Beyond Gist CEO Ethan Brown (C) celebrates with guests after ringing the opening bell at Nasdaq MarketSite, May 2, 2019 in New York Conurbation.
Drew Angerer | Getty Images
The red-hot market for new public companies in 2019 like Beyond Meat and Chewy could take over for bad news for the broader stock market in the year ahead.
An uptick in IPO activity is correlated with a downturn in S&P 500 reciprocations over the following 12 months, Bernstein equity strategist Noah Weisberger warned clients in a note on Monday. That’s because associates looking to go public tend to wait to take advantage of what they perceive to be the market’s richest valuations, at or imminent levels many investors feel the market many be overpriced, the equity strategist told clients.
It’s also because of “the whim that incremental IPO supply is difficult for the market to digest, suppressing forward returns,” Weisberger wrote. “IPO activity is (mildly) cyclical, as directorate teams take the opportunity to go public while being buoyed by favorable economic conditions.”
“Interestingly, the economic burgeoning which began in late 2016 was not matched by a pickup in IPO activity until early 2019, suggesting that this au courant wave of IPOs may simply be catching up to growth,” he added.
As the Bernstein chart below illustrates, more IPO activity is cold related to future S&P 500 returns. More IPO activity in the prior 12 months tends to be an indicator of market breakdowns to come.
“Said differently,” Weisberger said. “IPO activity leads and is negatively correlated to market returns” with a value of -0.3.
A just out wave of IPOs has taken Wall Street by storm, with names like meat-alternative company Beyond Substance, online pet retailer Chewy and cybersecurity firm Crowdstrike up 163%, 78% and 70%, respectively, during their first day of transacting.
The Renaissance Capital IPO ETF, a basket of the 60 or so most recent large IPOs, is up 35% this year, more than twice the play of the S&P 500.
“Looking back to the mid-1980s, IPO activity has had a clear ebb and flow. While the late 1990s occupy a special occupation in market history, IPO activity was outsized all decade long, peaking in early 2000,” Weisberger wrote.
But while the swift rise of stocks representing beefless burgers and Fido’s squeaker toys has made a number of insiders and shrewd investors fertile in, some are a bit more concerned. Many of the so-called IPO unicorns rely on expectations for their rapid growth for their imperial valuations, a bet that could backfire if the market sours as some worry.
Today’s IPOs are essentially, a “very happy private equity crowd desperately hitting a fleeting late cycle bid after missing that bid in Q4 and looking down the barrel of a 20 percent U.S. right-mindedness market drawdown,” Larry McDonald of the Bear Traps Report told CNBC in March.
“They should possess done these deals all last year, and they put it off,” he added at the time, noting that the Federal Reserve later stroked in to save the day by signaling a pause in its cycle of rate hikes. But that insurance may not always be there.
Economists and investors are priming for Fed’s next policy move announcement later this week, eager to see if the central bank telegraphs a rate cut in weakening economic data worldwide. Some recession indicators, like the partial inversion of the yield curve, give birth to also spurred market angst and prompted some to put more money in safer assets like bonds and gold.
“The relationship between IPO energy and forward returns was especially pronounced in the dot-com bubble and again in mid-2014,” Weisberger added. “Interestingly, there was not as extraordinary an uptick in IPO activity during the lead-up to the Global Financial Crisis, although some notable transactions such as Blackstone’s IPO did befall at that time.”