Using IPO Trends to Time the Stock Market

If you know anything about Wall Street you won’t be surprised to learn that the cyclical nature of IPO trends can be studied to gain insight into the stock market.

After all, companies don’t go public as a gesture of charity. They do so because they think that they will gain something by exchanging their shares for your money. A transaction occurs when the two sides agree on the price but disagree on the value of the asset in play.

But there is an inherent asymmetry when it comes to IPOs. Although we have put in place measures to protect the public (through circulars, public disclosures, etc.) the insiders still know much more about their company and its merit as an investment than the general public who are taking the other side of the deal.

So obviously when we have an avalanche of insiders wanting to sell to the public, they aren’t doing so because they want to hand over their hard earned capital out of the goodness of their hearts. You know that valuations are so out of whack that they are about to soon regress to the mean. This is what happened in early 2000 - when you had people taking everything short of their daughter’s lemonade stand public.

The current market environment is very different from then. That is why I’m just not persuaded by the dire predictions of mass market meltdown or financial Armageddon. We are actually enduring a severe IPO drought.

To play Devil’s advocate, today’s lack of IPOs may be partially explained by the low interest rate environment. Financially strong companies can turn to the fixed income market to find funding at lower cost of capital than equity markets. But I don’t think that explains it completely.

Here is a great article written by Mark Hulbert for the NY Times which goes into more detail about several research studies which look at the predictive characteristics of the IPO market.