It has been a wild couple of weeks for U.S. Treasury bonds.  Because of this situation, we would like to provide an update about what we believe is happening in the bond market.  We have been monitoring the cause of the drop in yields since rates started peaking in mid-March.  Since then, economic growth and inflation expectations have steadily declined.  Bond yields have also fallen.

Source: Bloomberg. As of 07/08/2021
Source: Bloomberg. As of 07/08/2021

This trend is not isolated to the United States alone.  Globally, yields have come down as the reality of temporary inflation, slower job growth, central bank intervention, and eventual slowing economic growth set in.  The decline in global yields has likely pushed international investors, looking for higher yields, back into domestic treasuries.

Source: Bloomberg. As of 07/08/2021

Real yields have dropped to near historical lows.  While inflation expectations have come down significantly, yields are dropping faster than inflation expectations. 

Source: Bloomberg. As of 07/08/2021

Even though economic growth is peaking, investors are starting to take a “risk-off” stance.  Jim Caron, a portfolio manager at Morgan Stanley, described the current environment as “a peak in growth, a peak in inflation, and a peak in policy stimulus”.  As investors digest this and start to accept peaking expectations, it seems they are adjusting their investment holdings accordingly.  Investors have started to take a more cautious approach to their equity and fixed income holdings.  The shift back into “safer” assets has contributed to the drop in yields.  Investors are more willing to accept negative real yields due to the expectation current yields will not seem so low once the economy starts to slow and a hawkish Federal Reserve slows growth even further. 

In our opinion, a “risk-off” rotation, global yields dropping, and continued Fed asset purchases are all contributing factors to the drop-in yields.  Another force pushing yields lower is a treasury short squeeze.  Over the past several months the market has seen net-short treasuries.  This trade made sense at the time.  It appeared investors believed significant economic growth, hotter than expected inflation, and a more hawkish Fed would push rates higher and bond prices lower.  However, inflation does not appear out of control, economic growth is likely peaking, and the Fed is in no rush to implement a policy change.  Once yields started dropping, short sellers needed to cover their losses by selling out of their positions, pushing yields even lower.  As yields continued to drop, more and more short sellers had to exit their positions continuing the cycle.

Source: Refinitiv Datastream. As of 07/08/2021

While this move in yields might be a surprise to some, we have anticipated this sort of reaction for some time now.  It is likely we see yields recover slightly once the short sellers settle and the risk-off rotation slows. 

Information and charts used in this commentary were obtained via Bloomberg L.P. as of July 8, 2021.

The opinions expressed in this commentary should not be considered as fact. All opinions expressed are as of the published date and are subject to change. Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. Investments in securities involves risk, will fluctuate in price, and may result in losses. The information has been obtained from sources we believe to be reliable; however, no guarantee is made or implied with respect to its accuracy, timeliness, or completeness.   It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results. Diversification does not protect against loss of principal.

Any charts, graphs, and descriptions of investment and market history and performance contained herein are not a representation that such history or performance will continue in the future or that any investment scenario or performance will even be similar to such chart, graph, or description.

Acumen Wealth Advisors, LLC® is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Acumen Wealth Advisors, LLC® and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Acumen Wealth Advisors, LLC® unless a client service agreement is in place.

I.  What is a SPAC?

A Special Purpose Acquisition Company (SPAC) is a shell company with no actual commercial operations created solely to raise capital through an initial public offering to acquire a private company.  Sponsors are required to acquire a company within a two-year span (additional year may be added given permission by SEC/investors).  Following the acquisition of the targeted company, the SPAC symbol is retired, replaced by the now public company on the stock market. 

SPACs are formed by a sponsor or experienced management team who possess expertise in a certain industry or business sector with intention to pursue deals in a selected area.  However, typically the sponsors are NOT obligated to a specific field unless stated in the disclosure.  The management team or sponsor has nominal invested capital translating into ~15% to 20% interest in a SPAC.  The remaining 80% to 85% is open to public shareholders through units, or common stock, and a fraction of a warrant.[1]

[1]  A warrant is a contract that gives the holder the right to purchase from the company a certain number of additional shares of common stock in the future at a certain price, often a premium to the current stock price at the time the warrant is issued.

