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Matt Winkler
Matt Winkler
Articles (118) 

Is IPO Froth Pointing to an Imminent Liquidity Crunch?

Biotech IPOs are setting new records, and some of them are ominous. Record amounts of new companies could be pointing to a top

October 30, 2018 | About:

Are we in a liquidity crunch? There aren’t many word pairs that make investors quake in their boots more than “liquidity crunch.” We’ve seen them before and they’re obvious in hindsight, but it’s very hard to tell if you’re actually in one until it’s well underway. Then you look back on it and say, “Well, that was a liquidity crunch!” Unfortunately, by the time you realize it, you’ve already had significant portfolio drawdowns.

As much as retail investors and even institutional investors would love to dodge liquidity crunches before they happen, the desire to get out before the fall is particularly amplified by those pursuing initial public offerings. After all, these are the people who directly get your money when listing as a public company. Whatever the price of an IPO ends up being, that money is basically locked in once the IPO closes. Investors can only hope the newly public company uses it well. If the stock goes down after the IPO, it’s much more acutely the investor’s problem rather than the problem of those that ultimately got all the money.

The more acutely those pursuing IPOs perceive that current price levels won’t last, the more anxious they are to complete the IPO while they believe there’s still time. That’s why, prior to equity price levels topping, we tend to see blowouts in the IPO market.

The chart below, taken from Statista, shows the total number of IPO dollars in the U.S. and Europe combined from 2000 to 2016. As you can see, the amount of money rasied in biotech IPOs specifically in 2000, during the dotcom peak, was unparalleled. When prices are that high, why not push for an IPO?

IPOs since 2000

The IPO dollars of 2000 have never been taken out and were not significantly rivaled until 2014, even taking into account inflation. That year happened to be one year before the biotech top of 2015, a top the sector has not reached since, even as the S&P and Nasdaq have both long since reached new highs.

The concept of following the IPO market as a broader signal on equities is similar to the Commitment of Traders reports, which measure speculative options hedgers versus commercial hedgers. Commercials hedge not for any speculative gain, but because commercial companies demand an actual commodity itself and buy puts when the price is high by industrial standards, and calls when price is low. Generally speaking, when commercials are long and speculators short, whatever it may be, price tends to rise and vice versa.

An IPO can be considered a “commercial put” since it is basically the right to sell a security at a certain price, just like a put option. If the IPO market is especially frothy, it can often be a bearish sign. Well, the IPO market has been quote frothy in 2018, especially in biotech, set to see the second-most biotch IPOs ever since records began way back in 1980.

Why the focus in biotech specifically as an IPO bellwether? Because one-third of all IPOs last quarter were biotech, far outweighing their portion of the global equity market. Plus, a new report released this month by Crunchbase indicates that 80% of IPOs are now unprofitable, a new record. If investors are willing to spend record amounts of money on record amounts of failed IPOs, we may be at the top of a liquidity cycle.

While we won’t clearly know if we are at the beginnings of a liquidity crunch until such is patently obvious, the recent moves in the tech and biotech sectors, coupled with this evidence, show the recent bearish moves in stocks might be the beginning of something bigger.

Disclosure: No positions.

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Comments

GeraldineMclaughlin
GeraldineMclaughlin - 5 months ago    Report SPAM

IPOs are top-notch investment as of now, only if the performance carries on and the overall market continues to settle in an uptrend. Selective investment in IPO can give up very huge returns. The company goes public with the help of investment banks.

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