To The Moon

What happened

Shares of meme stocks AMC Entertainment(NYSE:AMC),Gamestop(NYSE:GME), and Sundial Growers(NASDAQ:SNDL)all fell hard on Wednesday following the release of minutes of the Federal Reserve meeting in December.

At the end of trading Wednesday, the stocks were down 10.8%, 13.1%, and 4.5%, respectively.

IMAGE SOURCE: GETTY IMAGES.

So what

The drop didn't have anything to do with these companies specifically but rather signaled a continuation of the market's rotation out of "risky" stocks such as highly valued technology growth names. Countmeme stocks and cannabis stocks, which are generally unprofitable, as part of that risk-on group as well.

On Wednesday, the Federal Reserve released minutes from its December meeting. While officials had already announced a tapering of bond purchases and expectations for several rate hikes this year, the minutes revealed the possibility for even more aggressive moves. Several officials thought the Fed could shrink its balance sheet of Treasuries and mortgage-backed assets, which it has been buying for some time to nurse the economy back to health. Tapering asset purchases merely suggested the Fed would be buying fewer securities but would still be purchasing. Letting the balance sheet shrink would be an indicator of even tighter financial conditions than that.

Exacerbating matters, the December private payrolls grew by 807,000, a much higher number than anticipated. This further indicated a strong economy which could necessitate a quicker tightening.

Good news on the economy usually means good news for stocks, but rising interest rates can also lower valuations. While some cyclical sectors, like financials and energy names, did relatively well today, highly priced or speculative stocks such as AMC, GameStop, and Sundial, which are "story" stocks with negative earnings, sold off hard.

While the economic reopening would benefit AMC, higher rates could also be a killer. CEO Adam Aron said in recent days he had hoped to refinance some of AMC's high-yield debt it had to take on during the pandemic to ensure its survival. However, if interest rates go up quickly, it will be harder to refinance at meaningfully lower rates.

Now what

All three stocks are down more than 50% off their 52-week highs, but there's a good argument to be made these three names are still overpriced. All three are unprofitable, with AMC's results still significantly in the red, in part thanks to high-interest payments despite theater reopenings.

GameStop has been bid up on hopes of a turnaround under the leadership of large investor and current chairman Ryan Cohen. But that effort is still in its nascent stages, and GameStop's legacy business in physical games is still declining, so there is a high degree of uncertainty. And Sundial is a penny stock in a difficult cannabis market in Canada, with a still-expensive valuation of 23 times sales and little visibility into when it may be profitable.

The bottom line is, just because these stocks are down a lot doesn't mean they can't go down further. I'd stay away from all three amid this tightening cycle unless you have a small portion of your portfolio you can afford to lose completely on speculative bets.