Meme stock frenzy returns: Retail investors gamble against institutions, beware of the intertwining of bubbles and interest rate cut expectations
The meme stock craze is back, with intensified competition between retail investors and institutions, revealing risks of market bubbles. Although stocks like Opendoor and Kohl's remain at high levels, the S&P 500 and Nasdaq 100 indices have reached all-time highs, the momentum of meme stocks has weakened, and Bitcoin has also retreated. FINRA data shows that margin debt from investors borrowing funds to purchase stocks has reached a record high, with market valuations being elevated, as the expected price-to-earnings ratio of the S&P 500 approaches 23 times. Some investors are beginning to reduce their positions, wary of short-term risks
Zhitong Finance APP learned that last week, the frenzy of meme stocks made a comeback, putting professional investors in a dilemma: should they ride the wave of retail trading enthusiasm or view it as a warning signal of an impending market bubble correction?
This week, stocks caught in the speculative frenzy, such as Opendoor Technologies Inc. (OPEN.US) and Kohl's (KSS.US), although they retraced some gains mid-week, mostly remained at several-month highs. The S&P 500 Index and the Nasdaq 100 Index performed even more impressively, having strongly rebounded and reached historical highs since the sell-off triggered by the Trump administration's tariff announcement in early April.
Various signs indicate that investors are gradually abandoning caution and betting on further upward movement in the stock market. Data from the Financial Industry Regulatory Authority (FINRA) shows that margin debt for investors borrowing funds to purchase stocks on the New York Stock Exchange has surpassed the peak during the tech bubble, reaching an all-time high.
However, signs of market fatigue have quietly emerged: the latest round of meme stock gains lasted only a few days before losing momentum, and Bitcoin (BTC.US), a hallmark of speculative fervor, has also retreated from its historical highs. Some Wall Street trading desks are advising clients to purchase insurance at discounted prices to guard against potential losses. Current market valuations have significantly deviated from fundamentals, with the expected price-to-earnings ratio of the S&P 500 Index nearing 23 times, far exceeding the 10-year average of about 18 times, indicating that stock prices have greatly diverged from fundamentals.
"I have started to reduce some positions," said Eric Diton, President and Managing Director of Wealth Alliance. "I am bullish on the market in the long term but cautious in the short term. Excessive speculation has accumulated considerable risk, and a correction is due." To cope with volatility, some market observers are comparing the current situation to the meme stock peak in January 2021, when GameStop (GME.US) and AMC Entertainment (AMC.US) garnered global attention due to retail investors rallying on social media.
That rally was driven by homebound retail investors who, armed with government stimulus checks, pushed the market rebound of 2020 into a larger surge in 2021 (the S&P 500 Index rose another 27% that year) through zero-commission platforms and short-term options trading. However, the market faced a reckoning in 2022, with the index plummeting 19%, marking the worst annual performance since the financial crisis.
Victor Haghani, Chief Investment Officer of Elm Wealth and founding partner of Long-Term Capital Management, pointed out: "The euphoria of a bull market and risk appetite often persist until the end, making it difficult to predict the turning point." "We are aware that we are in a bull market, but we cannot determine whether we are nearing the end; the key lies in when the market will return to rationality, rather than whether it will return."
Last week, the stocks favored by retail investors were strikingly similar to those in 2021, being small distressed companies that hedge funds heavily shorted. The popularity of zero-commission trading and short-term options has further amplified speculative momentum. This is clearly reflected in the trading volume: on its busiest trading day, Opendoor traded 1.8 billion shares, accounting for nearly 10% of the total trading volume in the U.S. stock market; whereas the peak trading volume for GameStop in 2021 was only 800 million shares (despite both having smaller floats).
However, this round of frenzy came quickly and left just as fast, with a macroeconomic backdrop that is entirely different: interest rates have risen sharply, and investors expect the Federal Reserve to cut interest rates later this year, which could further boost the stock market. Don Calcagni, Chief Investment Officer at Mercer Advisors, believes: "Despite high valuations, the potential for future rate cuts by the Federal Reserve means that valuations may continue to rise. If the Federal Reserve cuts rates, it will be a positive for the stock market."
The current market is still digesting the impact of tariffs imposed by the Trump administration, but the final outcomes of most trade agreements are better than expected in early April. Additionally, inflation is becoming manageable, and earnings growth remains stable. Alec Young, Chief Investment Strategist at Mapsignals, states: "The meme stock phenomenon is indeed concerning, but the core of market trading is the fundamentals. From trade news, current pricing is better than early April."
Of course, if the Federal Reserve does not cut rates this year, or if factors such as tariffs and inflation weaken other positive factors, the market may face a correction. Calcagni points out: "At that time, the market will reassess." However, a short-term correction of a few percentage points may not be a bad thing; rather, it could provide investors with an opportunity to buy at a discount. Ross Mayfield, an investment strategist at Baird, believes: "In the current context, any short-term correction is worth buying."
