The Cult of Meme Investing

2020 was an interesting year. As the pandemic raged, an interesting development rose from the ashes - the rise of the meme investor.

What is a meme investor? A meme investor is an investor who bases investment choices and targets specific investments - whether stocks or cryptocurrency (meme stocks) - based on social media buzz.  

Meme investing is a relatively new phenomenon. Bored from widespread lockdowns and social distancing and armed with stimulus checks, millions of new investors (most young millennials and Gen-Zers) hit the public markets - aided in no small part by free trading platform Robinhood.

These meme investors traded purely on the buzz generated on Twitter and Reddit (specifically subreddit r/wallstreetbets) - often picking up stocks and cryptocurrencies of questionable value such as AMC, Gamestop, Bitcoin, and Dogecoin. The result was extreme volatility in the prices of these so-called meme stocks.

Take, for instance, brick-and-mortar Gamestop (GME) stock. Floundering from waning sales because of the pandemic, GME was trading around $18 at the end of 2020. Anticipating further declines in its price, hedge funds targeted GME and other flailing stocks for short-selling - pouring millions of dollars into short positions.

Then an interesting thing happened in early 2021...

Users on subreddit r/wallstreetbets decided to strike back at deep pocket institutional short sellers by driving the price of GME stock skywards by leveraging social media buzz.

It worked. Millions of meme investors latched onto GME stock - driving its price as high as $380 at one point in January. The 2,000% jump in the GME share price made many investors millionaires overnight. It nearly bankrupted several hedge funds who lost millions when they were forced to cover their short positions with significantly higher priced shares than the lower ones they had anticipated.

The power of meme investing cut both ways because just as easily as meme stocks rise, they can just as easily fall.  

Here’s a headline just from yesterday:

“Meme stocks hit a wall on Thursday with GameStop, AMC, and Clover down big.” -cnbc.com

From its high in January, GME has fallen back as low as $40 and has experienced extreme volatility since the beginning of the year - rising and falling depending on the day and the latest buzz. Other meme stocks such as AMC, Bitcoin, and Dogecoin have all experienced similar trajectories.  

As evidenced by the extreme volatility of the stocks targeted by meme investors, these investors have demonstrated a wanton disregard for any sound investing principles. They could care less about underlying economic fundamentals. They are only concerned about making a quick score rather than following any long-term investment strategy.

There is a psychology behind meme investing with FOMO (the fear of missing out) at the forefront. The FOMO door swings both ways. Just as easily as investors are prone to jump on the bandwagon, they are just as easily inclined to jump off with panic-selling at the slightest headwind, which is common in this type of environment.

Some have even compared meme investing to a cult - with members less motivated by sense and reason than by zealous devotion. For example, Bitcoin is ″more religion than a solution to any problem,” says billionaire Mark Cuban.

Mark Cuban hit the nail on the head with all meme stocks. Their prices have more to do with mass cult-like followings than any underlying value. AMC theatres and Gamestop stores are struggling from the pandemic, with sales down and losses in the millions. There is no reason their share prices should be trading as high as they are. To say they’re overvalued would be an understatement.

Interestingly enough, just like cult members and even Trekkies, Bitcoin adherents have their own jargon full of acronyms and phrases with physical gatherings (pre-COVID) attracting thousands of attendees.

Besides the religious angle, Cuban is right about another aspect of Bitcoin and other cryptocurrencies. They don’t offer any practical, real-world uses or provide any solution to any real-world problem.

In other words, they don’t serve many purposes. They’re not a great medium of exchange as very few retailers accept them, and they’re terrible insulators against inflation and aren’t particularly secure despite their marketing.  

This lack of underlying value explains why meme stock prices are so volatile and have such low floors. On the other hand, hard assets don’t experience the same type of volatility because they have underlying value making it less likely for investors to abandon them like they would with worthless stocks or crypto. Assets like real estate have a solid underlying value that typically doesn’t tank as far or quickly as meme stocks.   

A meme stock is the last asset you want in your portfolio in a downturn as it will tank along with the rest of the market. And as an inflation hedge, it is far too volatile - with no protection from rising prices and eroding buying power.

Meme stocks occupy big chunks of internet real estate - taking up a lot of cyberspace in social media discussions. Finding other investors talking about the same investment gives newbie investors a sense of belonging. But as we learned as kids, It’s all fun and games until someone gets hurt.

The downside of social media-fueled investing is that it promotes risky behavior. People are more prone to make poor decisions in groups; they wouldn’t think of doing it independently. When everyone is doing or talking about something, it’s easier for an individual in the group to adopt the same behavior.

Utpal Dholakia, professor of marketing at Rice University, found in his research on financial decision making that: 

“When people talk about their investments in online social environments, they tend to become more risk-seeking in the types of investments they make.”

The problem with cults is that they never end well, and everything in the market is pointing towards a crash with cracks already showing with intraday meme stock, and crypto plunges becoming more and more common.  

As for me, I have never cared what everyone else is doing. One of my principal requirements for any investment is that the underlying asset has value and serves a purpose.

While meme investors chase capital gains from assets with no underlying value, I prefer assets that fill a real-world need and have intrinsic value. And unlike the meme investors, underlying economic fundamentals matter to me.

Adhering to these principles has served me well in good times and bad, which is more than I can say for meme investors who are bound to suffer when the shoe eventually drops.