Trader’s Narrative

At the beginning of the year we looked at the long term trend of IPOs and how they track the speculative impulses that run through the stock market. If you missed it, check out the historical chart of IPOs.

Last year’s bear market completely shut down the initial public offerings and took the number of companies going public to lows that we hadn’t seen since 1978. Depending on what criteria you use, we had about last year we had between 20 and 43 IPOs. Although the year isn’t over, it looks like we are set for a quiet recovery. So far, about 67 companies have amended their existing filings or registered to go public. More than half of them coming after the March low in the stock market.

Here is a chart of the IPO market for the past 20 years:

Source: Bloomberg

There is no sign that we are about to revisit the speculative frenzy that we saw accompany IPOs in the last bull market. That kind of speculative sentiment takes time to generate and the current IPO market is merely returning to ‘normal’ after the shock of the financial crisis. If anything, the IPO landscape going forward will be more selective and opportunistic.

Secondary Market
While the primary market is returning to normal, the secondary issues market has roared to life as companies rush to recapitalize and heal their damaged balance sheets. Just this week more than 15 US companies announced plans to issue more shares for a total of $7 billion. The largest chunk of that comes from Barrick (ABX) who is removing their infamous short position against gold. The same is true around the world. Lenovo and Alibaba both will place shares in Hong Kong. As well Cemex, the Mexican cement giant, will issue $1.8 billion worth of shares.

IPO Pipeline
Here is a chart of the quarterly IPO pipeline for issues filed, priced, and withdrawn:

There is a limited history shown but you can see that the activity in the IPO market in the past few quarters has mirrored closely what we saw in the bear market that followed the tech bubble. Around the same time that the stock market stabilized in late 2002 and early 2003 and again in early 2009, the number of IPO withdrawals increased, filings and pricings dropped to a trickle.

Here you can read the recently released report on the third quarter IPO outlook from Renaissance Capital. If the link doesn’t work, you can also find it at the Free Trading Resource section of the blog (in the Reports folder).

If that a head and shoulder pattern, or a symmetrical triangle? Will Keynes ghost save us? Why did John get all the brains (and hair) in the Paulson family?

To find out, take a look at this weekend’s reading list from news.tradersnarrative.com:

• Still no clues of a bottom for stocks
• From GMO: Grantham’s latest letter to clients
• Peter Schiff on the defense about his performance
• As January goes, so goes the year?
• The new financial bubble
• John Paulson lives up to the name “hedge fund”
• The power of high dividend stocks
• JP Morgan quietly exited Madoff funds
• Historical chart of the IPO maket

And remember to check regularly since there are interesting links added regularly throughout the week.

If you know anything about Wall St. you won’t be surprised to learn that the cyclical nature of IPO trends can be studied to gain insight into the stock market.

After all, companies don’t go public as a gesture of charity. They do so because they think that they will gain something by exchanging their shares for your money. A transaction occurs when the two sides agree on the price but disagree on the value of the asset in play.

But there is an inherent asymmetry when it comes to IPOs. Although we have put in place measures to protect the public (through circulars, public disclosures, etc.) the insiders still know much more about their company and its merit as an investment than the general public who are taking the other side of the deal.

So obviously when we have an avalanche of insiders wanting to sell to the public, they aren’t doing so because they want to hand over their hard earned capital out of the goodness of their hearts. You know that valuations are so out of whack that they are about to soon regress to the mean. This is what happened in early 2000 - when you had people taking everything short of their daughter’s lemonade stand public.

The current market environment is very different from then. That is why I’m just not persuaded by the dire predictions of mass market meltdown or financial armageddon. We are actually enduring a severe IPO drought.

To play Devil’s advocate, today’s lack of IPOs may be partially explained by the low interest rate environment. Financially strong companies can turn to the fixed income market to find funding at lower cost of capital than equity markets. But I don’t think that explains it completely.

After the jump there is a great article written by Mark Hulbert for the NY Times which goes into more detail about several research studies which look at the predictive characteristics of the IPO market:

Continue reading ‘Using IPO Trends To Time The Stock Market’

Although I’ve previously touched on the predictive quality of the IPO market, I wanted to bring it up again because what last year was a slow trickle has now dried up to an outright drought.

So far in the first quarter of 2008 we’ve had only 12 IPOs: 5 in January, 4 in February and 3 in March. The last one being the high profile initial public offering of Visa (V). It added an enormous $18 billion to the quarterly value number, leaving less than a billion for the other 11 IPOs.

Visa has also provided the best IPO performance this year with a 50% rise from its $44/share offer price. BioHeat (BHRT) has been the worst performer, with a return of -24%.

Although this lack of activity can be interpreted by some as being negative because it means less business for Wall Street, less money for companies that are growing, and less opportunity for investors to fund new enterprises, in actuality it is a sign of good things to come.

To understand why, we’d have to put on our contrarian goggles: a drought of IPOs mean that there is a total lack of ‘froth’ in the market; it means that VC’s are holding off selling their equity because they know that it won’t get a bid; it means that most investors are in a retrenchment mode and are in no mood to put new money in unproven companies, instead preferring to hold more conservative securities.

When you restrict the supply of something, demand being equal or growing, prices go up. Economics 101. So as public companies continue to buy up their shares and private ones refuse to go public, the ‘float’ of equity decreases… pushing up average aggregate share prices.

Also, historically periods of IPO drought have not meant that new companies do not grow or find funding. Instead they have denoted incredibly opportune times to invest in the stock market.

As the maxim goes, “Be bold when others are fearful and fearful when others are bold.” And right now it doesn’t take a genius to see that with a lack of IPO filings, nervous companies pulling their filings and an empty roster of secondary offerings… that fear is rampant on Wall Street.

I remember learning the predictive power of IPO trends during the height of the bubble. It was one of the most powerful arguments that convinced me we were indeed in a bubble and would soon see a bear market correction.

But right now its message is the opposite. Just as it was in early 2003.

Here are some IPO resources:

• Hoovers IPO Central
• Marketwatch IPO Overview
• CNN Money IPO
• Yahoo! Finance IPOs
• MSN Money IPO Center
• IPO Home by Renaissance Capital the managers of the IPO Mutual Fund

Amid all the wailing and gnashing of teeth, we had a successful IPO: Visa (V) went public yesterday and made history.

Not only was it a resounding success for the investment bankers in a very difficult time, it was also the biggest IPO ever at $18 billion. And it managed to jump +30% from its $44 per share pricing.

But perhaps it was because of the financial and credit market turmoil that Visa did so well. Unlike many financial companies it carries no consumer debt but instead relies on small commissions on transactions.

Leadership
Each bull market has its leaders. A few years ago, Google (GOOG) and Baidu (BIDU) debuted on the stock exchange and quickly became the darling of momentum investors. Now they both lie broken, not only below their long term moving averages but also with the sword of Democles” (overhead resistance) hanging persistently above price.

So, if we are in the painful process of putting in another bottom here, as I’ve endlessly argued for the past little while, it is wise to look for the next leadership that will breath new life into the “new” bull market.

If Visa does as well as its competitor, MasterCard (MA), I’ll be a happy camper.

IPO Market? What IPO Market?
So far this year, we’ve had only 22 IPOS. Last year, by this time, we had 47. That is a greater than 50% drop off in activity.

If you’ll recall, the IPO market has predictive abilities.

The other way that the IPO market can help us time the market, or at least understand where we are in terms of market cycles, is by being a contrarian indicator of sorts. A bountiful harvest of IPOs has almost always preceded dramatic and sustained market downturns while a barren IPO market has historically meant the opposite.