IPO activity bodes well for stock market and the economy

Judging by the health of the IPO market, it may be time for investors to get their risk on. Indeed, the recent pickup in initial public offerings suggests that we are entering a period of “risk on” trading, in which investors display a willingness to go out on an investment limb and bid up prices in assets that are considered risky, such as stocks and commodities.

Conversely, in a “risk off” environment, investors prefer safer assets such as bonds.

Even investors who aren’t interested in buying shares in newly minted public companies should pay close attention to the message from the private-equity and venture capital groups behind the IPOs: Economic growth is coming.

“This is a great time to get back into the market if you truly believe an economic recovery is on the horizon,” said Maria Pinelli, global vice chairman for strategic-growth markets at Ernst & Young Global Ltd.

Globally, the IPO market is back to pre-recession levels, and the volume and quality of deals in the pipeline suggest that there is more to come, according to Ernst & Young.

During the second quarter, 378 IPOs raised $65 billion, representing a 29% increase in the number of offerings and a 39% increase in the dollar volume over the previous quarter. One indicator of the strength of the IPO market is that 79% of the capital raised is from offerings that are coming out of private-equity and VC funds.

“Over the past 10 years, the average from PE and VC funds has been about 60%, but when you get around 80%, that represents a hot market,” Ms. Pinelli said.

To be sure, it would be wrong to suggest that the IPO market is immune to the realities of the global economy. That said, various macroeconomic bumps and bruises over the past year, including Greece’s financial woes and U.S. budget uncertainty, haven’t been much of a drag on the IPO market — at least not so far.

The strength of the IPO market says a lot about the health of the capital markets overall, Ms. Pinelli said. IPO activity leads to debt refinancing as companies clean up balance sheets in preparation for offerings.

Looking just at domestic IPOs, through the first six months of the year, $25.7 billion was raised by 78 public offerings, according to Renaissance Capital LLC. That compares with $38.7 billion and 154 IPOs for all of last year, and $21.9 billion and 63 IPOs in 2009.

The pipeline of companies filing to go public has grown to 157 so far this year, compared with 258 for all of last year and 119 in 2009.

The First Trust US IPO Index Fund (FPX), which tracks the 100 largest domestic IPOs on a trailing-four-year basis, gained 11.2% through last year, compared with 6.5% for the S&P 500.

“The strong performance of the average IPO is really helping the overall IPO market to withstand the market volatility,” said Joseph Schuster, founder and chief executive of Ipox Capital Management LLC.

The market-capitalization-weighted IPO index is anchored by solid performers such as Phillip Morris International Inc. (PM), up 15.4% from the start of the year, and Visa Inc. (V), up 25.4%.

Both companies went public in March 2008, which means that they will be removed from the index on their four-year anniversary in March.

However, a lot of the more recent momentum behind the IPO market is coming from the technology sector, which accounted for 30 of the 78 U.S. offerings in the first half of the year.

NXP Semiconductor NV (NXPI), which went public in August, is up 5.8% from the start of the year. And on the social-media side, there is LinkedIn Corp. (LNKD), which has gained 10.6% since its May 19 IPO.

“It’s been a big year for IPOs, but tech is especially hot right now,” said Allan Flader, a financial adviser with RBC Wealth Management.

Mr. Flader, who has $600 million under advisement, said that he has participated in dozens of IPOs for his clients during the past year.

“There are a lot of macro issues out there, which means the IPO market could be hot one day and cold the next,” he said. “But you can’t go public anymore without a legitimate company that has legitimate potential, because the end buyers are a lot more selective then they used to be.”

Questions, observations, stock tips? E-mail Jeff Benjamin at [email protected].

Related Topics: Initial Public Offerings (IPO)