Meme Stocks and the Rise of Retail Investors

Steve Johnson:

Pet Rocks, Cabbage Patch Kids, meme stocks? All three of these have been fads over the past 25 years. Will meme stocks continue to be a fad or will this change the entire retail stock landscape? Join portfolio manager Charlie Toole and I as we discuss meme stocks and the impact on the market today.

Charlie Toole:

Hello and welcome to another The Adviser You Can Talk To Podcast. I’m Charlie Toole and I’m joined today by my colleague Steve Johnson. Hi, Steve, welcome to the podcast.

Steve Johnson:

Thank you, Charlie. Happy to be here again.

Charlie Toole:

We are the co-managers of the dividend income strategy, and usually we’ll be talking about high-quality dividend growth stocks, but today we’re going to the other end of the spectrum. Steve, we’re going to go to the dark side and we’re going to talk about meme stocks. Social media has become an integral part of our lives, and it was only a matter of time before that spread to the financial world. Now we’re seeing stocks being discussed on platforms like YouTube, Facebook, Twitter, and of course Reddit and its sub-platform WallStreetBets, which has more than 10 million readers. These investors, or maybe we should call them social media traders, have driven up the stock prices of companies like GameStop, AMC, and even cryptocurrencies like Bitcoin and Ethereum. Steve, this mania seemed to come out of left field, so why have meme stocks had such a meteoric rise?

Steve Johnson:

It’s a great question, Charlie. I think there are three factors that have come into play with the rise of the meme stocks and the traders. First is just the democratization of trading, right? We’ve seen Robinhood, the app which makes it very easy to trade stocks, come out in 2013, and we’ve seen that grow. We now know that their number of accounts has just exploded. We’ve also seen free trading. You and I have been in this business a long time; trades used to be $100, then they went down to $49, to $29, and now they’re free. It is easy for people to trade themselves, in a frenzy, without having it cost anything. First it was Schwab, and then it went to Fidelity, then TD Ameritrade Interactive Brokers, so it made it very easy to trade. And then we had the pandemic, so people are now at home, they’re working from home, they’ve got a tremendous amount of time on their hands. And a lot of younger folks received stimulus checks, so they were able to trade—they actually had a kind of free trading account provided by the U.S. government. Those factors all came together, which led to this massive explosion.

Steve Johnson:

In fact, I was reading a survey by Charles Schwab that said 15% of all of their traders started since 2020. This is a new phenomenon, but one thing I guess we can debate is whether or not that trend is going to last.

Charlie Toole:

That’s right. I think we talked about this a lot last year when we were in the middle of the pandemic and everything was shut down. There were no professional sports, no college sports, you couldn’t go out to a restaurant or to the movies. Really the only game in town was the stock market, and that’s where a lot of people, for lack of a better word, found their entertainment, and they were able to trade stocks on these easier-to-use platforms like Robinhood. We talked about it many times in our investment meetings—the number of new brokerage accounts that were opened in 2020. It was just off the charts.

Steve Johnson:

That point’s a great one, Charlie. Fidelity, for example, in this year—2020, 2021—has attracted 1.6 million new customers under the age of 35, a meteoric rise. Over a 200% rise from the year before. It is these people who are trading, but also I don’t think we can emphasize enough the impact of social media. You and I are active followers of folks on Twitter, and you get some great content there, but also these folks, to your point earlier, went from a million users on Reddit to 10 million. We’ve seen the growth slow, obviously, over the last couple of months, but that is a tremendous amount of people. Even though the stocks are smaller in the market cap range, that can have a big influence when you have 10 million people.

Charlie Toole:

Right. When there’s not a lot of liquidity in a stock that’s trading around $3, $5, you can get a lot of people to come in and put a lot of money there and move the stocks. We’ve seen that, and obviously GameStop is the poster child for meme stocks. It went from single digits in 2020 to nearly or just about $350 earlier this year. But these meteoric rises in these stocks and in some of these other asset classes, like cryptocurrency—you hear the stories about how these stocks have run up, but there’s a lot more that happens after the run-up. There’s a lot more volatility that gets embedded in these stocks, and I think some novice or new investors might not realize that.

Steve Johnson:

I think that’s a great point. It was President Kennedy who said, “Victory has a thousand fathers and defeat’s an orphan.” You never hear about the person who bought GameStop in the 300s and sold it at 150 or 200. Everyone likes to talk about their winners, but people don’t understand the tremendous amount of volatility that has gone on in these stocks. We’re talking drawdowns of 70, 80, 90% during the course of this trading. Even if you look at the crypto market, we’ve had huge drawdowns. I don’t know about you, but I’m too old to experience that kind of drawdown—nevermind on an annual basis, but we’re talking daily and weekly swings of 30, 40%. I know a couple of Fridays ago you went home, crypto closed on the highs for the week, and then you woke up on Monday morning and it was down 20 to 30%. I don’t think a lot of investors understand how difficult it’s been to hold on. Obviously there have been those folks who have done very well, but to do so, you have to have a very, very strong stomach or, as they say, diamond hands.

