Here’s why meme-stock manias are bad news for the Nasdaq

CNBC’s Jim Cramer said he’s not shocked by the Nasdaq‘s plunge on Monday, explaining that last week’s Bed Bath & Beyond trading frenzy indicated weakness in the index could be on the way.

On Monday’s episode of “Mad Money,” Cramer referred to two warnings he gave CNBC Investing Club members last week about the potential for meme-stock froth to spill over into the broader market, especially the tech-heavy Nasdaq. Those words of caution came initially Wednesday morning and then Friday afternoon. On Wednesday, Cramer trimmed two positions in his Charitable Trust to raise cash, citing the Bed Bath & Beyond fiasco as one reason to make the defensive sales.

“The next time you see one of these meme stocks roaring, I want you to ring the register,” Cramer said Monday. “At this point, the Nasdaq’s already down more than 6% from its highs last week, so, in some ways, it’s too late to sell even as I expect more pain. Better to just buy as we get closer to down 12% where the pain has tended to stop.”

Cramer reached the conclusion by looking at seven periods since January 2021 when a heavily shorted stock, or group of stocks, got bid up by retail traders to levels that were disconnected from underlying fundamentals. The first instance in the data set is the original GameStop frenzy in late January 2021, and the most recent example centered on the monster two-day move GameStop shares had on May 25 and May 26.

Cramer said in six of the seven meme-stock resurgences he identified, the Nasdaq had a meaningful pullback in the weeks that followed. It doesn’t matter that some of the biggest meme stocks, including GameStop and AMC Entertainment, are not even listed on the Nasdaq. While the severity of the downturns varies, he said on average the Nasdaq decline was about 12%, the level where Cramer suggested it might be time to put money to work.

“I know the connection might seem a little tenuous to you. Why would meme stock rallies signal that stocks are peaking? Because it’s a textbook sign of froth. It shows you that the bulls are getting complacent, and speculation is running rampant,” Cramer said.

Part of the selling pressure could be related to retail investors getting burned and deciding to turn away from the market altogether. However, Cramer argued that the more important factor at play is how large market participants respond to the meme-stock froth.

“When money managers see this kind of action, they tend to throw up their hands and step aside for a bit because they hate it when stocks can’t be judged on the fundamentals, even if it’s stocks that they don’t really care about,” Cramer said. “In other words, these meme stock spikes make the hedge fund guys feel like the inmates are running the asylum, so they decide to take some profits and maybe go on vacation for a week.”