Inflationary Boom: US IPOs Best Since 2007

IPOs function as a very useful sentiment indicator. When stock markets boom, IPOs tend to follow.

Referring to the US, a few weeks back, I wrote 

If US stocks continue with its record breaking streak, then we should also expect IPO activities to follow.

Nonetheless IPOs can also serve as beacon to important inflection points of stock markets.

Well here it is; IPOs have been ramping up as expected.

From the Marketwatch.com

U.S. companies are on track to raise the most money through initial public offerings since before the financial crisis, driven by the same thirst for risk among investors that has pushed the stock market to new highs.

Already this year, 64 U.S.-listed public offerings have raised $16.8 billion, according to Dealogic. In the same period in 2012, the biggest year in dollars since the financial crisis, 73 companies raised a total of $13.1 billion. Last week alone brought 11 U.S.-listed IPOs, making it the busiest week for such deals since December 2007.

A more robust IPO market is seen as a potential boon for the economy because it allows companies to raise money that can be used to reduce debt or invest in their businesses. Sellers of stock such as private-equity or venture-capital firms can trim or shed their current holdings, return money to their investors, such as pension funds, and turn their attention to new investments.

Behind this year’s pace is an ebbing of the wild price swings that had been a dominant feature of the stock market since the financial crisis, according to investors, companies and bankers. Instead, stocks have been on a steady grind higher. As markets reach new records, investors are taking chances on shares of new public companies.

IPOs again serve as sentiment indicators or as symptoms rather than THE cause. Expansionary risk appetite function as symptoms of the psychological “bandwagon” effect that are principally driven by price signals. 

On the other hand, current price signals have been heavily influenced by social policies. Thus social policies have produced a boom bust cycle that has been manifested in IPOs

Notice that US IPOs set a record, or boomed, prior to the technology or the dot.com bust. 

Following the bust, US markets went into a hibernation (or consolidation) phase for more than a decade and only broke out recently. The quasi-stock market boom during 2003-2007 only had a tepid response in the IPO market.

Today, milestone highs in US markets have rapidly been attracting companies to go public, and on the opposite end, for the yield chasers to finance them.

The mainstream sees “This time is different” or "Not a déjà vu" to justify the continuation of the IPO winning streak.

The USA today for instance declares that current levels are YET far off the 2000 highs, there are better fundamentals underpinning IPOs, today has a different marketplace where large institutional investors rather than the retail market have been the source of demand, current IPOs  have been subject to heavy discounting and less reliance on a single industry.

If one would have used these argument prior to the peak in 2007, then IPO financiers would have been the greater fool.

The reality is that today’s stock markets have hardly been driven by fantastic fundamentals but by a mania—yield chasing frenzy driven by debt. Yes fundamentals have also been rendered opaque by zero bound rates and QEs.

Like all zeniths in the US stock markets, they all have been accompanied by ballooning Margin debt.

And while there are hardly any definite threshold levels for an inflection point, current levels of margin debt suggests that US equities markets have reached a very fragile state vulnerable to a meaningful downturn. (chart from Bloomberg)

Of course much will depend on actions by the US Federal Reserve when volatility emerges. Will the FED destroy the US dollar to send US equities to the sky?

People have frenetically been reaching out for yields such that the markets have been paying high yield or “junk bonds” at the closest spread ever to “risk free” US treasuries.

In using the Merrill Lynch High Yield (Junk) Master Index as gauge against US sovereign bonds, the Bespoke Invest observes that,

At a current level of 5.24%, investors have never been paid less to own high yield debt.  Yields are so low, in fact, that five years ago the yield on the 10-Year US Treasury was higher than the current yield on junk bonds.  In the chart, the red dots on the blue line represent periods going back to 2000 where the yield on the 10-year US Treasury was higher than the current yield on the High Yield Master Index.  With yields this low, high yield bonds are anything but high yielding.

Risk doesn’t seem to exist anymore. Markets have been jaded and has essentially lost its function as discounting mechanisms. Yield chasing have become the ultimate drivers.

Ah but…

Booming US stock markets are beginning to put pressure on interest rates. Yields from government bonds, particularly 1 year (UST1Y), 5 years (FVX), 10 years (TNX) and 30 years (TYX) have markedly risen. If such a trend should continue, then there will be pressure not only on margin debt on US stocks, but also on all forms of debt that have been used as leverage to finance such mania.

As a final thought, I pointed out of the increasing interdependency between US stock markets and the bond markets, where much of the buybacks and dividends that has driven the markets to record heights have been financed by the latter. This means that a bear market or even just a prolonged selling pressure in bonds will also affect the stock market. 

We are living interesting times indeed.