Investors: Beware of the Many ‘Meme’ Traps

Like the Sergeant on Hill Street Blues Said Thirty Years Ago: ‘Let’s be Careful Out There!”

North American markets today, Monday, viewed several hours before the 9:30 a.m. EST opening, appear poised for a positive start with all major indicators in the United States and Canada in the green. However, at time of writing the

S&P 500 is weakening and there is a small chance that it could slip into the red.  The Canadian TSX 60 is also slipping and whether it will stay in the green is questionable.

European markets are open at time of writing and the main indicators there are strongly in the green.

Amongst commodities the safe havens of gold and silver are down.

Amongst currencies the Euro and Canadian dollar are up against the American greenback while the British pound sterling is down.

We have a substantial list of data to check this week including the Federal Reserve policy meeting on Thursday, the Labor Department producer price data tomorrow, the Commerce Department retail sales data, also expected tomorrow, the business inventories data, the National Association of House Builders/Wells Fargo Housing Market Index, inflation, the Labor Department release of initial claims for unemployment scheduled for Thursday and a range of other important economic indicators.

Outside of the hard data, we will also be looking for whether and to what extent last week’s focus on meme stocks will continue this week.

And if it does continue this week – or at any other time -- several notes of caution are in order. “There are many intriguing and potentially profitable opportunities in this market, but prudence is required,” argues Paul Bates, capital markets participant and adjunct professor (finance) at McMaster University in Hamilton.

Bates warns that there are many ‘meme’ traps.  Meme stocks can be broadly defined as stocks whose share prices are driven through social media fervor to beyond reasonable levels with the best-known examples including AMC Entertainment and GameStop Corp. In these cases, the ‘buy’ decision is based on the social media fervor, instead of on the company’s track record or prospects. The buy decision is also often based on FOMO – -the fear of missing out – which also has little to do with a company’s fundamentals.

And ‘trap’ is an apt description. "There are plenty of people making money, but there are plenty of people getting their heads handed to them," said Ken Polcari, founder and managing partner at Kace Capital Advisors in a Reuters report. "These names are risky because they're ripping all over the place.”

Quoting figures from Vanda Research, Reuters says that meme stocks including AMC Entertainment, Blackberry and Clover Health have seen $1.27 billion in inflows in the last two weeks. In that figure there are certainly some winners but there are probably some losers as well. If AMC shares drop sharply from their Friday closing at $49.30 some shareholders may indeed have their heads handed to them.

Bates suggests sidestepping the meme fervor and focusing on three main attributes to consider before the investment decision. Firstly, leadership: Is there a clear voice that can be recognized in the way the business operates? Secondly, is there a strategy that is reasonable for the emerging time and the operational capabilities of the enterprise? Finally, is there clear evidence of a financial capability that will support the strategy presented? (In other words, does the company have the cash and executive depth to support its plans?)

Bates argues that a firm grasp of these three questions is more important for successful investing than social media fervor.

“There are many market participants who are jumping on to momentum plays, and some of them will work, but a larger number will be ‘trapped.’ he says.

When it comes to meme stocks, remember what the grizzled police sergeant said in Hill Street Blues thirty years ago: ‘Let’s be careful out there’.

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Al Emid is a financial journalist broadcaster and author. His next book. The 2021 Emid Report on Volatility is scheduled for a Fall release.