The DJIA went above 10,500 for the first time in fourteen months yesterday. That is an impressive move from under 6,550 in early March. It is easy to argue that such a surge is too much too fast. Optimists defend the advance by explaining that the economy has quickly recovered from its worst period in eighty years. That defense avoids the issues of unemployment and large tax increases in the US that will occur a year from now.
The better prism through which to look at the market is probably IPOs, because these are gambles, pure and simple. Barclays says it expects initial public offerings in America to rise three-fold next year to $50 billion. The bank says this will be part of an increase of raising new capital by corporations in the US with the largest part from the issuance of convertible bonds.
Venture capitalists that have had money bottled up in private companies while the economy fell apart would like to see some return on the capital that they put up as long as three or four years ago. Their investors are anxious to see the kind of returns they did from 2003 to 2007 when there were often several large IPOs a month and investment bankers were getting nearly as rich as their venture capital clients. A large number of the companies taken public in 2010 will be in the tech, alternative energy, and biotechnology sectors if venture capitalists get their way. The best performing initial public offerings so far in 2009 are in those sectors, especially technology. Some of the worst performing IPOs of the year were also from these industries. Biotech company Omeros (NASDAQ:OMER) fell 36% during its first two weeks as a publicly traded company in early October. Talecris Biotherapeutics (NASDAQ:TLCR), which went public less than three months ago, has not done well either.
No one could have imagined how any of these public offerings would turn out. The investment banks that handle the transactions often misprice the stocks terribly for their first day of trading. Shares come to market and rise 30% in a matter of a few minutes. Both the company and its bankers had little idea what these IPOs where worth which is troubling. If they don’t know, who does?
The return of the IPO is a nearly perfect measurement for the market’s appetite for risk. Institutions and individual investors who are willing to put money into stocks that could have tremendous changes in their value the first day of trading are not much different from gamblers hitting the slot machines after midnight in Las Vegas. No one begins by thinking they will lose all of their money. It just turns out that way.
The Federal Reserve says it is not seeing any asset bubbles at this point so the agency feels comfortable keeping interest rates where they are. Gold and oil prices have begun to fall sharply after healthy runs, in the case of gold to record prices. There is little sign that the real estate market, either residential or commercial, will pick up this year or next. The only market where there appears to be a growing bulge is equities and that means an anticipation of particularly strong earnings next year. Analysts worried in the second half of 2009 that profits were driven by cost cuts and not real sales growth. There may not be a lot of expenses left to cut at many public companies next year. This means that analysts creating forecasts for 2010 must believe that there will be sharp increases in consumer and business activity. It is hard to make the case for how that will work with small businesses unable to get bank credit and the consumers who still have jobs saving their money and cutting back on debt.
The biggest single run up in prices in 2009, at least among widely traded assets, will probably be equities. Investment bankers and companies will use that as a spring-board to increase IPO activity next year. The last time there was a real rush to the IPO market after a sharp increase in stock prices was 2000. That year turned out badly for almost everyone.
Douglas A. McIntyre