II.  SPAC versus Traditional Initial Public Offering (IPO) – Simplified


The traditional IPO process requires immense efforts to implement.  The company begins by finding the most suitable underwriter for the IPO which involves many meetings.  Next, executives travel to potential investors to assess demand and other factors for their IPO.  As previously stated, this is a tiring process for executives, in addition to still having daily responsibilities for their company.

Through a SPAC, the sponsor(s) approaches the company, and does most of the work for them resulting in less work for the private company.

III.  Initial Business Combination

The initial business combination is an important phase for an investor as the SPAC changes from essentially a “trust fund” to a functioning company.  If it is disclosed the SPAC is required to acquire shareholder approval, it will provide a proxy statement.  Shareholders of the SPAC can vote on approval or redeem their shares.  If a shareholder decides to redeem their shares, it is the pro rata amount of funds in the escrow.  For example, if the IPO is ~$10, and the shareholder bought 100 shares at $20, the share of the trust account is $1,000, not $2,000. 

IV.  Current Environment

According to SPAC Alpha, the number of SPAC IPOs priced and mergers closed increased ~320% from 2019 to 2020 [Appendix, 1].  The value of SPAC IPOs drastically increased ~512% to $83.4 Billion [Appendix, 1].  Market share by number of US-listed SPACs versus all US IPOs averaged 18.4% from 2015 to 2019 with the highest market share of 23% (2019) [Appendix, 2].  However, in 2020 the market share spiked to 53% [Appendix, 2]. 

In 2020, the equity returns on SPAC mergers, NASDAQ, and S&P 500 were 41%, 38%, and 13%, respectively[Appendix, 3]. 

V.  Information to Consider

A 2018 study by Goldman Sachs focusing on 56 SPACs that completed acquisitions or mergers found they tend to underperform the S&P 500 during the 3-, 6-, and 12-month period AFTER transaction.  A 2017 through mid-2019 study of 108 SPACS in the United States found SPACs had an average of 2% return.  However, factors, such as COVID and the “rise of the retail investor”, seem to have affected the financial markets making room for abnormal SPAC returns. 

Shareholders must be careful in fully analyzing SPAC disclosures as additional funding is typically needed and the interests of the sponsors might pivot from the interests of the shareholders.  Shareholders should:

Attention must be paid toward the investor base.  A possible indicator of higher quality is the combination of who are the sponsors and larger investors.  With most things, higher quality managers tend to enter first, and after their deals have been made, lesser quality managers are attracted (SPAC boom).

VI.  Conclusion

SPACs offer many advantages including higher valuation, control, and time.  If one were to rely on historical analysis, public companies tend to have higher valuation multiples than private.  With traditional IPOs, most owners are unable to maintain a significant percentage of their companies.  However, the SPAC structure allows owners to maintain a significant percentage.  Speed is usually an obstacle for owners considering entrance to the stock market.  The nature of traditional IPOs limits their ability to predict when the process will be complete.  However, SPACs are required to acquire a company within a two- to three-year span, giving owners clarity on timelines.

One might question, why now? Well, it seems SPACs are being considered a mainstream alternative as well-known investors such as Richard Branson, Tilman Fertita, and Chamath Palihapitaiya have entered the field.  Sponsors and owners might observe the increase in retail investor activities as a positive, so they want to capitalize on the increase of cash flow.  Finally, in a year marked by volatility, quick entrance to the stock market at a fixed price can be seen as an advantage. 

Yes, it may be appealing to enter the SPAC field as it has recently shown a strong return on investment.  However, due to the nature of the asset vehicle itself, it is entirely speculative.  The investor must place his full trust in the sponsors’ ability to acquire a robust company.  Also, before one was to invest, she/he must read the disclosure intensely as sponsors’ and investors’ interests can separate at certain occasions in the acquisition of the target company.

