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Is The IPO Market Signaling A Stock Market Top?

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How Stock Market Observers Look To The IPO Market For Signs of a Top

Strong 2014 IPO MarketWith the broken King Digital Entertainment (NYSE:  KING) IPO and a rush of IPOs hitting the market, some are wondering if the IPO market is signaling a stock market top?  Stock market observes are always looking for signs of market tops and bottoms.  The performance of Initial Public Offerings (IPOs) is one factor that many stock market pundits and analysts take very seriously.  This is because broken IPOs and a large uptick in IPOs have historically been signs that a bull market run is maturing and may be nearing the end.  A broken IPO is an IPO that breaks its opening price and trades lower at the close of its first day of trading.  A surge in IPOs being bought to market by investment banks is a sign that investment bankers think that the bull market may be nearing a peak and their clients need to go public to cash in on the bullish market sentiment before it sours.

Is The 2014 IPO Market Pointing To A Market Top?

Stock Market TopThe IPO market during the first half of 2000 provided an early warning sign that the amazing bull market run in technology stocks that occurred during the late 1990s was coming to an end in 2000.  Savvy stock market observes have not forgotten the lesson provided by the IPO market in 2000, as the NASDAQ composite index lost over 75% of its value over the following two years during a severe bear market sell-off.

The performance of IPOs is a good stock market barometer for traders and investors looking for signs of stock market excessiveness and froth.  When IPOs trade much higher after opening and the stock’s fundamentals and valuation do not appear to matter, it is a sign that investors are too bullish and just throwing money at stocks; a sign that a valuation bubble is forming.  Conversely, when IPOs sell-off quickly on their first day of trading, or soon thereafter, it is a sign that the stock market may be becoming frothy, as money rushes into buy new IPOs but is not supported by follow through buying.

Many stock market analysts consider the failed PALM IPO of March 1, 2000 to be a harbinger of the steep NASDAQ composite index sell-off that months later that month and continued for two years, until hitting bottom in 2002.  On the day of its IPO, PALM shares were sold to those allotted IPO shares at $38 per share.  PALM then opened for public trading at $165 per share, and closed at the end of the trading session at $95 per share.  In hindsight, the poor performance of the high-profile PALM IPO was an indication that investors were too exuberant about investing in technology companies without concern for the underlying fundamentals of the companies.  The PALM IPO blow off top occurred just a few days before the technology heavy NASDAQ composite index suffered its own blow off top at just over 5,000.

With the number of IPOs coming to market during the first quarter of 2014 the highest since the first quarter of 2000 and the stumbling of the King Digital Entertainment IPO, analysts are wondering if it is a sign that the stock market is nearing a top, or at least the highly volatile technology sector of the stock market.  Are companies rushing IPOs to the market to capture the latest wave of investor over-exuberance, which should be taken as a sign that many high-level executives and Wall Street insiders believe the stock market is overvalued?  Or, is the strong IPO market just a sign that the overall economy is growing stronger and supportive companies going public?  Nobody knows for sure, but after the early warnings that the IPO market gave to the overall stock market in 2000, savvy stock analysts are assessing the IPO market for clues.

Can The IPO Market Signal Stock Market Turning Points?

IPO Market Top
The IPO market is used by stock market analysts as a contrarian indicator, in the same way that bearish and bullish investor sentiment is used a contrarian indicator.  While a roaring IPO market may be a sign of a healthy economy with many companies looking to go public to raise capital, it may also be a sign that insiders are trying to cash out while the time is good to get out, by selling their private shares to the public via IPOs.

While the IPO market cannot in and of itself signal a stock market turning point, such as a top in a bull market, it should be used as one of many indicators to assess whether a stock market top is approaching.  If the IPO market appears frothy, with IPOs valued at unrealistic valuations once they have gone public, or appears overextended, with IPOs selling off after going public, it is certainly a sign of stock market excess and stress.  This is not what a healthy bull market needs to continue.

Two expected IPOs worth keeping an eye to gauge investor sentiment during 2014 are Box and Redfin.  Box is a leading company in the fast growing cloud-based storage business.  Redfin operates, a website that provide real estate sales listings and a team of realtors that help users find, view, and purchase homes.  If these IPOs flop or run to excessive valuations well beyond realistic stock valuations, it may be a sign that a stock market top is near.

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