Is This The End of the Bull Run for the Stock Market?

Ho Khinwai
Ho Khinwai

Market experts have been warning investors to brace themselves for a global recession since the start of 2015.

Much more recently, we hear them sounding the alarm because the yield curve has inverted.

The difference (spread) between the 10-year and 3-month Treasury yields. The orange shaded areas indicate US recessions. Data from the US Treasury

A yield curve inversion has historically implied that a recession for the economy (and supposedly, a bear market for stocks) might just be around the corner.

You can see this quite clearly – when interest rate spreads go below the “zero” line and recover, that’s when major recessions hit.

This happens when investors are more uncertain about the economic future and expect interest rates (and reinvestment rates) to go to the dumps in the near future.

Therefore, they ditch shorter-term government securities (more notably, the 3-month T-Bills) for longer-term government bonds (more notably, the 10-Year T-Bonds) to hedge, hence boosting their prices and lowering their yields.

The uncertainty among investors is widespread – and very real.

Investors today worry if the US-China trade war will get blown up. Whether the US corporate debt bubble will balloon into a monstrous creature that will swallow US as a whole. Whether China will enter into an economic decline. Whether Brexit will materialize with a no-deal outcome. And the list goes on…

So… Is this the end of the bull run for the stock market?

Probably not.

According to the MSCI, stock price performance doesn’t seem to be much affected by yield curve inversions – although it does a pretty good job in predicting recessions.

This aligns with the findings presented by my good friend, Ser Jing, who writes for the Fool Singapore. He showed that Singapore stocks price performance in the short-run “has nothing much to do with… economic growth”.

Source: Ser Jing, at fool.sg

This essentially means that recessions don’t necessarily bring about stock bear markets. Clearly distinguishing each phenomenon from the other is important so that we don’t make rash decisions with our investment holdings solely based on market news.

That being said, we have reason to believe that markets are getting overheated.

Alvin Chow (CEO of Dr Wealth) and I have been monitoring this stock market cycle “predictor” (or whatchamacallit) recently…

…and it seems pretty robust in mapping out where we are at in the stock market cycle right now.

A Lens Into the Stock Market Cycle

We plotted these two charts below that show (1) the S&P 500 closing prices averaged monthly, on the top, and (2) the number of IPO listings and the amount of funds raised over the course of around 20 years in the United States on the bottom:

S&P Data from Robert Shiller, IPO Data from Renaissance Capital (Statista) and Bloomberg

Right off the bat, notice how the highest bars with the highest numbers of IPOs seem to coincide with the year prior to a major stock market downturn?

The bar at 2000 was the (end of the) dot-com bubble – which led to the crash that happened in the same year.

The bar at 2007 was the last sprint for the bull run – which led to the Global Financial meltdown and subsequently the stock market crash in late-2008.

The bar at 2014 followed with a 2015 global stock market sell-off. This was due to the uncertainty surrounding spillover effects from China’s economic slowdown. However, as you can see – the spillover effects did not hit the American stock market that badly.

It is interesting to note how each inflection (turning) point seemed to predict the end of the stock market bulls – but then again – we need to be aware that it might be a hindsight bias.

Nothing is as clear as it seems… when you’re looking forward.

However, we are of the view that the market-experts’ warnings of a major downturn are beginning to materialize.

From the above chart, we see that the 2018 bar has risen to levels that are near the major inflection points. This doesn’t necessarily mean anything in and of itself.

Bigger deal sizes and more IPO listings may sustain for a couple more years before it bucks the trend. Who knows? It took 4 years for the next inflection point in 2008. And it took 5 years (4 if you looked at deal size alone) for the one in 2015.

By contrast, we’re only into our second year.

It’s not a guarantee-four-year kinda’ thing. But the bottom line is – stocks are due for a big correction.

Why Focus on IPOs?

Now – we at Dr Wealth don’t randomly find charts that mimic stock market performance and claim that it will be the “holy grail” of future stock market performance.

Such phenomena has been backed by research and real evidence.

