By Michael Brush
I hear more money managers say it’s starting to feel like 1999 — the bubble year followed by an epic market crash.
They may be on to something.
The initial public offering (IPO) market now shows the froth that foreshadows big stock market corrections.
Consider these troubling signals from the IPO market.
1. Ominous volume: Second-quarter IPO proceeds were the biggest since — get this — the fourth quarter of 1999. The huge tech selloff that scarred a generation of investors started in March 2000 and then spread to the entire market.
Some details: A total of 115 IPOs raised $40.7 billion in the second quarter. That follows a busy first quarter when 100 IPOs raised $39.1 billion. Both quarters saw the largest amount of capital raised since the fourth quarter of 1999, when IPOs raised $46.5 billion. These numbers come from the IPO experts at Renaissance Capital, which manages the IPO exchange traded fund, Renaissance IPO ETF /zigman2/quotes/207665280/composite IPO -1.31% .
Of course, adjusted for inflation, the 2021 numbers shrink relative to the fourth quarter of 1999. But this doesn’t get us off the hook. The 2021 IPO figures, above, exclude the $12.2 billion and $87 billion raised by special purpose acquisition companies (SPACs) in the second and first quarters.
This spike in IPO volume is troubling for a simple reason. Investment bankers and companies know the most opportune time to sell stock is around market highs. They bring companies public at their convenience, not ours. This tells us they may be selling a top now.
Here are the other ominous signs of froth in the IPO market.
2. Tech leads the way: It dominates the IPO market again, just as in1999. The tech sector raised the majority of second-quarter proceeds and posted its busiest quarter in at least two decades with 42 IPOs, says Renaissance Capital. This included the quarter’s largest IPO, DiDi Global , the Chinese ride-hailing app. The large U.S.-based tech names were Applovin /zigman2/quotes/226004863/composite APP -5.15% in app software, the robotics company UiPath /zigman2/quotes/226284328/composite PATH -1.83% , and the payments platform Marqeta /zigman2/quotes/227203754/composite MQ -2.00% .
3. We can expect more of the same: A robust IPO pipeline sets the stage for a booming third quarter, says Renaissance Capital. The IPO pipeline has over a hundred companies. Tech dominates.
4. Frothy first-day gains: The average first-day pop for IPOs in the second quarter was 42%. That’s well above the range of 31%-37% for the prior four quarters.
5. Historically high valuations: Typically, tech companies have come public with enterprise-value-(EV)-to-sales ratios of around 10. Now many are coming public with EV/sales ratios in the 20-30 range or more, points out Avery Spears, an IPO analyst at Renaissance Capital. For example, the cybersecurity company SentinelOne /zigman2/quotes/208685669/composite S -3.47% came public with an EV/sales ratio of 81, says Spears.
6. Retail investors in the mix: They’re big participants in IPO trading — often driving IPOs up by crazy amounts in first-day trading. “In the second quarter there were a lot of small deals with low floats and absolutely insane trading, popping well over 100% and in one case over 1,000%,” says Spears. Pop Culture Group /zigman2/quotes/227704068/composite CPOP -1.00% rose over 400% on its first day of trading, and E-Home Household Service /zigman2/quotes/226757832/composite EJH -4.28% advanced 1,100%. “This demonstrates presence of retail investors in the market,” she says. Both names have since fallen.
Keep in mind that the 2000 selloff was not the only one foreshadowed by IPO froth. The selloffs during mid-2015 to early 2016 and the second half 2018 were both preceded by high-water marks for IPO deal volume.
“It’s different this time” are maybe the most dangerous words in investing. But market experts say several factors suggest the robust IPO market isn’t such a negative signal.