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Are IPOs a Warning Sign

At the height of the Tech Bubble of the late 1990s, many late-stage bull market divergences were already developing. The S&P 500 Index and Nasdaq Index both peaked in March 2000, observes Jim Stack, money manager and editor of InvesTech Research.

And by the end of the year, the blue chip S&P was only in mild correction territory (-13.6%) while the tech-laden Nasdaq had tumbled over 50% from its March high. That bear market would go on to last almost two more years, with final losses exceeding 49% in the S&P 500 — and a devastating 78% loss in the Nasdaq Index!

More from Jim Stack: Three Ways to Look at Valuations

Long duration bull markets always create excesses. And to many participants in the investing world, these potentially dangerous extremes are often invisible. In the late ’90s, a non-believer in the technology boom was considered out of step with the New Paradigm era.

Likewise, a doubter of the housing boom in 2005 was simply a detractor from the American Dream of home ownership. Both ended badly for those investors or speculators who overleveraged their euphoric optimism.

This year’s Wall Street headlines have been dominated by the number of companies going public through initial public offerings or the less-common direct public offerings. Today’s IPO mania has been ramping up since 2017, culminating in a record number of large companies debuting in the first half of this year.

The private market, awash in cash stemming from easy monetary policy, has been eager to finance almost any startup with a new concept, but has seemingly forgotten to analyze whether there is a viable path to profitability for these companies.

This overconfidence has led to a flood of large companies coming to market with massive losses on their income statements, and many with no clear plan to become profitable in the future.

While today’s IPO mania is a relatively small segment of the overall stock market, no one can measure or foresee the far-reaching impact that the much-publicized troubles in this group could have, particularly on investor psychology.

See also: Peloton: On the Right Track?

Keep in mind that few anticipated the total damage that would be inflicted by the popping of the 1990s Tech Bubble, and no one fully comprehended the carnage that risky collateralized loans and mortgage obligations would wreak on the economy in 2008.

Everything in the financial system is interconnected; seemingly esoteric mortgage rate security derivatives led to the worst recession since the Great Depression in a lesson that small parts of the market can have outsized effects. Thus, if deflated confidence in financially suspect IPOs permeates the broader market, larger losses may not be far away.

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