For those who worry that a decade of ultra-loose monetary policy has created asset bubbles around the world, the first signs of trouble may be growing in a market with high prices.
According to Bank of America strategists, including Michael Hartnett, the bubble is “bursting simultaneously” in assets including cryptocurrencies, palladium, long-term technology stocks, and other historically risky market sectors. The cooling of the speculative sector comes at a time when investors are preparing for the Fed to step up the pace of policy tightening.
“Reduced liquidity from the Federal Reserve will lead to a rise in stock risk premiums and interest rates, which will continue to have a disproportionate impact on the riskiest assets in the market, including kinetic-driven investments in loss-making technology stocks, influencer stocks (meme stocks), and particularly in cryptocurrencies with no intrinsic value,” said Jay Hatfield, portfolio manager at Infrastructure Capital Advisors.
The following chart shows speculative activity across asset classes being dissipated.
Ark Investment Management's flagship fund, the Innovation ETF, has fallen about 46% from a record high set in February 2021. The hawkish signals from the Federal Reserve have severely impacted expensive tech stocks, and many of them, including Tesla and Roku Inc. It is a heavyweight stock held by Ark's funds.
Speculative activity in other riskier corners of the stock market is also receding. Goldman Sachs Group's basket of unprofitable tech stocks fell sharply after several years of gains, and an index tracking special purpose acquisition companies (SPACs) has fallen 35% from a high point.
“The potentially rising interest rate environment is prompting investors to reevaluate the risks they are willing to take,” said Todd Rosenbluth, head of ETF research at CFRA. “Companies with high growth potential but are unstable are falling out of favor, and investors are instead prioritizing more stable companies.”
However, he does not believe that any recession in these areas of the market is a bursting of the bubble.
“I don't like the term bubble because it's just an afterthought,” Rosenbluth added. “We are in the middle of this trend, which may or may not reverse.”
The Nasdaq Biotech Index fell 6.5% in the first week of the new year, the worst five-day performance since mid-March 2020. The index includes companies such as Amgen Inc. and Gilead Sciences Inc. Many members of the index have yet to generate revenue or profit, and are affected by the rotation of investors from high-risk, high-return stocks.
Furthermore, the Invesco Solar ETF had a capital outflow of more than 70 million US dollars last Thursday, the biggest since March last year. The fund recorded gains of more than 230% in 2020, but lost its luster in recent days as the Federal Reserve became more hawkish.