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Why This Unusual Trend In The Market Is Sparking Bubble Worries

Why This Unusual Trend In The Market Is Sparking Bubble Worries

Experts warn that the speculative interest in this corner of the market is looking reminiscent of the dot-com bubble. And the bubble could soon burst…

SPACs were big in 2020 and are getting even hotter so far this year.

But the surge in interest in special purpose acquisition companies is raising some red flags about rampant speculation in the market, and some experts are concerned retail investors could get burned.

The SPAC market raised a record $30 billion in capital last quarter, with pre-merger SPACs also seeing outsized rallies in their first day of trading.

From 2003 to 2020, the average first-day return for a SPAC IPO was only 1.1%. But so far this year, SPACS have jumped an average of 6.5% on their debuts marking a nearly six-fold increase from historical levels.

“Every single one of them has gone up in price,” said University of Florida finance professor Jay Ritter. “It’s not driven by one of two outliers.”

SPACs are different from regular IPOs in that they represent blank-check companies of empty corporate shells that raise money from investors and then merge with a private business within two years, taking the company public. And while a pop on the first day of trading after an IPO generally represents investors’ appetite for a given company, rallies on the debut of a SPAC is mere speculation. 

“There’s a lot of money coming into the market,” said JJ Kinahan, TD Ameritrade’s chief market strategist. “That lends itself to people going outside the course of the S&P 500 or Nasdaq 100. You will continue to see this behavior just because people are looking around to see what else is there besides buying the same stocks everybody else is buying.”

Bank of America found that retail investors represented 46% of trading volume in SPACs on its platform in January, up from around 30% two months ago, and by comparison, retail investors take up just around 20% of trading of the S&P 500.

“The speculative nature of SPACs seems to be particularly appealing to retail” investors, Bank of America said in a note. “We definitely don’t need to remind anyone what can happen when something speculative comes on the retail radar (ahem, GameStop).”

GameStop (NYSE: GME) shares surged as much as 1,023% in the last week of January as an army of retail investors inspired by the WallStreetBets subreddit forced a short squeeze of the stock. Since hitting a peak of $483 on January 28, the stock has fallen back to earth dropping nearly 90% and trading near levels since prior to the short squeeze surge – burning many investors on the way down.

The case of GameStop is similar to the retail interest in SPAC in that it was seemingly driven purely by unchecked animal spirits. And that could spell disaster reminiscent of the dot-com bubble.

“If done well, [SPACs are] a very effective transaction. It’s one of the few times where the quote-unquote buyer has enormous power,” said billionaire investor Sam Zell. “In other words, if you’re a buyer of an IPO SPAC, the worst thing that can happen is you get your money back in the cost to carry. The best thing that can happen is they make a very attractive deal and then you have a decision to make as to whether you want to play or not.”

But Zell warns that in some cases, SPACs acquire companies that aren’t that attractive.

“In this speculative environment we’re talking, you’ve had a number of these SPACs done with making money going to the moon and I saw one the other day on electric charging stations” where the company didn’t project positive cash flows for years, Zell continued. Not only that, but some of the companies acquired have yet to even produce a physical product or prove market viability.

“This is rampant speculation again, very much like the dot-com boom,” Zell added.

And while investing in SPACs has delivered big returns in recent months, Ritter says the trend isn’t likely to continue. 

“The last couple of months have been great for the SPAC investors with the returns being really high,” Ritter said, “but I don’t think it’s going to be able to continue like this.”

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