Here's why meme stocks are hinting at another flashy rally for `junk stocks`

Meme stocks are perking up again, with GameStop (GME) and AMC Entertainment (AMC) rallying over 30% at one point on Thursday, and adding 10% and 5%, respectively, on Friday. Separately, the ARK Innovation ETF (ARKK) shot up 25% off Thursday's — testing price levels first seen in 2017.

While we've seen this movie before — only to watch dip-buyers get fleeced — a growing chorus of money managers are finding increasing reasons to wade into this unforgiving market.

"Almost everything I look at is screaming to buy," wrote Paul Schatz Friday morning after the S&P 500 had minted a fresh, 52-week low.

Schatz pointed out that investor sentiment is mired at historic lows as more and more stocks capitulate. The number of stocks listed on the NYSE making new 52-week lows surged above 1000 for the first time since the pandemic sell-off in 2020. Most pandemic darlings have round-tripped their gains and are now in the red since 2020 (or before).

"[T]he stock market is set up for a face-ripping short-covering rally over the coming weeks or so," wrote Schatz. "It is also possible the final bottom has been seen, but that is not something I am counting on right here."

Front and center are the high-growth names and meme stocks that have been pounded the most. "[T]he first bounce should see whatever fell the most rally the most," writes Schatz. Indeed, this is what some traders call a junk-off-the-bottom rally.

Of the 45 stocks in the informally-constructed meme stock basket compiled by Yahoo Finance, the median drawdown, or loss, from recent highs is 73% (the average is 65%). Peering inside ARKK, it's not quite as bad — but still not pretty. The median component in the Cathie Wood-sponsored disruption ETF has been cut in half (average 44%).

But even if stocks reward the dip buyers this time around, it's not necessarily the all-clear signal sought by longer-term investors.

"This will not be a 'V' bottom like 2020 and 2018 when the Fed quickly pivoted and 'risk on' returned overnight," Schatz wrote. "It is going to take some time."

Handicapping the next move by Jerome Powell and his cohort at the Federal Reserve is the biggest piece of the puzzle — and THE major unknown. Investors are still pricing in 50-basis-point hikes for the next three meetings, and the Fed is only beginning to sell bonds from its balance sheet — a pace that will soon reach $95 billion per month.

Any liftoff in risk assets will likely arise from the markets predicting another Powell pivot — this time to the dovish side with a concurrent easing of monetary policy. But that will take time to play out. In the meantime, tight financial conditions could easily cap any fledgling rally.

"The Fed can’t pivot yet, although they will later this year. Huge asset sales are still to come," Schatz wrote. "In other words, the markets have a [great] deal of repair left."

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Jared Blikre is a reporter focused on the markets on Yahoo Finance Live. Follow him @SPYJared. Devan Burris is a producer with Yahoo Finance Live.

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