- Echoes of speculative episodes of 2021 and 2024 as downtrodden shares in loss-making firms surge
- Krispy Kreme and Beyond Meat are heavily shorted, to set up another duel between Main Street and Wall Street
- Prior meme stock surges fizzled out pretty quickly (but silver would have worked out well, had the buyers held on)
- Frothy markets are an additional complication for the Fed as it seeks to set monetary policy
“Here we go again. This time it is Beyond Meat and Krispy Kreme, rather than GameStop, AMC Entertainment or even silver, but social-media focused meme stock hunters are back looking for quick bucks,” says AJ Bell investment director Russ Mould.
“Regardless of how long this latest speculative episode lasts – and Beyond Meat rose from $3.62 to $6.50 and then fell back to $3.58 on Wednesday alone – it does raise serious questions about whether the US Federal Reserve should be contemplating a reduction in interest rates and loosening monetary policy when financial markets continue to run very hot, given the potential for someone to get badly hurt if yet more liquidity is poured into the system.
“This is happening barely four years after the GameStop melt-up (and, lest it be forgotten, subsequent melt-down), which also saw social media influencers and commentators stir interest in a range of meme stocks, including AMC Entertainment and even silver (which now seems to be doing rather well despite the Reddit crowd’s apparent loss of interest in the commodity).
Source: LSEG Refinitiv data.
“The last meme stock surge did not last long and, it could be argued, presaged 2021-22’s nasty correction in risk assets. The risk remains that investors could get caught out this time, too, especially if they are latecomers to the buying frenzy.
Source: LSEG Refinitiv data.
“Benjamin Graham, Warren Buffett’s mentor, argued that the best long-term investment returns were reaped by realists who bought from pessimists and sold to optimists. You can argue that the short squeezers are at least buying from pessimists when it comes to Beyond Meat and Krispy Kreme, but it may be that more than a few optimists are piling in now, hoping to ride the share price momentum to a quick gain.
“Such a devil-may-care attitude to risk can lead to trouble and the precedents are clear to see in the overheated markets seen in the late 1920s and late 1990s and (to a lesser degree) the mid part of the first decade of this century. They all ended in tears and big market setbacks which hurt a lot of investors, traders and ultimately did damage to the wider economy, as money was misallocated and squandered.
“Perhaps we should therefore all be heeding the warning of economist (and stock market investor) John Maynard Keynes when he said, ‘When the capital development of a country becomes the by-product of a casino the job is likely to be ill-done.’
“Quite what plan the buyers of Beyond Meat and Krispy Kreme have remains to be seen, although long-term, efficient allocation of capital does not necessarily seem to feature. That may be of no concern to those who are confident that there are quick profits to be had, but previous efforts to squeeze short sellers in this stock ultimately failed and it is hard to push around the price of a security or asset on a sustained basis, for three reasons.
- The best cure for high prices is high prices. In the end some traders somewhere are going to want to take a profit on Beyond Meat and Krispy Kreme and someone is going to left holding the bag – at least one unfortunate person must have paid the top tick in GameStop at around $87 and be sat on a loss to this day.
- All short squeezes or ramps have an element of a pyramid scheme about them as they need new money coming in to maintain the upward price momentum (and also give early movers a chance to book their profits and move on), so ultimately you start to run out of (other people’s) money.
- If none of that works, the regulator can take umbrage and get involved. This is what happened when the Bunker Hunt brothers tried to corner the silver market in the late 1970s, although the authorities only tend to get involved once the bubble has burst, and heavy losses, financial distress or wider market or economic turmoil have resulted.
“The collapse of the South Sea Bubble in 1720 eventually germinated Sir John Barnard’s Act in 1734, which outlawed both short selling and the use of derivative products such as futures and options (and was only repealed over 200 years later). Similar responses followed the 1929 Wall Street Crash, in the form of the Glass-Steagall Act, and the 2007-09 Great Financial Crisis, with the Wall Street Reform and Consumer Protection Act (or Dodd-Frank, as it is more commonly known). The theme across all three acts was limits to the use of derivatives and leverage.
“However, the use of margin debt continues to flourish in the USA, and the total now sits above $1.1 trillion for the first time.
Source: NYSE data to February 2010, FINRA data from February 2010. LSEG Refinitiv data.
“That could be helping to fuel markets now, but history shows that confidence soon evaporates if the market stumbles and history suggests the liquidation (forced or voluntary) of positions bought on margin accentuate any subsequent market decline.
Source: NYSE data to February 2010, FINRA data from February 2010. LSEG Refinitiv data.
“It is here that dangers may lie today. There are legion examples of how leverage, overconfidence, and central bank provided liquidity create trouble in the form of one crisis after another. In the past 30 years alone, we have gone from Orange County to the Tequila Sunset, to Barings to the Asian currency crisis, to the Russian debt crisis and LTCM to the tech bubble, to the mortgage securities bubble and the Big Short and beyond.
“Central banks have a very difficult balancing act ahead of them, as they try to do what they feel is right for the real economy, without handing out too much rocket fuel to financial markets, while keeping government interest bills manageable and, in some cases, fending off political interference for good measure.
“It will not be easy to get the balance right, and it is possible to argue that now is not the time to cut rates in the USA, given frothy markets, healthy GDP growth, low levels of unemployment and above-target inflation rates. Bubbly financial markets may help the capital gain tax take, for sure, but a speculative blow-off must surely lead to a blow-up at some stage, with all of the deleterious consequences that could have for savings, consumer confidence and capital formation, especially if much money has been wasted and lost.”