With the recent SPAC performance of nearly 41%, it is worthy to remember here, an average SPAC returned a measly 2% from 2017 to 2019.  However, we must remember, these are not ordinary times.  The world is under conditions rarely observed before.  A pandemic-stricken world has reduced the normalcy of the economy and everyday life while adding more volatility to financial markets.   

In our opinion, the surge of stimulus and the rise of the retail investors are most likely the culprits behind the continual demand for highly speculative assets, such as Bitcoin and SPACs.  Instead of looking at historical data or educating themselves on a topic, the average investor is flocking to the “hot news,” in this case, SPACs.  We believe SPACs will perform well short term, but, contrary to current popular belief, there will be losers in the SPAC market, and one must choose wisely if they wish to enter the SPAC scene. 

VII.  Additional Sources/Notes

What You Need to Know about SPACs

Special Purpose Acquisition Companies

Conflicts of Interest

Spectacular Rise of SPACs

VIII.  Appendix

[1] SPAC Alpha

[2] SPAC Alpha

[3] Statista

To learn more about how Acumen can help you Invest Intentionally®, please contact us.

Charts used in this commentary was obtained via Bloomberg L.P.

The opinions expressed in this commentary should not be considered as fact. All opinions expressed are as of the published date and are subject to change. Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. Investments in securities involves risk, will fluctuate in price, and may result in losses. The information has been obtained from sources we believe to be reliable; however no guarantee is made or implied with respect to its accuracy, timeliness, or completeness.   It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results. Diversification does not protect against loss of principal.

The S&P 500 Index is widely regarded as the best single gauge of the U.S. equities market. The index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. All indexes are unmanaged and an individual cannot invest directly in an index. Index returns do not include fees or expenses.

Any charts, graphs, and descriptions of investment and market history and performance contained herein are not a representation that such history or performance will continue in the future or that any investment scenario or performance will even be similar to such chart, graph, or description.

Acumen Wealth Advisors, LLC® is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Acumen Wealth Advisors, LLC® and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Acumen Wealth Advisors, LLC® unless a client service agreement is in place.

With the presidential election only one week away, our team at Acumen has been researching a variety of topics relating to the potential impacts of the election and we are sharing this information with you in a three-part series called “The Election Effect.”  In today’s final installment, we explore the policy implications on investment portfolios.  We hope you find this information interesting and welcome your thoughts on the series.

The Election Effect: Part 3 of 3

Policy Implications on Investment Portfolios

Acumen has previously communicated our belief the broad understanding of the effect of presidential elections on financial markets is widely misinterpreted. From our research, we found the party holding control of the White House, or even sometimes the White House and Congress, does not have a high correlation with asset class returns in financial markets.  This research does not discount the potential definitive effect this election could have on specific asset classes or industries.  In fact, we believe we can better position portfolios for the future after assessing many of the potential policy moves by both candidates and after assessing the odds of each outcome.

One of the possible misunderstandings investors may have about this election season is the fear of sudden financial market turmoil if Joe Biden is elected president.  Whether our research about political party correlation to financial market returns reigns true or not, we must be aware of the more progressive ideas a Biden presidency could bring.  One factor we have focused on extensively is the sudden increase in the betting average Biden will become president over his polling average and the decrease in the betting average Trump will become president below his polling average.  We saw this trend play out in 2016 with Trump and Hillary Clinton.  Clinton’s polling average showed her in a significant lead over Trump, but their betting averages were much closer together.  We saw the two measures begin a greater divergence after the first debate.  Since then, the S&P 500 is up more than 6%, the 30-year yield is up 11 basis points, and the spread in high-yield bonds versus treasuries is down more than 10.5 basis points.  These indicators are all financial market characteristics supporting the forecast that a Biden nomination will not crash financial markets.  Granted, there will be long-term implications of a Biden presidency possibly producing slower nominal growth.  The implications of a higher corporate tax rate, large fiscal spending, and more heavily regulated markets could be a reason to forecast slower (still positive) economic growth in the long-term.  At the same time, industries within the stock market that will probably benefit more from a Biden presidency have outperformed the broad equity market.  Sectors such as Industrials and Financials have been outperforming Technology – a sector which will likely face greater scrutiny under a Biden presidency.  Those who believe in the forward-looking nature of the stock market are likely discounting a Biden win right now.

