Market

An IPO Love Affair With US Stock Market Means A Shakeup Is Near

They’re coming out of the woodwork. New common stock issuances are pouring out of venture capital and private equity portfolios, from already well financed US firms, from the brains of Wall Street and even from overseas. Everyone wants in on the action – that is, the inflated prices investors are willing to pay for stocks. And that means any stocks, so long as there is a good story that implies a potentially fast gain could come.

The IPOs this year reveal the reality

Most IPOs now have produced losses (see, “Stock Market’s ‘Hidden’ Risk Is Wall Street’s IPO Failures – Realization And Fallout Are Close.”) However, initial, short-lived price jumps have conjured up the view that IPOs are “red-hot.”

Virtually anything can be sold, even debt-ridden, stagnant companies with brand names like Weber and Dole. Some IPO money is even being used to cash out private equity holders who first used company debt to pay themselves dividends. Other IPO money is going to pay off excessive, junk-rated debt. In other words, the companies are not receiving IPO cash to foster growth – like for innovation or expansion.

Then there are the surefire Wall Street money machines of SPAC funds, “biotech” anything and technology/software. No earnings? Not a problem. In fact, investors have it in mind that the lack of earnings can lead to a big payday when the dazzling story becomes fact and the earnings pour in.

Value investing – say, what?

Oh, and value investing is dead. Who wants to own something that is forecast to grow at, say, only 5% and a corporate strategy of more of the same? An established company is viewed as being weighed down by fixed assets, a multitude of employees and already known products.

The very operation of such companies is perceived as sluggish and out-of-date. “Kaizen,” the Japanese term for steady improvement, is seen as ponderous and slow.

“Kaizen is a Japanese term meaning ‘change for the better’ or ‘continuous improvement.’ It is a Japanese business philosophy regarding the processes that continuously improve operations and involve all employees. Kaizen sees improvement in productivity as a gradual and methodical process.” (Investopedia.com)

And not only is value investing dissed. So, too, is the valuation process. “Value” is now seen as stock price rise. A high gain is the sign that a company is great. A fast, high gain implies it’s really great, so get in now.

The Robinhood Markets IPO is a good case example

The company’s facts produced a valuation lower than Wall Street’s offering price. Therefore, institutions tended to sit out the $38 IPO. The opening 2-day price sag of over 10% was seen as proof that Wall Street had goofed. Then, the crowd jumped in and the stock took off – for three days – rising from $35 to a high of $85 (+143%). Once again, the large, fast rise was over and done quickly and the stock is now down by almost half to $44. However, that dramatic run-up was taken as proof of success.

So, what about all those reversals and losses?

Two attitudes seem to be at work in accepting those.

First, day trading is popular. Thus, a “short-lived” daily move can seem lengthy when the minute hand is the time measurement and the moves are large. (Robinhood Markets’ 3-day rise had 300 million shares trade hands.)

Second, the crowd flits. So far, there has always been something new that attracts the crowd’s interest, making the fate of the been-there, done-that stocks immaterial.

The bottom line: Supply is growing too large this late in the demand-driven game

Wall Street will continue to create supply whenever there is investor demand, particularly when there are company clients clamoring to sell their stock. Professional fund managers will support such a trend while demand continues to lead supply. However, they get antsy when demand growth slackens as new supply hits, thereby softening prices. That’s when the undoing starts, with the professionals leading the selling.

The extraordinary rise in supply now will be a major test, and the demand could fail to expand. That, combined with the already visible selloffs in discarded “hot” stuff could produce a trend reversal.

Will such a change affect the rest of the stock market? Probably. Rampant speculation in one area of the stock market usually infiltrates other areas. (For example, increased margin buying and option activity.) Moreover, any shakeup within the stock market tends to temper investor enthusiasm everywhere.

So, a good strategy is to hold some cash reserves now in order to take advantage of shakeout opportunities later.

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