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The IPO or “Initial Public Offerings” market — more commonly known as the new issues market — has gone through an extraordinarily bad time this year. It’s been bad for all three of the groups that take part in this market. They are as follows:
Investors who put their money in new issues have lost substantial sums in the past year. On average, new stock issues tend to do worse than the rest of the market in their first few years of public trading. This past year, they performed much worse than ever.
Financial institutions that bring new issues to market for sale to investors have suffered, too, because demand for new issues has dried up. At this time of year in 2021, the new issues market had raised around $100 billion. So far this year, it has raised just $5 billion. In the past quarter century, the new issues market raised an average of $33 billion at this point in the year.
Companies that raise capital for themselves through the new issues market are suffering as well. When the new issues market began drying up as a source of corporate funding, many would-be issuers of new stocks found it was harder and more expensive than ever to find alternate sources of financing.
This will be worst year for IPOs since 2009
This will be the worst year for raising money in the new issues market since 2009, when the economy was struggling to pull out of the 2008/2009 recession.
As long-time readers know, we generally advise staying out of new stock issues. After all, there’s a random element in the success or failure of every business, especially when it’s just starting out. But new issues expose you to a special risk that you avoid with stocks that have been trading publicly for some time. That is, you can only invest in new issues when they come to market.
This is just one more example of a conflict of interest, which we’ve often referred to as the worst source of risk you face as an investor.
Companies only come to the new issue market to sell their stock when it’s a good time for the company and/or its insiders to sell. The insiders can’t predict the future, of course. However, they do know much more than outsiders do about their company.
New issues also come with one additional negative factor: it costs a lot of money to convert a private company into a publicly traded new issue. These costs include substantial legal and accounting fees, plus brokers’ commissions and other marketing expenses. These new-issue costs come out of the funds supplied by the new issue buyers.
To top it off, typical new issue buyers/traders know about these negative factors, in many cases from bitter experience. They take them into account when deciding when to sell. This raises new-issue volatility.
Ukraine, inflation and rising rates all negatives for new issues
This past year, three big special negatives weighed on the market: interest rates and inflation both shot up, and Russia invaded Ukraine. All three issues were bound to weigh on the market generally, but especially so for risky and volatile market segments such as new issues.
Our view now is that a diversified portfolio of high-quality stocks is likely to gain in value over the next year or longer. However, a portfolio like that should include little if any exposure to recent new issues.
Some of last year’s new issues may never get back up to the peaks they reached last year: some may go broke. Before buying, the best thing to do is wait and see how your favourites perform in the next upturn in the stock market and/or the economy. In the next six months to a year, I suspect we’ll recommend more recent new issues as buys than we ever have before.
Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books. This article was originally published as a commentary published on Aug. 23, 2022. It is republished on the Hub with permission.
