Excessive speculation is often a sign of a potential market turn. The difficulty is that it isn't easy to measure speculation, and it will almost always persist longer than seems reasonable.
We had a classic illustration of a speculative top in February 2021. You won't see it in the major indexes, but that is when special purpose acquisition companies (SPACs), meme stocks, cannabis, biotechnology and other highly volatile stocks favored by retail investors hit a top. This is when the bear market first started for much of the market, but the indexes didn't really start to reflect this for another 10 months.
The recent market surge off the June lows has produced another speculative surge. Biotechnology has been one of the leading groups and meme stocks have come back to life again. There has been a concentrated effort by traders to target stocks with high short interest and SPACs that have high levels of redemptions and have very thin floats.
On Thursday, there was a dramatic reversal in many of the meme names, such as Bed Bath & Beyond (BBBY) , AMC Entertainment (AMC) and GameStop (GME) . Ryan Cohen, who is chairman of GameStop, liquidated his very large position in Bed Bath & Beyond and caused a panic run among meme traders that had followed him into the stock.
The obvious question is whether this is the start of another speculative top that will eventually cause broader pressure.
Conditions are never the same, but there are always some similarities in the way cycles develop. The market has become extended recently primarily due to poor positioning rather than improving fundamentals. The speculative trading has helped to create tremendous fear of missing out, and now those who chased some of the highest risk situations are being badly burned here on Friday morning.
As I've discussed, I've raised my cash levels substantially primarily because I do not see prudent entry points in the charts. I'm not predicting a major collapse right now, but I don't see any reason to build up long positions.
Meme traders don't give up easily, which is why they often suffer so much pain when things turn. Today is options expiration, and that means the end of the gamma squeezes that some of these traders were counting on to drive their favorite names higher.
The speculative excess that has developed recently is looking like a signal for increased caution.
