Key Takeaways
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Deutsche Bank research suggests that a rise in supply is not great for stocks—but there are caveats.
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Some experts, meanwhile, are worried that fast-tracking mega-IPOs into major benchmark indexes might not serve investors well.
Big IPOs from SpaceX and OpenAI are expected soon. Both are expected to fetch trillion-dollar valuations. And investors are starting to ask: Where will the money come from?
The supply-and-demand question lands as major benchmark indexes continue their ascent and more startups are joining a wave of companies going public. Investors are hunting around for the next big thing, diving into artificial intelligence plays, chip stocks and space-themed funds. Though Deutsche Bank says the “willingness to invest” in stocks remains strong, there’s a growing concern that the coming wave of new issues could “crowd out” the broader stock market—even and trigger a selloff.
That may not be a baseless concern: An increase in supply of new stocks, all else being equal, is “negative for equities,” Deutsche Bank’s strategists including Parag Thatte wrote in a recent report. The vital question may be how much.
WHY THIS MATTERS TO YOU
IPO waves tend to coincide with strong stock market returns. But the coming set of mega new issues is raising concerns that they’ll catalyze a selloff as they displace stocks of other companies out of major benchmark indexes.
The coming wave of IPO activity stands to be much larger than it has been in the recent past. But the largest expected IPO—likely Elon Musk’s SpaceX, based on disclosures and news reports—would represent just 0.1% of the current S&P 500 market cap, according to Deutsche Bank.
Adding in the new stock supply into a framework that takes into account investor positioning as well as flow into stocks suggests that the largest IPOs could move the broader market lower by about 1%, the firm said.
“Given the lumpy nature of the listings and concerns around crowding out other stocks in index benchmarks, the risk is of a somewhat larger negative impact,” Thatte and his team said. They added market declines of 3%-plus usually occur every one to two months on average for a variety of reasons. Historically, waves of new stock issuance haven’t blunted the equity-market party.
Meanwhile, some market watchers worry that these high-profile new listings may be muscling their way into big indexes before their time. The Nasdaq, as well as S&P Dow Jones Indices have changed, or are in the process of changing, their rules to fast-track newly listed mega-cap stocks into the likes of the Nasdaq 100 and the S&P 500. The S&P 500, for example, under its current rules, says a company included in the index has to have been public for at least 12 months and have positive GAAP earnings in its most recent quarter and the sum of the trailing four quarters. SpaceX would not currently qualify.
“The index wasn’t designed to do that,” said Jay Woods, chief market strategist at Freedom Capital Markets. “It was designed to reward companies that have already earned their place through profitability, staying power, and the patience of real markets,” Woods said. Such a change, he said, would create “artificial demand” and make regular folks invested in index funds such as the State Street SPDR S&P 500 (SPY) “involuntary SpaceX shareholders.”
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