×

Looking for bubbles? Here are two below-the-radar trouble spots

  • Analysts at Yardeni Research believe cryptocurrencies like bitcoin and ethereum and special purpose acquisition corporations are exhibiting bubbly characteristics
  • Both are attracting billions in cash from investors who may not fully understand what they're getting themselves into.
  • The SEC recently warned about digital currencies, saying investors who get swindled may have little recourse.

With stocks hovering around record highs, investors have been on the watch for signs that enthusiasm is getting out of hand. However, the source of real market bubbles could be in some less obvious places.

Two areas stand out: initial coin offerings for cryptocurrencies, which are getting plenty of attention due to their meteoric price surge, and special purpose acquisition corporations, or SPACs, which have attracted considerably less notice.

Analysts at Yardeni Research believe both areas are exhibiting bubbly characteristics, mainly because they are attracting billions in cash from investors who may not fully understand what they're getting themselves into.

SPACs are sometimes called "blank-check companies" because they look like initial public offerings but have no actual operations. Instead, they raise money in the public market and then look for businesses in which to invest.

So far in 2017 these companies have attracted $5.5 billion through 18 offerings, according to data Yardeni cited from Renaissance Capital. That's close to the total raised over the past two years combined and is on pace to challenge the all-time high of $10.7 billion through the 58 deals that came to market in 2007.

"This is concerning because ideally SPACs should raise and invest money when prices are low and they can make acquisitions on the cheap," Yardeni Research founder Ed Yardeni said in a note. "However, when stock prices are low, investors aren't usually brave enough to buy into a blank-check offering. High stock prices appear to embolden bravery at what may turn out to be exactly the wrong time."

A trader on the floor of the New York Stock Exchange.
Brendan McDermid | Reuters
A trader on the floor of the New York Stock Exchange.

Federal Reserve officials lately have been pondering the question of whether risk-taking is getting out of hand. The S&P 500 is up 10.2 percent year to date and about 270 percent since the March 2009 low in the second-longest bull market on record.

Policymakers at their July meeting discussed the surge in stock prices but concluded that the rise in equity values has a fundamental backing, according to an account of the session the central bank released Wednesday.

Not mentioned in the meeting minutes, however, was the stratospheric climb of cryptocurrencies bitcoin and ethereum this year. Yardeni believes both are alarming, considering how much speculative money is going into the space.

He focused primarily on initial coin offerings, which give investors the ability to bet on the direction of freshly minted digital cash.

"They are betting that the coins will rise in value because they are issued in limited supplies, which seems to be their only selling point. This is an odd bet on demand getting stimulated by a shortage of this funny money," Yardeni wrote.

Further, he worries that fraud — a familiar theme in the cryptocurrency world — could wipe out the billions that investors are pouring into ICOs.

The Securities and Exchange Commission recently issued a warning that if investors are swindled by less reputable crypto operators, the ability to recoup their losses likely will be limited.

"If fraud or theft results in you or the organization that issued the virtual tokens or coins losing virtual tokens, virtual currency, or fiat currency, you may have limited recovery options," the commission said. "Third-party wallet services, payment processors, and virtual currency exchanges that play important roles in the use of virtual currencies may be located overseas or be operating unlawfully."

ICOs are estimated to have raised $1.3 billion this year [according to a recent Wall Street Journal report] and that doesn't include 48 more that are expected to come to market before Nov. 1.

The push for coin offerings come as bitcoin's price has risen more than 360 percent and ethereum has jumped more than 3,000 percent.

Should the demand go south, that could lead a lot of digital currency believers with money that vanishes into the ether.

"At some point, if the number of ICOs falls, a major source of demand for these cryptocurrencies will be declining. ICOs could stall if too many dollars are required to buy an ether or if too many of these business-plan companies fail to germinate,"" Yardeni said. "This complicated area with its own language seems to be filled with exuberance, and that rarely ends well."

WATCH: Dennis Gartman warns investors to stay away from digital currencies.