Investor Strategy

‘Classic signs of euphoric sentiment’: Famed economist David Rosenberg warns that Snowflake-led IPO mania is inflating a market bubble that could soon pop

  • David Rosenberg — the founder of Rosenberg Research and famed economist who forewarned about the housing bubble — pegs the latest IPO mania as yet another reason to be skeptical of stocks.
  • Rosenberg points to deviations between historical relationships, overzealous market sentiment, and excessive appetite for IPOs and secondary offerings as fodder for his thesis.
  • For months now, Rosenberg has stated that equities were simply in the midst of a bear market rally, adding that “we’re in the reflexive rebound right now,” which precedes a steeper drawdown.
  • “Unfortunately, many will try to explain why this time is different, but the fact is the quality of companies appears to be no better than they were twenty years ago,” he said.
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Although most would rank 2020 exceedingly high on a list of years to soon forget, the past few months haven’t been all that bad from an investing standpoint.

Despite an unprecedented virus, stockpiling bankruptcies, and double-digit unemployment, markets have demonstrated a fierce level of stoicism. On Friday, the S&P 500 sat about flat for the year.

But now, things are getting stranger. And David Rosenberg, the famed economist and founder of Rosenberg Research, thinks he’s pinpointed a reemerging trend that could aid an unwind — one investors haven’t had to grapple with for decades. He is concerned about the spurt of initial public offerings that was most recently juiced by the record-breaking debut of cloud-software provider Snowflake.

“Going into this recent corrective phase, we have been identifying signs of excess and elevated sentiment whether it be in retail participation, the Citi panic/euphoria model, fund flows into ETFs, small speculator positioning in the Nasdaq or the elevated bull-bear spread in the Investors Intelligence survey,” Rosenberg said in a recent client note.

“Well, now there is another that can be added to the list — IPO activity which, by the way, is starting to look like the frenzy that took place in the dotcom bubble.”

Rosenberg provided the following chart dating back to 1990 to provide historical context to the recent spike in IPO activity.

Source: Bloomberg, Rosenberg Research
image

Source: Bloomberg, Rosenberg Research

He continued: “As the first day of trading in Snowflake’s recent listing indicated (doubling its IPO price in one day!), the appetite for newly listed shares is insatiable at the moment.”

To Rosenberg, that’s cause for concern. He’s seen similar market behavior push equity prices to nosebleed levels during the dotcom era, a period when profits and sales were erroneously eschewed in place of eyeballs and clicks as valuation metrics. To him, investor appetite is looking distinctly similar.

To demonstrate this idea visually, Rosenberg compares the Renaissance IPO ETF, a conglomerate that tracks new listings, to the S&P 500. Needless to say, investor enthusiasm for new issuance has hit a fever pitch as of late.

Source: Bloomberg, Rosenberg Research
image

Source: Bloomberg, Rosenberg Research

To further his thesis, Rosenberg takes a broader look at equity appetite throughout the marketplace, and adds secondary offerings into the mix. Each way he carves it up, the conclusion seems to remain the same: an overzealous environment.

“Moving beyond just the IPO market, it is clear how much investor appetite there is for equities,” he said. “Recent events from Hertz and Tesla are some examples of companies looking to take advantage of a wide open equity issuance window due to increased investor enthusiasm — one that saw a record high 567 total (IPOs plus secondary) offerings a few weeks ago (also on a trailing three-month basis).”

Rosenberg provided the following chart depicting a recent record high in combined IPO and secondary offerings.

Source: Bloomberg, Rosenberg Research
image

Source: Bloomberg, Rosenberg Research

“Ultimately, the flurry of IPO and equity issuance activity, and the frenzy with which investors are snapping up these shares, are all classic signs of euphoric sentiment and bubble-like conditions bringing back memories of the dotcom craze (we know how that ended),” he said.

For context, when the technology bubble finally burst, the Nasdaq shed over 80% from 2000 to 2002, while the S&P 500 lost approximately 50% of its value.

He continued: “Unfortunately, many will try to explain why this time is different, but the fact is the quality of companies appears to be no better than they were twenty years ago.”

Rosenberg’s assessment of IPO enthusiasm and sentiment dovetails seamlessly with his overarching view of the marketplace and economy. He’s compared today’s environment to “castles built on sand,” denoting a frothy market built upon shaky fundamentals.

But that’s not all.

For months now, Rosenberg has viewed the rally in stocks from the March lows with a hefty dose of skepticism, likening the environment to Phase 2 of Bob Farrell’s famous three phases of bear markets. For the uninitiated, Phase 2 is synonymous with a reflexive rebound in stocks from a precipitous drop, followed by Phase 3: a long and drawn out decline.

Here’s a visual of Farrell’s phases.

Street Talk Live/Business Insider
image

Street Talk Live/Business Insider

“We’re in the reflexive rebound right now,” Rosenberg said recently in the “Things That Make You Go Hmmm…” interview series. “We had the mother of all reflexive rebounds coming off the October, 1929 crash. We had a 50%, six-month rebound.”

Here’s a quick snapshot of other reasons for Rosenberg’s bearish tilt.

  • A stock market that resides in the top 10% of historical valuations on a normalized basis
  • An estimated 5 million permanent job losses
  • Low interest rates denoting slowing economic growth and corporate profits
  • Spreads on high-yield bonds rivaling that of of the tech bubble and financial crisis
  • An increase in the savings rate delineating a gloomy consumer consumption outlook
  • A decrease in the labor participation rate

To him, the latest IPO mania is yet another incentive to view these current market levels with a grain of salt.

“With plenty more companies looking to come to market on the horizon, not to mention the explosion in special purpose acquisition companies (SPACs), the trend does not appear to be slowing anytime soon,” he said.

“And until it does, this is yet another sign of excess that has crept into equity markets and is further documentation of the ‘bubblehead’ sentiment that has taken over, reminding us of Bob Farrell’s rule #2: ‘excesses in one direction will lead to an opposite excess in the other direction.'”

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