Why Are Things So Crazy Right Now?

I’ve been off from writing for a few weeks because I was writing the CFA Level 2 exam at the end of May and needed to devote more time to studying. For those who don’t know CFA stands for Chartered Financial Analyst and is one of the more common designations in the financial world. It’s an extremely challenging exam with a huge amount of material to cover. However, even with all of that material in the curriculum, one thing that was definitely not on the exam was how to deal with meme stocks!

What is a Meme Stock?

A meme stock is a very recent phenomenon where the value of the company is not derived from the underlying value of its business but from its popularity in social media. In other words how funny is the meme is the only thing that matters for the value of the company. This is not rational. But if you thought human beings were always rational, you really haven’t been paying attention in the last 18 months!

GameStop

The original meme stock was Gamestop. I’ve written about Gamestop before (attached link) and why the price of its stock shot up to unsustainable levels back in February. We’ve seen bouts of volatility since then and Gamestop has recently surged again, trading at around $253 today. To illustrate the insanity of the Gamestop price movements over the past 6 months, the following are the closing prices on the first day of each month:

• January 1st - $18.84 a share
• February 1st - $225.00 a share – (it opened on Feb 1 at $316.56 a share!) (+1094%)
• March 1st - $120.40 a share (-46%)
• April 1st - $191.45 a share (+59%)
• May 1st - $162.20 a share (-15%)
• June 1st - $249.02 a share (+54%)
  
  

Efficient markets these are not! These kind of price movements are not at all explainable by the actual underlying business. GameStop did not become an 11 times more profitable company in February. No the reasons for these price movements has more to do with the madness of crowds.

AMC Entertainment

The latest champion for the meme stock community is AMC Entertainment. AMC was part of the original meme stock surge back in February but it played second fiddle to GameStop. Now in the most recent surge it has taken the lead, not the least of which is because, while GameStop has largely ignored its popularity as a meme stock, AMC on the other hand has leaned into it fully.

AMC’s stock price has risen from about $2.12 a share on January 1st to close at $62.55 a share on June 2, a 2,850% return. You can see from the chart below that although it did have a very sharp rise in the price in February, that was nothing compared to the most recent surge.

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During that time, AMC has issued and sold hundreds of millions of dollars of stock to the public in order to raise cash for their business. This was done on the theory that - our stock is popular, and people are buying it anyways, so we might as well be the ones to sell it to them! This despite the fact that AMC movie theatres remain closed or at limited capacities in many jurisdictions due to the pandemic. It’s also not clear how quickly they will recover even after the pandemic is in the rear view mirror. Again, this rise in prices is not based on fundamentals!

Why Are Things So Crazy Right Now?

Well there are a lot of factors at play with these two stocks in particular. They are smaller companies which were heavily shorted and that has led to some price volatility that wouldn’t have happened in a larger, less shorted name. They are probably two of the companies that would be hardest hit by a pandemic, and I suppose the end of such pandemic might result in a very strong resurgence. They are also easily understood businesses that probably appeal to a retail investor crowd for that reason. What’s more retail investors have harnessed the power of social media to coordinate buying for these meme stocks on a level not seen before.

Still none of these reasons can really explain the madness we’ve seen.  But then again… is it madness? Thousands of investors have probably made a lot of money on trading GameStop and AMC. So is it really irrational for them to think they can do it again?

Depends on Your Perspective

Well I guess it depends on your perspective. A lot of the trading that is being done by these retail traders has more in common with gambling at a casino then it does with investing. When you’re gambling you know that you’re expected to lose, but it can be fun anyways. That might not be rational in the strictly financial sense, but if people enjoy it then there is nothing wrong with it. Where it becomes a problem is where a person risks more than they can afford to lose. Losing money at the blackjack table or in the stock market is no different if you are just having fun with it. When you mortgage your house to try and get rich though it quickly becomes a very bad and very irrational idea.

An Intelligent Investor

Ben Graham defined the difference between Investing and Speculating 72 years ago when he wrote the Intelligent Investor. We obviously stick to investing in our practice but that’s not to say that speculation is evil or shouldn’t be done. But you can tell from the title of Graham’s book that “intelligent” investors should try and stick to investing for their retirement savings and leave the speculation for their fun money. Meme stocks definitely fall into the fun money category and for now, the fun money seems to be ruling the market.

- Craig White, BA, LL.B., CIM®

Craig White is an Investment Advisor at Endeavour Wealth Management with iA Private Wealth, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Craig White an Investment Advisor for iA Private Wealth and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.