March capped another month of record highs, with the Dow Jones Industrial Average rising above 33,000 for the first time ever and ending the quarter up 7.8%. The S&P 500 finished up 5.8%, and the NASDAQ finished up 2.8%. The continued and accelerated rollout of vaccinations nationwide, decreasing unemployment, strong housing demand, and the $1.9 trillion relief bill signed by President Biden provided the confidence and optimism that helped to drive markets higher.

No doubt part of this market activity has been driven by the tremendous growth of new-to-investing individual investors: More than 10 million new brokerage accounts were opened in 2020 alone, and Credit Suisse estimates that at times this year, retail trading has accounted for a third of all US stock market trading. But it was also partially driven by the popularity of what’s called “special purpose acquisition companies” (SPACs). Bitcoin, other cryptocurrencies, and the newest technology, non-fungible tokens (NFTs), have also been in the headlines.

This surge affected technology stocks, whose rich valuations have been justified by low interest rates. Technology and other high-growth stocks are valued based on future earnings, so higher interest rates makes those future earnings less valuable in today’s dollars.

Are these the new ways of building wealth? Are they here to stay, or are they in an unsustainable bubble? Before we tackle that question, let’s take a step back and explain what SPACs and NFTs are.

SPACs (special purpose acquisition companies)

SPACs, also called “blank check companies,” are shell companies listed on a stock exchange that have the objective of buying or merging with a private company in order to take it public. It’s basically an IPO without a lot of the expense, hassle, and regulatory oversight.

SPACs are created by sponsors, who are usually industry experts with deep experience in private equity and mergers and acquisitions. Once a SPAC has been created, its sponsors have two years to identify a target company. If they don’t meet that timeline, they must return investors’ money (minus fees).

For private companies, SPACs offer a faster, cheaper, and more efficient way to go public. For investors, SPACs offer the potential and allure of getting rich, and of participating in what’s perceived as pre-IPO stock. And because SPACs are traded on stock exchanges, anyone can purchase shares in a SPAC. In return, investors hope the sponsor gets a deal done within the two-year time frame, and that the value per share of the completed deal is worth more than they originally paid.

NFTs (non-fungible tokens)

An NFT is a digital token (like a digital certificate of authenticity) linked to either a tangible or digital asset — like artwork, an audio or video clip, or even real estate. Ownership of the token is stored and tracked using blockchain, a digital ledger that’s similar to those used for bitcoin and other cryptocurrencies. (Click here if you’re looking for a primer on cryptocurrency.) Each NFT is unique, like a collector’s item, and non-fungible, which means it can’t be swapped. (Cryptocurrencies like bitcoin, on the other hand, are fungible — you can swap one bitcoin for another because they’re exactly the same thing.) And because ownership of NFTs is managed using blockchain, it’s nearly impossible to fake or steal them.

Here’s what’s behind the hype: NFTs have risen as a means of representing everything from art to audio, video clips, digital trading cards, and even GIFs — all of which have recently sold for stunning amounts. Artists and musicians can use them to create limited-edition digital goods and monetize their artwork. NBA topshot sells video clips of highlight reels using NFTs; they’ve sold north of $230 million since 2019. Heard of Nyan Cat? (Beware: Lower your computer volume before clicking.) The creator of the viral GIF was able to sell it for a whopping $590,000! And popular digital artist Beeple sold a collaged image file as an NFT for more than $69 million through auction. Talk about cashing in.

Such eye-popping figures associated with NFTs and SPACs have led some to notice parallels between today and the tech-bubble of the early 2000s, when everything with a “.com” after their name was getting funded. And while most of those turned out to be unsustainable (see pets.com), keep in mind that investors weren’t wrong about technology — they were just wrong about the valuations.

So is it different this time?

Are SPACs, cryptocurrencies, and NFTs in a bubble about to burst? Or will these grow to be a more permanent part of investing?

We don’t know for sure, and neither does anyone else. In general, an asset bubble occurs when the price of something exceeds its fundamental value by a large amount. The problem is it’s hard (basically impossible) to identify a bubble at the time. We only know it existed after the bubble has “burst” and prices come back down. Still, we can get some insights by looking at the different phases that typically occur during a bubble, as shown below.

A telltale sign of a bubble — particularly as it moves from boom to euphoria — is frenzied growth, when everyone wants to buy without much regard for price. Last year was a record-breaking year for SPACs, which raised $83.4 billion, and in the first 3 months of 2021, they’ve raised a staggering $87.9 billion. With sports and music celebrities like Jay-Z and Serena Williams jumping in, some believe that SPACs are already in a bubble.

While the feverish growth of SPACs is worrisome, they do have benefits for both private companies and individual investors, as I mentioned above. Still, although recent SPACs have risen in price shortly after listing, historically, SPACs have not performed well as a longer-term investment. According to one study, for the 114 companies that went public via SPAC mergers in the past ten years, investors lost an average of 15% if they bought a merged company’s common shares on the first day of trading and held it for at least a year — with similar results for those holding even up to three years.

Along the same lines, the jaw-dropping prices people are paying for NFTs have led some to believe that the NFT bubble is not sustainable.

So while some have made small fortunes by buying SPACs, bitcoin, and NFTs, it’s taken luck and near perfect timing — two things we’d rather not bet our clients’ money on. While FOMO (the fear of missing out) is a powerful force, we believe these kinds of assets are speculative and best suited for money you can afford to lose.

We’ll know soon enough whether these are bubbles on the verge of bursting. But even if they do, SPACs and NFTs won’t disappear. SPACs can play an important role for private companies, and the potential applications for NFT technology could be game-changing. The tech-bubble of the early 2000s burst, but since then, technology companies have become some of the fastest growing companies and most rewarding investments. In the same way, once the hype dies down, SPACs and NFTs will be here to stay.

Disclosures