The red hot SPAC market is getting even hotter in 2021, raising concerns about rampant speculation detached from reason that could leave retail investors fresh off the GameStop bust holding the bag.
Not only are special purpose acquisition companies raising a record level of capital — more than $30 billion so far for its biggest quarter ever — pre-merger SPACs are also seeing an outsized pop on the first day of trading.
New deals this year recorded an average jump of 6.5% on their debuts, a nearly six-fold increase from their historical levels (from 2003 to 2020, the average first-day return of SPAC IPOs is only 1.1%), according to University of Florida finance professor Jay Ritter.
“Every single one of them has gone up in price. It’s not driven by one or two outliers,” Ritter said.
Unlike traditional IPOs where debut pops are generally viewed as sign of healthy investor appetite and bullish market environment, SPAC initial rallies are less rational in nature. These blank-check companies are empty corporate shells that raise money from investors and then merge with a private business within two years, while taking it public.
So when yield-hungry investors bid up prices of blank-check deals, they are essentially taking a leap of faith betting on something without valuation or an actual business. Many believe the rise in SPAC prices could be a sign of speculative behavior in a new bull market with massive liquidity and unchecked animal spirits.
“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.”
There are signs that the SPAC boom is getting caught up in the retail trader-fueled market frenzy. Bank of America’s client flows showed that retail investors represent 46% of trading volume in SPACs on its platform in January, up from about 30% two months ago. In comparison, the retail crowd takes up only about 20% of S&P 500 trading on Bank of America’s platform.
“The speculative nature of SPACs seems to be particularly appealing to retail,” Bank of America analysts 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).”