The IPO Rout Has a Silver Lining

(Bloomberg Opinion) -- Companies with plans to go public in the U.S. are getting the  cold shoulder from investors, as evidenced by the steep drop in Peloton Interactive Inc.’s newly listed shares Thursday, Endeavor Group Holdings Inc.’s pulled offering and WeWork parent We Co.’s shelved ambitions. This is typically a bearish signal, suggesting equities have become overextended. Now, though, the pushback looks more like a sign of a healthy market.

With major stock indexes hovering near all-time highs, it’s no surprise that private companies would try to get in on the action before investors retrench or the economy turns. A Bloomberg analysis of new listings of at least $100 million shows unprofitable companies have raised more money by going public in 2019 – some $30 billion - than any year since at least 2000. But the Renaissance IPO Index tracking stocks of companies that have gone public in the last two years has fallen 14% from its record high on July 26.

It’s natural to interpret the decline as a warning sign for the broader market; are the animal spirits that fueled the longest bull market in history finally dying down? The reality is, traders are already on the defensive. Various surveys show the ”smart money,” or institutional investors, have generally been “underweight” equities. That means they own a smaller percentage than is contained in benchmark indexes, so there has already been a great deal of unwinding of bullish positions.

One of the more comprehensive measures of investor sentiment is the State Street Global Markets monthly index, which is derived from actual trades and covers 15% of the world’s tradeable assets (the latest reading was released Wednesday). It shows that all this year, investors have been less confident in the outlook for equities than even during the financial crisis.

The weakness in the IPO market also shines a spotlight on one high-profile area of the market where valuations are high: technology-related shares. This group has led the market higher in recent years, and is doing so again in 2019. One proxy for the tech sector is the Nasdaq 100 Index, which has gained 22.6% this year. That compares with an increase of 14.8% for the broader New York Stock Exchange Composite. The Nasdaq 100 now trades at 22 times this year’s earnings, which is about the highest of any point in the past decade. The New York Stock Exchange Composite Index, though, only trades at about 16 times this year’s estimated earnings, which is comfortably below the recent highs of 19 times reached in 2016 and 2017.

Put another way, equity values overall may be near the high end of the recent range, but that’s mainly due to a smallish group of highfliers. So if the weakness in the IPO market causes investors to rethink the multiples afforded stock prices, the universe of equities impacted is likely to be limited.

The stock market this year has climbed a wall of worry this year, from the escalating U.S.-China trade war  and  a slowing economy to an inverted yield curve, stalled profit growth, and political strife that has led to an impeachment inquiry. But investors are well aware of these risks and positioning themselves accordingly. The pushback against high-risk IPOs is just another example of that. 

To contact the editor responsible for this story: Beth Williams at bewilliams@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.

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