The IPO Signal – FAANGs out.

A rush of IPOs is a warning signal.

• The sudden rush of technology IPOs is indicative of a sector where valuations are becoming stretched and which bear little resemblance to reality even including a pandemic-related revenue bump.
• The list is impressive.
• Palantir, Airbnb, Snowflake, Unity, Asana are all rushing to go public as the IPO window is wide open and the valuations are at all-time highs.
• There is an awfully familiar ring to the sound of the market at the moment which takes me back to the Internet bubble in 1999 and 2000.
• At that time, the Internet was the biggest thing since sliced bread and way too much money was chasing too little equity.
• This was when the likes of AOL, Cisco, Ericsson, Nokia achieved market capitalisations that they have never seen again and when IPO valuation become an art form.
• Valuation methods were created from thin air and some innovators even went so far as creating theoretical option values to justify internet service providers that were trading on price-earnings ratios of over 100x.
• With paper being in short supply, everyone who could make any claim about being involved to the Internet rushed to the market to meet demand.
• However, it turned out that reality once again asserted itself and a 2-year bear market resulted where the S&P500 halved in price and many of the former Internet darlings were consolidated for pennies on the dollar.
• The technology sector bore the brunt of the correction.
• The current situation is very different in a number of ways but it has had the same result which is a huge supply of money chasing overvalued paper.
• When the supply of money runs out, the market must inevitably fall.
• Back in 2000, the money was supplied by investors terrified of missing out on the bonanza, but this time it is the US Federal Reserve.
• Since the beginning of the pandemic, the Federal Reserve has printed around $3tn of new money the vast majority of which has been used to buy US Government debt to keep the government afloat and to prevent interest rates from rising.
• Historically low-interest rates have led to a rush back into the stock market which is now trading at valuations not seen since the height of the Internet bubble.
• The benchmark S&P500 index is trading on a forward PER of 26.4x compared to its all-time high of 26.7x achieved on 29^th December 1998.
• This ratio corrected to around 15x in the subsequent sell-off and then again to 10x during the 2008 financial crisis.
• The problem is that the Federal Reserve cannot print money forever and when its stops, interest rates will rise as a result of removing the buyer of last resort of US treasuries.
• The stock market is likely to correct very sharply as it did at the end of 2018 when the Federal Reserve tried to end quantitative easing and increase interest rates.
• Furthermore, it is the FAANG stocks that have driven the recovery as removing them from the Nasdaq and S&P500 indices show a very different picture where the regular economy has not shown much recovery.
• In fact, the banking sector is doing very badly as a result of the recession triggered by the pandemic.
• This means that when the cheap printed money runs out and the correction comes, it is likely to be the technology stocks that bear the weight of the correction as they did between H2 2000 and 2002.
• Deep down, everyone seems to know that this is likely which is why we are seeing a flood of IPOs aimed at raising money very cheaply or enabling current investors to divest their holdings at good prices.
• I do not want to be holding the equity when the music stops and stop it eventually must.