Chaos theory is the science of surprises. By understanding how our ecosystems and our economic systems are interconnected, we can hope to avoid actions detrimental to our long-term well-being. One example is the butterfly effect. This refers to the impact of a butterfly that has flapped its wings in New Mexico subsequently causing a hurricane in China.

Over my lifetime, I have observed how seemingly singular events can have global repercussions. The OPEC oil embargo, the meltdown of hedge fund Long Term Capital Management and the subprime mortgage implosion created worldwide meltdowns.

Is there an economic tsunami in the offing? The fantastic run-up in the prices of initial public stock offerings (IPOs), the boom in financings by Special Purpose Acquisition Companies, and the absurdly low level of interest rates offered by high risk CCC bond issuers could have significant downward repercussions.

The 2020 return in an index of IPO stocks was 111%. First-day rallies were three times greater than the average over the last 40 years.

On Friday, United Wholesale Mortgage (UWM) made the largest-ever offering of a Special-Purpose Acquisition Company at a valuation close to $16 billion. UWM works with independent brokers around the country to underwrite and service mortgages.

According to SPACInsider, SPAC deals have become all the rage on Wall Street. SPACs stand for special purpose acquisition companies. They are essentially “blank-check companies” because the investors backing them invest their money before an acquisition target is identified. Investors hope that the sponsor finds good deals. SPACS that have not announced acquisition targets rose more than 20% in 2020.

This past week, David Solomon, Goldman Sachs CEO, in a speech to analysts worried “that the popularity of SPACs has gone too far.” Solomon expressed concerns that the incentives for the sponsors of SPACs are too high – 20% stake in return for an investment of $25,000.

According to data provider SPAC Research, there are nearly 300 SPACs looking for investment opportunities. In 2021, there has been an average of five new SPACs launched every day, some $20 billion. More than 70% of all money raised through IPOs has been for SPACs.

The speculative bubble has morphed to junk corporate bonds. Investors have poured billions into the lowest-rated junk debt, driving their yields to record lows. The yield on an index of triple-C rated bonds settled this past week at 6.42%.

The low yield on these risky assets reflects a dramatic change from the mood following the onset of the pandemic one year ago. Bank of America (BAC) wrote, “There is no historical comparison to this improvement in credit-market conditions.” BAC expressed concerns that the market is implying an absurdly low default rate of 2.1% over the next 12 months. According to Standard & Poor’s, the default rate on CCC securities traditionally was approximately 26%. Fed intervention has helped many struggling companies refinance their debt at lower interest rates.

These are indeed difficult times to make the correct investment decisions. On the one hand, we are suffering though a once-a-century pandemic. On the other hand, the stock market almost daily reaches new highs, housing prices have skyrocketed, and the initial public offering market is red hot.

I saw an interview on YouTube with Warren Buffett who mentioned, “The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.”

In 1996, former Fed Chairman Alan Greenspan decried the irrational exuberance of unfounded market optimism reflected in the dot.com era. He decried rightfully about investor enthusiasm that drove asset prices higher than was justified. The Nasdaq Composite stock market index subsequently fell 78% from its peak by October 2002.

Originally published in the Sarasota Herald-Tribune