Beware of “Blank Check” Investing

I’m old enough to remember Monty Hall, who from 1963-1986 hosted the tacky but hugely popular television game show “Let’s Make a Deal.”

Mr. Hall yelling his iconic catchphrase “Let’s…make…a…DEAL!” comes to my mind, as I observe the surge in special purpose acquisition companies (SPACs).

I’m generally optimistic about the economy and stock market over the long term, but my bullishness doesn’t preclude the risk over the short term of a sell-off. From my perspective, a glaring red flag right now is the rapid rise of SPACs.

Read This Story: Asset Bubble: Toil and (Maybe) Trouble

Stocks continue to hover at record highs, underscoring the hunger for risk-on assets. On Tuesday, the major U.S. stock market indices took a breather from their winning streak. The Dow Jones Industrial Average fell 96.95 points (-0.29%), the S&P 500 fell 3.97 points (-0.10%), and the tech-heavy NASDAQ slipped 7.21 points (-0.05%).

In pre-market futures trading Wednesday, all three U.S. indices were trading higher. Global stocks also have been on the rise in recent days, as economic growth picks up speed around the world.

The deal-making frenzy…

Massive fiscal and monetary stimulus has spawned a flood in liquidity. Investors are desperate to put that cash to work. Hence the proliferation of SPACs.

Often referred to as a “blank check” company, a SPAC has no commercial operations. It’s essentially a shell company created strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company. Subsequently, an operating company can merge with or be acquired by the publicly traded SPAC and become a listed company without going through the regulatory rigors of its own IPO.

Private companies resort to SPACs because they view the traditional IPO process as too lengthy and burdensome. SPACs streamline the process.

However, SPACs offer scant transparency and tend to give the sweetest deals to institutional investors and insiders who get aboard early. Investors don’t know for certain what they’re investing in. Sometimes, early investors cash out and leave the other investors holding the bag.

The sponsors of SPACs typically are wealthy private equity investors. Fueling the SPAC market has been Fear Of Missing Out (FOMO), a reliable contrarian indicator that stocks are poised for a fall. The dynamic is based more on greed than fundamentals. FOMO may soon give way to something else: just plain fear.

But for now, SPACs are red hot. Last year saw an unprecedented number of IPOs of SPACs and the pace has accelerated so far in 2021.

Read This Story: 2021: The Year of the SPAC?

SPACs are especially prevalent in the technology sector. According to a report released on Tuesday by 451 Research, soaring SPAC activity boosted technology merger and acquisition (M&A) spending to its highest quarterly level in history. (451 Research is part of S&P Global Market Intelligence.)

The total value of announced M&A deals in the first three months of 2021 is jaw-dropping. Acquirers ponied up $302 billion for tech vendors around the globe in the just-completed first quarter, according to 451 Research’s M&A KnowledgeBase. Almost 50% of the first quarter’s unprecedented spending came from SPACs (see chart).

SPACs are contributing an average of $2 billion per M&A tech deal and they’re making some investors very rich indeed. Previously rare, SPACs have moved from the fringes of the market into the mainstream.

But there are caveats. Notably, the Securities and Exchange Commission warned in a recent investor alert:

“SPAC sponsors generally purchase equity in the SPAC at more favorable terms than investors in the IPO or subsequent investors on the open market. As a result, investors should be aware that although most of the SPAC’s capital has been provided by IPO investors, the sponsors and potentially other initial investors will benefit more than investors from the SPAC’s completion of an initial business combination and may have an incentive to complete a transaction on terms that may be less favorable to you.”

Not surprisingly, SPACs have led to an outbreak of litigation, as investors who claim to have been burned launch lawsuits. When Wall Street’s lawyers start to get busy, it’s usually a foreboding sign for all of us.

Investors have a tendency to only recognize the warning signs of a correction in retrospect, after the damage has been done. Frenzied speculation, especially involving exotic investment strategies such as SPACs, is an ill omen. You should take proactive measures now, to protect your portfolio.

Under current market conditions, at least 15% of your portfolio should be devoted to hedges. As part of your hedges sleeve, about 5% – 10% should be in precious metals, such as gold.

Gold provides shelter during crises and it’s not too late to add some to your portfolio. The “yellow metal” has experienced a healthy run-up in prices over the past year and it has further to run.

I prefer gold mining stocks, which bestow greater potential for outsized gains than physical bullion or gold-linked funds. For details about a well-positioned gold mining play, click here now.

PS: Are there any topics that you’d like me to cover more often or in greater depth? Let me know:

John Persinos is the editorial director of Investing Daily. To subscribe to his video channel, follow this link.