Markets are a way to express a view on important questions: will the US successfully reshore a substantial portion of the supply chain? That's good for US-based railroads and for the currencies of allies with a similar GDP per capita to China (since the latter will get more of the low-value-added manufacturing jobs that China loses). Will growth slow? Time to buy treasury bonds. Will AI models keep scaling? They'll probably keep buying chips. Etc.

But markets are also a venue for trades that combine some element of self-expression with outright gambling. It doesn't make the world a better-informed place to buy zero-days-to-expiration index options, or to make nostalgia-driven bets on dowdy theater chains or dying strip mall video game retailers, not to mention trading memecoins based on the new First Lady's sartorial decisions on Inauguration Day. But these markets connect, in the sense that what happens in one of them can affect prices in others; when meme stocks were doing well, a broad set of reasonably cheap growth companies suffered because those companies' shares happened to be owned by funds that were betting against the memes. Crypto booms and busts can sometimes hit traditional financial institutions; the collapse of FTX was a proximate cause for the deaths of Signature Bank and Silvergate, both US-based and US-regulated financial institutions. The product doesn't actually exist just yet, but at least one ETF provider has filed a preliminary prospectus for, among other things, an ETF that will track Donald Trump's memecoin.

It would be nice, in theory, to draw some line between the parts of finance that serve a constructive purpose, like raising capital, and the parts that are mostly a form of gambling, like short-term options, day-trading, and meme assets. But that's a hard line to draw, for several reasons. For one thing, the meme-y nature of a stock is hard to separate from the possibility that it's a genuinely interesting company that has a hard-to-parse story. You can't make that case very well for someone like AMC, whose main innovation is their unusual willingness to soak retail investors given the opportunity. But plenty of dot-coms in the 90s had the same delirious enthusiasm, and while most of those didn't work out, a few made up for this—if you'd bought Amazon at the absolute peak in 1999, you still handily beat the S&P 500 since then, and wound up with 43x your money versus 6.6x in the index. At that time, it was absolutely a meme, a low-margin retailer trading at 21x sales, despite margins getting worse as it grew (in 1999, sales rose 169% and losses rose 476%). You really had to believe in the long term story, which, to be fair, Jeff Bezos did an incredible job of outlining in his early shareholder letters. Famously, he attached Amazon’s 1997 shareholder letter to the end of every single subsequent annual letter until he stepped down as CEO in 2021, always emphasizing the section titled “It’s All About the Long Term”.

Tesla is a bit meme-y today, but it was even more so when it was a money-losing company that always looked like it was inches away from insolvency. Their stock was a winner before they were moving many units (though, to be fair, their first big run-up in 2013 was sparked by reporting a surprise GAAP profit). Tesla's had a long winning streak, which is another way of saying that it's spent basically its entire life as a public company being valued in a way that only makes sense if it performs incredibly well.

But it's net good for the world that Tesla shares were so expensive for so long, even if a big share of its investor base was fairly delusional and got lucky. (And it's worth noting that some of Tesla's early investors were, in fact, quite well-informed, and accurately predicted that ever-cheaper batteries would turn EVs from an inconvenient luxury item to a meaningful contender.)

For more short-term speculative trades, there's a different force at work. Market-makers actively pay to trade with retail investors, a feature of the market that's widely misunderstood. The reason they do this is not because they have some specific way to take advantage of these customers—in fact, retail investors get better prices than institutions as part of payment-for-order-flow deals—but because those customers are less likely to take advantage of them, in the form of making small orders that are first in a series of larger ones. What speculative traders do is inject noise into the system, making it safer to quote a bid/ask spread and thus making the optimal spread narrower. And that increases the reward for fundamental research. For a large fund, it's simply not worth the time to do deep research on a $500m market cap company if half of the valuation gap would disappear just because of the purchase, or if they spent so much time gradually building a position that the stock drifted to where they'd expected it to trade in the first place.

And even the purely speculative stuff bleeds into this. Market-making is subject to booms and busts, where the booms are the result of either a steady rise in retail participation or a new market behavior that not everyone can model. Since these switches are hard to predict, the optimal approach for market-makers is to follow some markets that aren't immediately profitable in order to take advantage of these spikes. And that, too, means that noisy retail trading is indirectly subsidizing these liquidity providers.

Most instances of these more speculative, goofy trades aren't directly value-creating, but they subsidize things that actually create value. And, perhaps more importantly, it's hard to tease out exactly where the gambling ends and the price-discovery begins: Avis and Gamestop really were a bit too cheap when they first achieved meme status, and Tesla was on to something with the whole electric car thing. Fortunately, the purely value-destructive trades have their own constraints: the people inclined to do them end up with a smaller bankroll, and the main thing that keeps it from shrinking even faster is that there's competition to take the other side of their trades and that competition comes in the form of better pricing. Markets eventually sort themselves out, though sometimes it takes an inconveniently long time.

In The Diff, we've covered memes and speculation in a few different ways:

• Robinhood is uniquely levered to meme stock performance, making it an excellent hedge ($).

• The SEC's report on Gamestop left many unanswered and unanswerable questions ($).

• How meme stocks and multi-manager funds reshape the market ($).

WallStreetBets went from obscure to market-moving in a surprisingly short period ($).

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