Charlie Toole:

You got to be able to hold. Hold on for dear life.

Steve Johnson:

Yep. I’m not suited for holding at this point in my life. So…

Charlie Toole:

I think one of the other issues that we’ve heard about and that we’ve seen is the leverage that some of these investors are using. There are many that are taking out loans to make these purchases. When you’re buying a stock and half the money is borrowed, if you have one of these big drawdowns, the borrowed money is still owed. It’s your personal capital that disappears very quickly.

Steve Johnson:

And new investors, not only have they discovered volatility—they discovered the dreaded margin call. This is where the brokerage, whether it be Schwab or Fidelity, sends you an email and if you don’t put money in to cover that margin call, they have the ability to sell you out. The old margin clerks go in at 2:00 or 2:30 and sell that position. That leverage issue that you point out too, Charlie—that even talks to the broader markets here, because as we’ve seen over the last month, it’s one thing to buy a volatile stock; it’s another thing to go on margin, which is a loan from the broker. It’s also another thing to borrow from your 401(k), to use credit card debt. These are actual reports that we’ve seen. People have done this and that is a very dangerous game. For us, that is kind of a warning sign as we look at sentiment, perhaps of some excessive complacency in this market. The amount of leverage that’s in the system and the fact that people are speculating and engaging in this kind of behavior, it’s a bit worrisome at this late in the market.

Charlie Toole:

Absolutely. We talked about how these WallStreetBets readers band together to drive up a stock price. When you get those margin calls, when you get that forced selling, it has the opposite effect; it drives down the stock price, and you see this volatility being exacerbated by the leverage, by those margin calls.

Charlie Toole:

I want to switch gears a little bit and talk about where do we go from here? What’s the future impact that this is going to have on the market?

Steve Johnson:

That’s a great question, and I think it’s the one question that, frankly, I don’t know if we have an answer to. We know two things, though. We know that people are going back to work, and we also know that the stimulus checks are ending here in September. So two of the factors that led to the rise of this are coming to an end. But the easy access to trading and the free commissions—those are going to still be in play. One side of me says, “This is a great thing.” Fidelity has encouraged kids to open brokerage accounts to learn more about investing. I think that is a wildly positive impact, and the more we can teach, and the more we can encourage folks to become financially literate, that’s wonderful.

Steve Johnson:

The bad thing is it’s been pretty easy for folks in the last 10 years. We haven’t experienced an extended drawdown—and by that I mean longer than a month. Last March we saw the pandemic hit, the market dropped significantly, but it rebounded faster than I think anyone had anticipated. Most investors who have started since 2020, they haven’t experienced—even this year—a 5% drawdown. By a drawdown I mean from the market going down over days or weeks. Back in 2000 to 2002, you remember coming to the office and it was a slog because the market went down every day, it seemed, for three years. The fear that I have is that there are a lot of people who can’t afford to lose this money, aren’t prepared to lose it, and so we’ll see.

Steve Johnson:

I know folks have been saying this is going to end badly, and I think everyone says that at one time or another, but the proof will be when we go through an extended period of volatility and market drawdowns to see who is still holding at the end of the day. But we’ll see. Is this a fad or is this more about the democratization of the stock market and how that will have an impact? We have seen it have an impact. It’s had an impact on several hedge funds. We’ve seen several hedge funds go out of business because they were on the wrong side of these trades. We actually saw AMC—in the last two weeks, they pulled a secondary offering because the shareholders didn’t want it, which is extraordinary. Extraordinary in this day and age that that would happen. It is having an impact, but I guess we’ll see a year from now, when we’re hopefully back to normal, if that trading still continues.

Charlie Toole:

Well, a bull market makes geniuses out of many. I think it was the old Warren Buffett adage: “Only when the tide goes out do you see who’s swimming naked.” We haven’t really had the tide go out for an extended period of time, and we will see what happens when we enter a market environment like that.

Charlie Toole:

Steve, we’ll wrap it up there. Thank you for joining me today. I think a big takeaway from this conversation is that meme stocks are just the latest version of a financial mania. Each previous financial mania ended badly for investors, so we would caution anyone thinking about buying into meme stocks to be prepared for a lot of volatility. Certainly, if you can, avoid the leverage when purchasing these stocks.

Charlie Toole:

This has been Charlie Toole and Steve Johnson from Adviser Investments, thanking you for listening to The Adviser You Can Talk To Podcast. If you’ve enjoyed this conversation, please subscribe and review our show. You can check us out at adviserinvestments.com/podcasts. Your feedback is always welcome, and if you have any questions or topics you’d like us to explore, please email us at info@adviserinvestments.com. Before closing, I’d like to thank Kailey Steele and Ashlyn Melvin. They do all the hard work making this podcast possible, so thank you, and thank you for listening.