Jan Breughel the Younger’s Satire of Tulip Mania, circa 1640 (Image: Wikimedia)

The great tulip bubble of 1637 is probably going to be bumped out of a lot of finance textbooks pretty soon because a far more astonishing and incomprehensible rise in prices has happened in 2021 and, just possibly, it’s starting to unwind.

They call them “meme stocks”. Unlike the memes your uncle emails to you (FW: FW: FW: Funny!), these are real companies trading on the market for real money. Trading for a lot more money than they used to. 

The graph below shows the prices of some of the hottest assets of 2020-21. They include pure meme stocks Game Stop (GME), a computer game retailer, and AMC Entertainment (AMC), a movie theatre chain headquartered in Kansas. Also included are cryptocurrencies Bitcoin (BTC) and Ethereum (ETH), plus the original hot stock, Tesla (TSLA).

They’ve each had a fast rise and a recent pullback, of various sizes.

We can see the price movements more clearly if we set all the stocks equal at the beginning of the year and watch what happens.

This next chart shows the changes after setting price = 100 on January 1.

AMC stock rose more than 30-fold, an astonishing rise based only on the fact that traders who gather on reddit stock-trading message boards decided to target it and push its price up. The same phenomenon explains the rise in Game Stop. (The relevant message board is called r/WallStreetBets, in case you are interested, and the top posts there right now are all full of snark and fatalism as the market turns down.)

The meme stocks are pure, crystalline proof for the argument that in recent years some assets have risen for no good reason. That was debatable for assets like Tesla, where the product is real but the valuation is extremely frothy. But for meme stocks, the value argument is torn off completely and stomped on. The reason to invest in it is that it is fun to do so. And profitable!

Meme stocks work — for now. There is so much money and liquidity loose in global markets that it has to go somewhere. So it piles in to something — anything — and as the price of that thing rises, more investors follow. Success begets success, the speculators laugh, the champagne fizzes.

First they laugh at you, then they fight you, then you win, then… ?

Cryptocurrencies are a good example of the rise of assets nobody previously believed in. Bitcoin rose throughout the past decade in fits and starts and against the odds. Its eventual triumph was due largely to low interest rates making a few speculative investment choices seem like a reasonable bet. 

Then came the monetary and fiscal explosion of the pandemic. Governments borrowed incessantly to spend enormously, record low interest rates were cut even further, and central banks bought bonds in never-before-seen volumes. 

All these interventions created an environment where asset markets were flush with money. That money flowed to normal assets — the S&P 500 has been at record highs for most of the time since 2013 — but it didn’t stop there. Big tech firms got huge valuations in public markets. Venture capital flowed like water in private markets. Bitcoin rose from under US$10,000 in January 2020 to US$50,000 today. And finally, when the liquidity was most extreme, we got meme stocks.

Meme stocks make a mockery of the idea that an asset must be useful or profitable — or at least show a prospect of being so — to justify investing in it. That idea was already dying when Dogecoin (a cryptocurrency that is explicitly a joke) briefly achieved a market capitalisation of US$75 billion.

The capitulation of meme stocks (and Dogecoin) in recent weeks is related to the prospect of a great normalisation. Interest rates are rising, central government bond purchases are going to slow, and fiscal policy is going back to normal.

Australia’s central bank is expected to start raising rates in 2022 or 2023 as inflation gets back to normal. The US Federal Reserve is expected to move sooner. New Zealand raised rates last month. As interest rates rise above zero, the return on safe investments gets better and the need to invest in crazy, risky assets falls. 

Interest rates in Australia are expected to be much higher by the end of 2023. The big question is: what happens to the party when the booze runs out?

The meme stocks are the first to get a headache, of course. So are they the canary in the coalmine that warns investors to get out? Does their fall mean stocks can fall too? And houses? It is worth observing that the Australian sharemarket is off its August peaks, and the big banks are predicting house price falls in 2023. 

Asset prices have gone mad everywhere you look. The madness can’t last forever. The tulip bubble lasted from 1634 to 1637 when it ended in a crash. Let’s hope we see a more orderly descent.