock price rises, these speculators are forced to quickly buy the stock to repay the borrowed shares, a costly episode known as a short squeeze.

When the Kitty roared on WallStreetBets in 2021, followers reveled in the pain inflicted on short sellers, sort of a chat version of sticking it to the man. The short squeeze briefly sent the stock 1,500% higher for a cup of coffee before collapsing 85%. Short sellers lost around $5 billion, but so did most of the Reddit bros who jumped in at the top before the stock plummeted back toward some approximation of its true value. Once the excitement subsided, Gill retreated from posting and GameStop resumed its gradual decline until the recent reemergence of Roaring Kitty. Rinse and repeat.

Some Reddit forums like WallStreetBets exude the ambience of a high school locker room. With wagering idled in 2020 due to the pandemic shutdown of major sports, adrenaline junkies flush with wads of Covid stimulus cash turned to stock trading to scratch their itch, following the often-costly advice of sports book celebrities-cum-stock jockeys. Meanwhile a crop of new online brokers like Robinhood offering commission-free trading gained popularity on Reddit. Tie it together with social media bulletin boards linking these rookie stock traders in real time, and you have the recipe for some wild rides.

While a handful of early speculators like Gill can pocket large gains during these transient bubbles, most individuals who followed the herd got fleeced. S&P estimates that meme-influenced players who leaned forward into the latest GameStock trade lost $13 billion in just 3 days.

Ironically, one real beneficiary was the troubled GameStop itself, which cleverly sold $1.6 billion in new stock during the 2021 frenzy, providing a critical lifeline even as it has suffered over $2 billion in operating losses and closed 24% of its stores since 2019. The company also awarded the outgoing CEO a Reddit-powered $179 million bonus. So much for sticking it to the man.

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