Speculative Stocks Soar as Investors Dust Off Low-Rate Playbook

Shares of speculative companies, many of which aren’t expected to be profitable until many years in the future, are among those most sensitive to the trajectory of interest rates. When rates are higher, investors have more options to earn yield and less patience to wait for future profits. Low rates have the opposite effect.

Other stocks that suffered steep declines last year are also soaring. Tesla Inc. increase; green up pointing triangle and Spotify Technology increase; green up pointing triangle have surged more than 50% in 2023. Robinhood Markets Inc. decrease; red down-pointing triangle and Cathie Wood‘s flagship ARK Innovation exchange-traded fund, known for its bets on unprofitable and “disruptive” technology firms, have climbed more than 30%.

“The low-rate environment and speculative tech go hand-in-hand,” said Neil Dutta, head of economics at Renaissance Macro Research.

Even Friday’s unexpectedly strong monthly jobs report did little to slow the stocks’ momentum. The S&P 500 extended gains last week and is up 7.1% on the year through Monday. The tech-focused Nasdaq Composite has climbed even faster, rising 14% in 2023.

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Skeptics point to 2001 as a cautionary tale. The Nasdaq rose 12% in January of that year but fell 30% over the following 11 months when the dot-com bubble burst. Others note that stocks historically haven’t bottomed out before the Fed is done tightening monetary policy.

If the euphoria in risky assets is a concern for the Fed, Chairman Jerome Powell did little to quell it in his press conference Wednesday, said Garrett Melson, a portfolio strategist at Natixis Investment Managers Solutions.

“We’ve had markets rallying for the entire month, and you’ve had opportunities for [Federal Open Market Committee] members to push back on that, and they haven’t,” he said.

After the central bank raised its benchmark interest rate by a quarter of a percentage point, Mr. Powell acknowledged that it sees signs of disinflation but reiterated that he doesn’t expect the Fed to cut rates this year. According to CME Group, traders of interest-rate derivatives are betting otherwise, putting the chance of at least one rate cut by year-end at 89% as of Friday.

The rally in speculative stocks has been accompanied by a frenzy in the options market, indicating that many traders expect even more significant gains.

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Strategists say that traders who shed exposure to the stock market may be trying to catch up and profit from the stocks’ gains through the options market. Other investors may be looking to turbocharge their exposure to the rally through options.

Options give the right to buy or sell shares at a stated price by a specific date. Calls confer the right to buy, while puts give the right to sell.

“I think the market was caught offside in a bearish direction heading into the year, and now you’re seeing a chasing dynamic,” Mr. Melson of Natixis added.

Call options trading tied to Ms. Wood’s ARK fund hit a record on Jan. 27, Cboe Global Markets data show. Many traders appeared to be positioning for a continued rally. Some of the most popular bets on Thursday were bullish calls tied to the fund jumping to $48 or $50, up from $44.40, where they closed that day.

Options trading tied to Tesla has also climbed to fresh highs, and activity in other stocks, such as Peloton, has also surged. 

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The rally in the risky stocks doesn’t necessarily match their fundamentals.

Carvana, an online seller of used cars, posted sharply lower car sales and laid off more staff in January after cutting around 20% of its workforce last year. Several junk-rated Carvana bonds were trading around 50 cents on the dollar Monday, according to MarketAxess. Yet the stock is up 183% in 2023.

Cryptocurrency exchange Coinbase reported almost $2 billion of losses over the first three quarters of 2022 and is contending with increased regulatory pressure after the collapse of competitor FTX. Coinbase laid off about 20% of its staff in January. Its stock is up 111% this year.

Peloton, the maker of exercise bikes that boomed in popularity during the pandemic, reported last week a 30% decline in sales and another quarterly loss. However, the company reduced its cash burn. The stock soared 26% in the following session and is up 99% this year after giving back some gains Monday.

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After last year’s tumble, the broader market looks less expensive than it did 12 months ago. The S&P 500 is trading at about 18.5 times its expected earnings over the next 12 months. That is down from around 21.5 times at the beginning of last year and is in line with its five-year average of 18.7.

Of course, many of the speculative companies leading the recent rebound can’t be evaluated by traditional valuation metrics because they aren’t profitable. But Tesla, for example, still trades at lofty levels at about 46 times its projected earnings over the next 12 months.

Brook Dane, an equity portfolio manager at Goldman Sachs Asset Management, said he agrees that defensive positioning coming into the year has accelerated the rally. Still, he cautions against investing in the riskiest, high-flying stocks.

“You can find high-quality companies with good growth outlooks that you can own for long periods without having to dip into the super highly speculative, binary outcome kind of names,” Mr. Dane said.