Analyst Mark Hulbert recently raised the question of what the rate of initial public offerings means for the stock market. He looked at IPOs and dividends as a broad way to evaluate investor sentiment. He used a variety of different data points to gauge if stocks were in a bubble. He also drew on (among other things) some interesting data from Jay R. Ritter, a professor at the University of Florida, who is an expert on IPOs. This led to some interesting observations.

Consider these five issues, in order of persuasiveness:

No. 1. Volume: In the first quarter of 2000, there were 123 IPOs. In the first quarter of this year, there were 58 — less than half as many, according to data compiled by Ritter.

No. 2. First-day returns: The average return for an initial public offering in the first quarter of 2000 was a blistering 96 percent. This year, only 22 percent.

To put this into broader context, have a look at these first-day percentage increases from that era based on Ritter’s research:

Va Linux (12/09/99) 698 percent (11/13/98) 606 percent

Foundry Networks (9/28/99) 525 percent

Webmethods (2/11/00) 508 percent

Free Markets (12/10/99) 483 percent

Cobalt Networks (11/05/99) 482 percent (1/15/99) 474 percent,

Akamai Technologies (10/29/99) 458 percent

Cacheflow (11/19/99) 427 percent

Sycamore Networks (10/22/99) 386 percent.

There’s nothing like this happening today.

No. 3. Dividend Premiums: Malcolm Baker and Jeffrey Wurgler published a paper in 2006 titled “Investor Sentiment in the Stock Market.” Baker is at the Harvard Business School and Wurgler is at New York University’s Stern School of Business. Both also do research for the National Bureau of Economic Research.

The study compares the relative valuations of dividend-paying companies with those of more speculative companies. Hulbert observes that:

As exuberance reaches extreme levels, investors become bored by established, dividend-paying companies. In March 2000, speculative companies on average had a 43 percent higher valuation than the dividend-paying stocks. The comparable premium today for stocks in the S&P 1500 index is 26 percent, according to data from FactSet.

The key difference here is that with rates so low, dividends have become an alternative to fixed income. That makes this data point a little less compelling than it might have been otherwise. Still, it points to a lower risk appetite.

No. 4. Equity Issuance: Companies raise cash from the secondary market when that window is open. Can that be used to evaluate periods of speculative excesses? Perhaps. In the first quarter of 2000, corporate cash derived from equity issuance was 20 percent; the most recent data is from the fourth quarter of 2013, and it showed the equity share of cash was only 11 percent.

Two caveats on this data point: First, using the fourth quarter versus the first runs into seasonal issues. Second, the bond market has become a very inexpensive way for companies raise cash, especially with the 10-year Treasury yielding less than 3 percent. Hence, this metric isn’t an apples-to-apples comparison.

No. 5. Share turnover: Comparing share turnover is another way to distinguish the bubble era from today. The turnover rate in listed shares on the New York Stock Exchange in the first quarter of 2000 was an annualized 89 percent. In the first quarter of this year it was 58 percent.

This is the least persuasive data point to me. Exchange traded funds and the move away from active trading has dramatically reduced trading volume. Indeed, almost the entire 180 percent rally since the March 2009 low has been on volume that is lower than normal.

Taken as a whole, these five points suggests that speculation hasn’t run rampant today the way it did in 2000. The list above contains two strong points, one moderate and two that perhaps could be rationalized away.

The conclusion is that we are not in a speculative bubble.

Originally published here

Category: Investing, IPOs, Sentiment

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

8 Responses to “Using IPOs to Measure Investor Sentiment”

  1. b_thunder says:

    “…these five points suggests that speculation hasn’t run rampant today the way it did in 2000…. The conclusion is that we are not in a speculative bubble. ”

    So there’s no bubble right now and, unlike in 2000 bubble and bust cycle, Nasdaq won’t fall 78% and S&P won’t fall 50% from top to bottom Maybe they’ll only fall 25-30, maybe 35pct, as in other “average” bear markets.
    My contention is that a 30-35% market drop today will be more harmful long-term than a 50% and 78% drop in 2001-2003 due to the levels of debt (private + public), the levels of un- and under-employment and the fact that Fed is very limited in what it can do (unless Congress lets them buy SPY and QQQ.)

    My humble suggestion is to stop discussing if there’s a “bubble” and spend more time thinking about a basic fact of life that one day this economic cycle will come to its natural end and, and how to manage your money (and OTM if any) when “it” happens. And when it happens, the effect of the Fed will be smallest since per-1987 crash, coupled with unprecedented high levels of debt and leverage (overall, not just in FIRE sectors.) Unless, of course, you think that our distinguished PhDs found a way to extend this business cycle indefinitely.

  2. egghead says:

    Just because we are not 2000 means we are not in a bubble? Barry, I think you have lost your usually cool head a little bit lately and keep making calls that markets are fairly valued or only slightly expensive. It’s ok to make such market calls. But the arguments your conclusions are based on are highly biased or flawed.

    • So you think a comparison to the last bubble is inappropriate way of determining if we are in a current bubble?

      What methodology would you prefer to determine if we are in a bubble at present?

      • egghead says:

        If you use 2000 as the bubble standard, 2000 is the only bubble we’ve had in the past 50, 60 years. But there have been maybe 7, 8 or even more bear markets with 20% or more in declines. I don’t know if we are in a bubble or not. But I don’t think you can say we are not in a bubble just because the market is not as crazy as it was in 2000.

      • Liquidity Trader says:

        20% is a bear market

        Bubbles collapses are far worse: Technology fell 80% in 2000; Homebuilders fell 80% from 2005 peaks; banks fell 80% from 2006 peaks.

    • larrr1 says:

      Agree. Just because we’re not swapping houses for tulips doesn’t mean valuations are ok and IPO environment isn’t frothy as hell

  3. EIB says:

    This is not even close to a bubble.
    People have forgotten what a bubble even is.

    Bubble = People were quitting their jobs to stay home and trade and make $20k a month. (instead of $10/hr)
    Bubble = People bought houses and cars with cash from last month’s stock profits.
    Bubble = Kids in high school were buying new cars with cash from a stock trade.
    Bubble = People were talking about stocks at parties.
    Bubble = People bought $5000 watches and purses b/c “that’s just one trade”

    This is not even close to a bubble.
    People have forgotten what a bubble even is.