August 2, 2023 – The Death of Equities: How Inflation Is Destroying the Stock Market was featured on the front page of BusinessWeek on August 13, 1979. This cover is now infamous for its remarkably inaccurate prediction about the stock market’s prospects and is the flagbearer for the magazine cover indicator, a favourite market signal of contrarians.
During the late 1970s, the U.S. was experiencing a period of high inflation, which was a cause of concern for investors and the overall economy. In response to soaring inflation rates, the Federal Reserve Chairman at the time, Paul Volcker, implemented a series of monetary policies to combat inflation. These policies included raising interest rates to historically high levels, causing stocks to enter bear market territory.
The BusinessWeek cover story, The Death of Equities, reflected the prevailing sentiment at the time that investing in stocks was futile in the face of rampant inflation and high interest rates. Many believed stocks would no longer provide attractive returns compared to other investment options. Stock market sentiment was at rock bottom.
History proved this prediction to be profoundly wrong. In the early 1980s, inflation rates started to decline as the Federal Reserve’s tight monetary policies began to take effect. The previous equity bear market and negative investor sentiment had taken stocks to single-digit earnings multiples, with valuations at historical lows. By the mid-1980s, the economy stabilized, and a long-term bull market for stocks began, lasting throughout the 1980s and 1990s.
During this period, the U.S. stock market experienced significant growth, and investors who remained in the market and maintained their equity positions were rewarded with substantial returns. This period became known as one of the most prolonged and robust equity bull markets in history.
The BusinessWeek cover story serves as a cautionary tale about the dangers of making sweeping predictions about asset classes. It is indicative that going against the crowd can sometimes turn out to be extremely lucrative. Typically, when sentiment is poor and there are few buyers for particular assets, those assets tend to be the most attractively priced.
While we have not yet seen a BusinessWeek cover pronouncing the death of SPACs, sentiment is rock bottom for the asset class.
One question I often hear from clients is, “What are going to do in your arbitrage fund now that SPACs are dead?”
In response, I quote Mark Twain in saying, “The reports of SPACs’ death are greatly exaggerated!”
Rewind four years, blank check companies were a backwater asset class that would barely make page 19 of the newspaper, let alone page 1. A couple of years later, SPACs were all the rage, and everyone and their dog were launching one. The market could not get enough.
As we have discussed throughout our memos over the past two years, the blank check market became far oversaturated in 2020 and 2021. It was due for a correction. The steady rise in interest rates, and the equity bear market of 2022, put the SPAC market in check. Hundreds of vehicles liquidated without a merger, and new issuance slowed dramatically.
Now, four years after the asset class took off into a frenzy, it is back to being a backwater that remains the domain of specialists and arbitrageurs.
We have been steadfast in our prediction that the asset class would shrink to where it was before the boom, both in terms of aggregate market capitalization and issuance. The market seems to be confirming this thesis.
From a starting point of $20 billion in 2019, the aggregate market cap of SPACs ramped up to $220 billion by 2021. It has shrunk back down to $30 billion as of today. We believe it will likely continue to shrink back to $20 billion, a sustainable size.
New issuance also continues to normalize. Nearly $2.5 billion of SPACs has been issued year-to-date, representing a $5.0 billion blank check IPO run rate. To sustain a $20 billion market, we expect new issuance to pick up to around $10 billion per year, or $800 million per month.
While the above SPAC market predictions are problematic for those running $1 billion+ arbitrage funds, it is more than enough for smaller hedge funds such as the Accelerate Arbitrage Fund (TSX: ARB).
In July, four SPAC IPOs raised approximately $700 million in total. ARB participated in three of the four new issues and a dozen year-to-date. Given attractive Treasury Bill yields, combined with overfunded trusts, warrant/right coverage, and the tax efficiency of SPACs’ Cayman domicile, we expect to generate attractive risk-adjusted returns participating in SPAC IPOs.
In addition, ten business combinations were announced over the past month, representing an aggregate enterprise value of $4.3 billion. The largest blank check merger announced was Churchill Capital Corp VII’s $1.58 billion merger with CorpAcq (ARB has a position).
Nevertheless, in a shrinking market, liquidations will dominate. Over the past month, 26 SPACs matured (compared with 4 new issues), with 10 completing business combinations and 16 liquidating. As the blank check market normalizes, we expect liquidations to subside.
Looking forward, there will be a dearth of SPACs come 2025, and sponsors are now beginning to position themselves for a far less competitive market. We are seeing highly respected repeat sponsors come back to the well with new vehicles, and we expect this activity to pick up.
While we have not yet seen the Death of SPACs magazine cover indicator, sentiment remains poor, and many believe the asset class has gone the way of the dodo bird. Nothing could be further from the truth. We remain very active in the SPAC market, participating in both the primary and secondary markets, with the aim of generating yields in the range of 6% to 8%, with both the upside optionality of a potential attractive merger and the downside protection of Treasury bills. Not to mention the yields generated via SPAC arbitrage represent tax-efficient capital gains as opposed to the tax-heavy interest income of traditional fixed income.
While we do not mind if competitors view the SPAC market as dead, we want our clients to know that the market remains alive and stocked with attractive uncorrelated investment opportunities.
The Accelerate AlphaRank SPAC Monitor details various metrics on the current opportunity set while offering details on every individual SPAC currently outstanding. The Accelerate AlphaRank SPAC Effective Yield tracks the average arbitrage yield offered. The Accelerate AlphaRank SPAC Index tracks the price return of the SPAC universe.
* AlphaRank is exclusively produced by Accelerate Financial Technologies Inc. (“Accelerate”). The Accelerate Arbitrage Fund may hold a number of securities discussed in this research. Visit AccelerateShares.com for more information.