Experts warn of IPO bubble in US

New York

THE US initial public offering (IPO) market is manic. Stocks have not been this expensive since the dotcom era. The Nasdaq 100 has doubled in two years, leaving its valuation bloated - all while volatility remains stubbornly high.

It is a setup that has left investors sitting on fat returns from 2020, a year that defied easy explanation. It is also one that has a growing cohort of experts warning about a bubble.

Knowing when market rallies turn from logical to excessive is always tough. It was nearly impossible as 2020 ended, with interest rates pinned near zero and the federal government unleashing another US$900 billion into the economy. But history offers clues, and a raft of current market conditions meet criteria that would likely be found on a bubble checklist.

Take a study by Harvard University researchers published in 2019. It noted that while not every stock surge meets with disaster, those that do share some attributes - including increased share issuance, heightened volatility, and a sector or index that doubles and is twice as high as the broader market. Check, check and almost check.

"Are there areas of the market that are in a bubble? Yeah, clearly," Peter Cecchini, founder of AlphaOmega Advisors LLC, said on Bloomberg's What Goes Up podcast, adding that "many of those are obviously speculative technology companies".

Share issuance, IPOs and blank-cheque companies have grown so popular that record after record fell in 2020. US companies sold US$368 billion in new stock last year, 54 per cent more than the prior high, according to data compiled by Bloomberg.

IPOs raised US$180 billion, the most ever, as companies including Snowflake, Airbnb and DoorDash took advantage of the rebound in equity markets. First-day pops in share price among the newcomers were the biggest in two decades, according to Bill Smith, CEO and co-founder of Renaissance Capital.

"Those are telltale signs," said Robin Greenwood, professor at Harvard Business School and co-author of the 2019 study. "The probability of a market correction is much greater today than in the historical average."

A subclass of IPOs took off in 2020 as well, adding to worries. Special-purpose acquisition companies (Spacs), which use proceeds from a stock sale to acquire a private company, raised about US$80 billion in 2020, more than was notched in aggregate over the previous decade. Spacs that made a purchase are up about 100 per cent for the year, according to research from George Pearkes, global macro strategist at Bespoke Investment Group.

"That's pretty bubbly stuff," he wrote in a recent note, though he added that what's "more remarkable" is that Spacs that have yet to announce deals have gained about 20 per cent. "Obviously, this is pretty speculative behaviour."

While certain assets exhibit worrying signs, the broader market may not be in for an immediate comeuppance. For one thing, the Federal Reserve has promised to keep interest rates pinned near zero, making stretched stock valuations look more reasonable when compared to bond yields. BLOOMBERG