We believe understanding policy propositions from both parties and the effects they could have on financial markets is incredibly important.  For starters, there are a few policy implications we believe will be realized no matter who is elected.  In our eyes, the most important factor to watch would be the pace at which we continue to grow our fiscal deficit.  For instance, both candidates are likely to impose a new infrastructure plan.  Trump attempted to put an emphasis on the infrastructure during his first term.  Biden has said he would propose a $2 trillion spending plan on infrastructure.  Obviously, this action should generate better returns in infrastructure assets.

Both candidates also support another stimulus package for the coronavirus pandemic.  This influx of liquidity leads us to believe that with the roughly 20% fiscal deficit the IMF has projected for 2020 will continue to grow.  Our economy may not grow at the same rate, but we do not believe either candidate will be able to simply reverse the trend.  There are major implications to this.  For one, a higher than expected increase in economic growth could spark higher inflationary pressures.  We believe alternative assets, like gold and real estate, should benefit from these pressures.  At the same time, fixed income has become less attractive than both equities and alternatives due to the negative REAL rate of return investors will see across the bond market.  This rate is truly one of the only ways governments know how to deal with large deficits – they “inflate it away”.  In fact, we have already seen the Federal Reserve change the way they measure inflation targeting.  During their last meeting, the Fed said they would now allow inflation to overshoot their typical 2% target after periods of extremely low inflation.  This change likely speaks to the prospect of ever actually seeing inflation greater than 2%.  Either way, we believe the rate of change towards greater deficits will continue.  The other implication that may result from larger fiscal deficits is higher taxes.  The Biden administration has offered insight into their plan to cut back much of the Trump administration’s tax cuts and jobs act.  These cuts would likely increase the tax rate many “big-tech” companies are currently paying.  One way we have begun diversifying this risk is by reaching out into tech disruptors, such as cloud computing and software-as-a-service companies, instead of the crowded trade seen in many large-cap technology stocks.  We still believe a strategic allocation into these investments are prudent, but also do not believe it should be the primary source of allocation.

One of the largest policy implications on the horizon is the movement toward a greener future.  While a Biden administration and a Trump administration will likely mean much different strategies in the short term regarding our dependence on fossil fuels, this difference is a policy area we believe we will make significant headwinds on in the near future no matter who controls the White House.  Green and sustainable energy has become a much greater bipartisan issue over the last few years.  We see this issue, as well as a lower dependence on oil and gas, continuing to cause disruption in the energy sector.

To learn more about how Acumen can help you Invest Intentionally®, please contact us.

 

 

Information used in this commentary was obtained via Bloomberg L.P as of 10/12/2020.

The opinions expressed in this commentary should not be considered as fact. All opinions expressed are as of the published date and are subject to change. Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. Investments in securities involves risk, will fluctuate in price, and may result in losses. The information has been obtained from sources we believe to be reliable; however no guarantee is made or implied with respect to its accuracy, timeliness, or completeness.   It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results. Diversification does not protect against loss of principal.

The S&P 500 Index is widely regarded as the best single gauge of the U.S. equities market. The index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. The S&P 500 Index focuses on the large-cap segment of the market; however, since it includes a significant portion of the total value of the market, it also represents the market. The International Monetary Fund (IMF) is an organization of 190 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world.

Acumen Wealth Advisors, LLC® is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Acumen Wealth Advisors, LLC® and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Acumen Wealth Advisors, LLC® unless a client service agreement is in place.