Meme stocks had a breakout year in 2021 as investors banded together on popular sites like Reddit and Stocktwits to discuss their favorite names and trade in tandem. Popular meme stocks GameStop (NYSE:GME), AMC Entertainment (NYSE:AMC), BlackBerry (NYSE:BB) and Koss (NASDAQ:KOSS) all enjoyed generous gains, but also wild swings. However, 2022 is off to slow start for meme stocks, driven by a hawkish Federal Reserve.
What’s Going on With Meme Stocks?
Yesterday, the Fed released the minutes from its Dec. 14-15 Federal Open Market Committee (FOMC) meeting. The minutes implied a more hawkish stance and willingness to slow down the pace of Treasury and mortgage-backed securities purchases. At the current rate of tapering, the Fed’s purchases of securities are expected to end in March. Additionally, many investors are now expecting a 25-basis-points (bps) increase in the interest rate as soon as March.
According to the CME FedWatch site, futures are pricing in a 25 bps interest rate increase in March as well.
Meanwhile, the yield on 10-year U.S. treasury bonds has risen steadily since December. This week, the yield increased to as high as 1.751%, which would be the highest closing point since January 2020. The 10-year yield is currently trading at a 6-month high.
So, how exactly does this affect meme stocks?
What Does This Mean for AMC, GME?
When the Fed reduces securities purchasing, liquidity in the general market drops. This affects all stocks, and meme stocks aren’t an exception. During times of decreased liquidity, investors may flee to safer stocks that offer a profitable business model. Out of the four meme stocks mentioned in the first paragraph, none reported a positive earnings per share (EPS) during the last quarter.
A potential interest rate hike bears negatively for meme stocks as well. When valued using a discounted cash flow model, interest rates are in the denominator of the formula. A higher interest rate would imply a lower present value when discounting future cash flows. Since none of the four meme stocks mentioned are profitable based on Q4 EPS, the basis of their valuation lies in future cash flows.
Finally, rising bond yields can provide a safe haven for investors when stocks are declining. Investors may be more incentivized to invest in bonds rather than stocks during times of uncertainty
On the date of publication, Eddie Pan did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
