Speculations Went South Wednesday

Editors’ Note: MarketMinder does not make individual security recommendations. The below merely represent a broader theme we wish to highlight.

The flashy highfliers fell fast and far Wednesday. If you have so much as peeked at the Internet today, you will have seen that bitcoin and other cryptocurrencies had a rough day, falling as much as -30% intraday at one point before clawing most of it back.^[i] But even with that rebound, bitcoin is down by about -38% since early April.^[ii] Meanwhile, using an ETF as a proxy, special-purpose acquisition companies (SPACs) are down about -30% since mid-February, dashing this year’s early enthusiasm that they were a one-way ticket to riches.^[iii] We have seen ample chatter about these downdrafts spilling over into broader stock markets, with some pundits warning they signal the end of the road for Tech and other winning sectors over the last year. We think that is a stretch, but we do see some other interesting implications.

The first: sentiment. SPACs and cryptocurrencies have represented the speculative, frothy corners of the investment world for months now. Sometimes, when fringe mania erupt, they are early warning signals for everything else. That seems to be what many fear now. But that is generally the case only when fundamentals are overall deteriorating and the euphoric masses are too blind to see it. The prime example is 2000, when the dot-coms rolled over in March but the vast majority of the non-Tech market held up fine until autumn. Then, few worried about spillover—most portrayed Tech’s drop as a buying opportunity, a last chance to get in on New Economy stocks before they went to the moon. The simple fact that many people today see negative spillover potential in every fringe, niche asset’s drop shows sentiment isn’t broadly euphoric—a good indication to us stocks probably aren’t peaking.

Here is another way to see that. Stocks’ rise since March 23, 2020 has solid underpinning: the ongoing recovery from lockdowns’ devastating economic impact. Cryptocurrencies’ rise seems a lot more like a speculative mania built on hopes, dreams and sand. Exhibit A: the wild rides bitcoin and dogecoin take every time Tesla CEO Elon Musk utters their names. Securities that people buy for their realistic long-term earnings-generating potential don’t do that. Exhibit B: the reason everyone gives for bitcoin’s crash today. That would be China’s new ban on financial services companies and payment processors’ having anything to do with bitcoin and its crypto brethren. The way pundits portray it, this was some massive shock and sudden change, which seems juuuuust a bit outside of reality.

China has long had a de facto ban on cryptocurrency transactions. While it doesn’t prohibit ownership, it banned financial institutions from facilitating bitcoin use and shut down major crypto exchanges. Officials outright said bitcoin isn’t a real currency several years ago, and they introduced their own state-run digital currency to much fanfare several months ago. Is anyone really, truly surprised they trash-talked it again today, while trying to protect and shepherd their own entry into the digital coin space? Moreover, were the bitcoin-hoarding masses really operating on the theory that they would eventually sell to eager buyers in China at a higher price? None of this passes a basic logic test. But we guess what goes up for irrational reasons could just as easily come down for irrational reasons, too.

As for SPACs, we think the lesson here is simple: They aren’t special, despite the name. They are just IPOs with a different name and less paperwork. Fisher Investments founder and Executive Chairman Ken Fisher has long quipped that IPO doesn’t just stand for initial public offering, but also, “it’s probably overpriced.” While the SPAC process is different than the traditional IPO process’s expensive underwriting and strict regulatory requirements, the basic incentives are the same: Early investors want to cash out at the highest price possible. If they cash out and the price soars afterward, then that is generally a poorly executed offering from their standpoint. This, of course, cuts against the popular viewpoint of IPOs as ground-floor tickets to big riches. But that romantic notion stems from the exceptions, not the rule.

None of this is to say that we think more downside for these assets lies ahead. But we have long counseled readers on these pages and elsewhere that chasing hot returns and fads isn’t a viable investment approach. In our view, investing in something requires a rational, forward-looking thesis to own it. Wednesday’s fast fall in former highfliers is a reminder of that, in our view, and it should be a moment for reflection for those heavily involved in these speculations.