Is the speculative bubble of retail investors in the US stock market reappearing? This time it might be different.

Analysts believe that, unlike the 2021 meme stock frenzy dominated by GameStop and AMC Entertainment, current speculative activities are primarily concentrated on small-cap and low-priced stocks, with minimal impact on major indices such as the S&P 500. Although there are risks of capital misallocation, historical experience shows that such speculative bubbles typically do not spill over into the broader market.

Written by: Bu Shuqing

Source: Wall Street Watch

Meme stocks are making a comeback, igniting retail investors' speculative enthusiasm and sparking a market frenzy in July, which has also raised concerns about a stock market bubble. However, analysts believe that the spillover effects of this round of speculation on the overall market are relatively limited.

Analysts believe that, unlike the Meme stock craze dominated by GameStop and AMC Entertainment in 2021, the current speculative activities are mainly focused on small-cap stocks and low-priced stocks, with minimal impact on major indices like the S&P 500.

Despite the risk of capital misallocation, historical experience shows that such speculative bubbles typically do not affect the broader market when they burst.

Low-priced stocks become the new favorites for speculation, trading volume hits record highs

The most significant feature of the market in July was the frenzy for low-priced stocks. Data shows that the median increase for the lowest decile of stocks by price at the beginning of the month reached 16% on July 23, when the new round of Meme stocks peaked, far exceeding the 1.4% increase of the highest-priced stocks. The initial stock prices became the best predictor of performance for the month.

This investment logic based on stock prices rather than company fundamentals seems quite absurd to institutional investors. A company can easily change its stock price through simple stock splits or reverse splits, without affecting shareholders' actual ownership percentage or profit sharing. Unless the stock price remains below $1 for a long time and faces delisting risk, the absolute stock price itself has no practical significance.

However, a large number of retail investors either do not understand this basic principle or choose to ignore it. During the frenzied trading in July, these investors' strategies did indeed work, while the rational analysis of professional investors failed instead. When the speculative frenzy reversed at the end of the month, the cheapest stocks also saw the largest declines, reaching 6%.

Concerns Over Capital Allocation Emerge, Historical Lessons Worth Heeding

Excessive speculation can lead to improper capital allocation, and the Meme stock frenzy of 2021 has provided a clear example.

At that time, companies like GameStop and AMC issued billions of dollars in new shares while their stock prices were high, but the stock prices subsequently fell significantly. GameStop and AMC are currently down 74% and 99% from their peaks, respectively.

Economist Keynes warned in 1936 that when "industry becomes a bubble on the whirlpool of speculation," capital will flow to the wrong companies, harming growth and employment. This concern is equally applicable in the current environment, especially when speculative funds rush into companies with weak fundamentals.

However, the impact of current speculative activities is relatively limited.

There are no low-priced stocks in the S&P 500 Index, and no clear performance patterns have emerged for cheaper stocks among large companies in July. When retail investors drove up the prices of green stocks, SPACs, and loss-making tech stock bubbles in 2021, the impact of these bubbles bursting on the broader market was similarly negligible.

Market sentiment is becoming rational, overall risk is controllable.

The long-term sentiment surveys by the American Association of Individual Investors and Investors Intelligence show that current investor sentiment is more positive than at the beginning of the year, but has not yet reached an overly optimistic level. Futures traders tend to favor call options, but to a much lesser extent than in 2021.

Analysts estimate that retail investors may have boosted the S&P 500 index through buying on dips since April, but the impact in July has been relatively limited.

The current round of Meme stocks, referred to as DORK stocks (derived from the stock codes of companies like Krispy Kreme, Opendoor Technologies, Rocket, and Kohl's), is merely the public facade of the speculative frenzy among retail traders this summer.

Despite investors having reasons to worry about high stock prices, the impact of tariffs on profits, potential weaknesses in the economy, and excessive enthusiasm for artificial intelligence, the boom and bust of Meme stocks and low-priced stocks have a relatively limited spillover effect on the rest of the market. Historical experience shows that such speculative activities are more of a fringe phenomenon in the market rather than a significant source of systemic risk.