A Wall Street sign is seen in front of the New York Stock Exchange (NYSE) in New York, U.S. (Photographer: Michael Nagle/Bloomberg)

Speculative Fervor Builds at Fringe of a Quiet Week for S&P 500

(Bloomberg) -- It was an outwardly boring week in the S&P 500. But in chancier corners of the market a decidedly risk-on tone is building, evidence traders are awakening after three months of shell shock.

While broad benchmarks sat still, speculative shares soared, among them companies that recently went public, stocks favored by short sellers, and firms with weaker balance sheets. A seven-week rally was preserved in the Russell 2000, which was joined in record territory by an index of microcaps.

Gains in the third category, companies with shakier finances, breathed new life into a trade that had prevailed for most of the bull market before deteriorating as investors sought safety. Known as the low-quality rally, its revival may signal indiscriminate buying pressure is building again for equities.

“Folks feel good about the risk-on trade,” Gary Bradshaw, a portfolio manager at Hodges Capital Management in Dallas, said by phone. “It’s not easy to get people to put money into the market, but you kind of have a healthy consumer, you’ve got healthy corporations, companies buying stock. Life’s good, the way I look at it.”

It was a week billed as the most important stretch for the world economy this year. President Donald Trump met with North Korea’s Kim Jong Un, the Federal Reserve pondered interest rates, the European Central Bank set a limit on bond buying and China vowed to retaliate after the U.S. announced tariffs on $50 billion worth of goods.

Looking at reactions in the broad market, you would’ve thought nothing happened. The wire-to-wire change in the S&P 500 was the smallest of 2018, and benchmark volatility is roughly half its level in late March. Friday looked exciting early as the S&P 500 fell as much as 0.8 percent, but ended in a whimper.

For the five sessions, the S&P 500 gained 1 one-hundredth of a percent, closing at 2,779.42. The Dow Jones Industrial Average lost 0.9 percent to 25,090.48. The Nasdaq Composite Index climbed 1.3 percent to 7,746.38.

Below the surface, things were jumping. Technology companies that went public recently soared. Dropbox Inc., which began trading on March 23, climbed 32 percent. Cloud-based software company Zuora Inc. surged 18 percent, topping off gains of more than 50 percent since the start of the month. An exchange-traded fund that tracks newly public companies, the Renaissance IPO ETF, posted its second-best weekly gain this year.

Avalara Inc., a Seattle-based company that provides sales tax-management solutions, started trading on the NYSE Friday and nearly doubled. There have been 22 technology companies to go public so far this year in the U.S., and they’ve gained an average of 70 percent, weighted by offer size, according to data compiled by Bloomberg.

To Chris Bertelsen, chief investment officer of Aviance Capital, a Florida-based advisory firm, it’s a sign of just how much risk investors are willing to take to juice performance.

“They’re chasing returns,” he said in an interview at Bloomberg’s New York headquarters. “They’ve been forced into taking risk generally in equities where they’re in an area where they’re really not comfortable in.”

As crazy as it’s been, it’s still a little early for comparisons to past IPO frenzies such as the one in 1999. About 130 technology companies made their IPO in the U.S. that year, and the average gain was more than 300 percent, according to Bloomberg data.

The outperformance in weak-balance-sheet companies came even as the Fed was raising interest rates. A basket compiled by Goldman Sachs of companies with flimsier finances outpaced their stronger counterparts this week by more than half a percent. It may signal investor optimism as we enter the summer, according to Bertelsen.

“It shows that it’s actually a pretty healthy economic environment,” he said. “Why would you invest in a company where the balance sheet is stressed? You would do it if you felt that either the company or because of the economic situation that they’re going to grow into a more satisfactory fundamental balance sheet.”

Stocks that speculators bet will fall instead rose. A basket of 50 heavily shorted companies jumped more than 3 percent this week. The performance is more than double that of a separate group of companies favored by hedge-fund longs. The outperformance isn’t completely out of the blue either, as the high short interest stocks have jumped nearly 9 percent since June’s start.

“Honestly, people think growth is going to be the way that the market moves in perpetuity,” Kim Forrest, senior portfolio manager at Fort Pitt Capital Group LLC in Pittsburgh, said by phone. “And whenever I hear the word perpetuity, I know we’re in for a change. Stuff doesn’t last forever.”

©2018 Bloomberg L.P.

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