I’m hearing more money managers say it’s starting to feel like 1999 — the year of the market boom, followed by a massive market crash. They could have a point. The froth in the initial public offering (IPO) market now foreshadows major stock market corrections.
Take a look at these alarming signs from the IPO market. 1. A foreboding volume: The largest IPO proceeds were recorded in the second quarter since — wait for it — the fourth quarter of 1999. In March 2000, a massive tech selloff began, scaring a generation of investors, and eventually expanded to the entire market. Here are some specifics: In the second quarter, 115 initial public offerings (IPOs) raised $40.7 billion. This follows a hectic first quarter, in which 100 initial public offerings (IPOs) raised $39.1 billion. Both quarters witnessed the most capital raised since the fourth quarter of 1999, when $46.5 billion was raised through IPOs. These figures come from Renaissance Capital’s IPO professionals, who operate the Renaissance IPO ETF IPO, -2.04 percent IPO exchange traded fund.
Naturally, when adjusted for inflation, the 2021 figures are lower than the fourth quarter of 1999. However, this does not absolve us of responsibility. The $12.2 billion and $87 billion raised by special purpose acquisition companies (SPACs) in the second and first quarters are not included in the 2021 IPO estimates. This surge in IPO activity is concerning for one simple reason. Around market highs, investment bankers and firms realize it’s the best moment to sell stock. They make corporations public when it is convenient for them, not for us. This indicates that they may be selling a top right now. Other alarming symptoms of froth in the IPO market are listed below. 2. Technology takes the lead: It once again controls the IPO market, as it did in 1999. According to Renaissance Capital, the tech sector raised the majority of second-quarter proceeds and had its busiest quarter in at least two decades, with 42 IPOs. This included DiDi Global DIDI, +4.83 percent, the Chinese ride-hailing service, which had the largest IPO of the quarter. Applovin APP, -2.91 percent in app software, UiPath PATH, -1.38 percent in robotics, and Marqeta MQ, -8.41 percent in payments, were among the large U.S.-based tech firms.
3. More of the same is to be expected: According to Renaissance Capital, a strong IPO pipeline is setting the groundwork for a strong third quarter. There are nearly a hundred companies in the IPO pipeline. Technology is in charge. 4. Big first-day gains: In the second quarter, the average first-day gain for IPOs was 42 percent. This is significantly higher than the previous four quarters’ range of 31% to 37%. 5. Historically high valuations: Historically, tech businesses have had enterprise-value-to-sales ratios of approximately 10 when they went public. According to Avery Spears, an IPO analyst at Renaissance Capital, many companies are now going public with EV/Sales ratios in the 20-30 range or higher. According to Spears, the cybersecurity firm SentinelOne S, -4.31 percent went public with an EV/sales ratio of 81 when it went public. 6. Involvement of retail investors: They’re key players in IPO trading, typically propelling IPOs up by huge sums in first-day trading. “There were a lot of minor trades with low floats in the second quarter that had absolutely amazing trading, exploding well over 100 percent and in one case over 1,000 percent,” Spears adds. Pop Culture Group CPOP, -10.21 percent increased by more than 400 percent on its first day of trade, while E-Home Household Service EJH, -0.30 percent increased by 1,100 percent. She claims that this proves the presence of retail investors in the market. Both names have now been dropped. Keep in mind that IPO froth was not the only thing that anticipated the 2000 selloff. Both the mid-2015 to early-2016 selloff and the second half of 2018 selloffs were preceded by high-water marks for IPO deal volume. Pushback on the IPO froth The phrases “it’s different this time” are maybe the most harmful in investing. However, according to market experts, a number of variables suggest that the booming IPO market isn’t necessarily a bad thing. For starters, good companies are going public. “You are seeing considerably more mature companies coming public because companies stay private longer,” says Todd Skacan, equities capital markets manager at T. Rowe Price. These aren’t the same speculative Internet businesses that existed in 1999. “More questionable firms coming public as in the fourth quarter of 1999 would be more of a signal of froth,” he says. We saw some of this with the SPACs, but the SPAC frenzy has died down, according to Skacan. According to a Renaissance Capital analysis on the IPO market, second-quarter SPAC issuance decreased 79 percent from the first quarter, owing to “investor fatigue and regulatory scrutiny.” 63 SPACs raised $12.2 billion in the second quarter, compared to 298 SPACs raising $87 billion in the first quarter. Next, the type of company that goes public could allay anxieties. There are several industrial and consumer-facing enterprises among the tech names – not the kinds of businesses that signal froth. Public national brands like Mister Car Wash MCW, -1.31 percent, and Krispy Kreme DNUT, -1.39 percent, as well as the high-growth oat milk brand Oatly OTLY, -5.35 percent, fall into this group.
Third, IPOs only float 10% to 15% of their total value, and many post-IPO valuations aren’t significantly higher than pre-IPO capital raising valuations. In comparison to 1999, this is a significant change. “They aren’t selling a large quantity of shares at inflated prices,” Skacan explains. This makes sense because companies that are more established at the time of their IPO require less capital. Flood of liquids Regarding the IPO rush, Kevin Landis of Firsthand Technology Opportunities TEFQX, -0.59 percent says, “I think it indicates more about general liquidity than it does about where the stock market is heading next.” “There’s a lot of money floating about. The capital markets resemble a wealthy visitor who has just stepped off a cruise ship, and we’re all trying to sell him something,” he says. “Things are going higher purely because of liquidity,” Landis adds, “which suggests there will be a top eventually.” “However, there isn’t always an impending top just around the corner.” According to Morningstar, Landis’ fund has outperformed his technology area by 9.6 percentage points annualized over the last five years. Last but not least Market predictions are always based on what intelligence operatives refer to as “the mosaic.” Each piece of data is a part of a larger picture. While the IPO market froth is alarming, it should be viewed as only one of several warning signs. Michael Brush is a MarketWatch columnist. He was the owner of APP at the time of publication. Brush Up on Stocks, his stock newsletter, has recommended APP. @mbrushstocks is his Twitter handle./n