Think about this – companies generally don’t want to IPO unless their stakeholders have something to benefit from it.

Being public means being subject to more regulations and more disclosures – which can hurt operational efficiency, increase costs and increase the risk of diluting their competitive advantages as information about their core competencies will be available to competitors – simply put, being a public company puts them at a disadvantage. A very big disadvantage.

Companies would prefer to go public when they feel that they can raise the most money for their company, and allow their private shareholders (which many times includes the management) a chance to “cash out” some or all of their private investments at an attractive market price.

This only happens when investors are very optimistic about the economy and the stock market.

In particular, a study done in 2009 concluded that most IPOs occur when markets are overvalued. The authors demonstrated that the majority of companies only go for IPO when:

  • market conditions are entirely clear (and positive)
  • their companies’ cash flows are at high levels as a result of the strong market demand
  • the stock market is on the rise
  • and there is a clear increase in IPO activity

This is not an anomaly. Such phenomena, referred to as a “hot period”, is widely recognized by industry professionals and academics for many years.

It is found that there is a strong correlation between high levels of initial returns and large volumes of IPOs – where markets would see strong bull runs followed by a surge of IPO listings.

So… Where Are We Right Now?

The bulls may run faster than our four-year historical mark – and we want to give you a little more insight if that’s going to happen.

We’ve updated the chart for the IPOs that were done in 2019 thus far (June 18, 2019).

S&P Data from Robert Shiller, IPO Data from Renaissance Capital (Statista), NASDAQ

We’re mid-way into the calendar year and IPOs in 2019 have totalled an estimated sum of US$32.09 billion. This is way below that of 2018 and 2017 which totalled US$54.4 billion and US$43.9 billion respectively.

Note that this is despite 2019 being hailed as the hot year for IPOs – with well-known companies like Uber, Lyft, Slack and Airbnb going public.

Things can go two ways from now till year end. IPOs can surpass 2018’s levels and we see a market crash next year 2020. Or, IPOs stay low this year and build up acceleration like what you see in the bars at 2005 to 2007.

I tracked the planned deals that are already filed to list with NASDAQ or NYSE and we get our final chart that looks like this:

Data from Renaissance Capital (Statista), NASDAQ

As you can see, even with the planned deals, IPO amounts raised will estimate to total only US$41.8 billion, and number of listings may increase from the current 102 to a range between 136 and 143.

This is still lower than 2018 and 2017’s figures.

Note that these data excludes the numbers for Seasoned Equity Offerings (SEOs) and companies that opt for direct listings.

Direct listings (also known as Direct Public Offerings, DPOs) have gaining popularity since Spotify kick-started the trend in 2018. Direct listings are when a company decides to go public without using an Investment Bank to help market and price its shares – and decides to “Do It Yourself”.

The latest direct listing was from Slack (20 June) and coming up, Airbnb on 30 June.

This means our figures may be understated… by a lot more.

Nonetheless, we think that the bulls haven’t entirely left – the market simply hasn’t gone to euphoric levels yet, like we’ve seen in 2007 or in the 1990s.

In the classic Buffett- and Munger- speak, the “animal spirits” haven’t taken over.

But we are not optimistic.

Companies are still riding this bull to float new shares – and propping up share prices.

The de-synchronicity between the stock market bulls and economic bears may grow larger.

Unfortunately, when the insiders think that it’s time to cash out – that’s when the game is over.

What Should You Do With Your Stocks Then?

It is impossible to accurately time when a stock market downturn (or crash) is going to happen.

No one has a crystal ball. Run – if anyone says they do.

The best advice is to stick with your investment framework and/or trading rules.

If you have no clue what you are doing with your stocks (let’s be honest about it) – Alvin has a free intro-class that you can come sit in and listen to.

You’ll learn about his framework known as Factor-based investing which, like what we do here at Dr Wealth, is supported by years of research and firsthand success as experienced by other Singaporeans.

You’ll discover how – by using factors – you can buy stocks that are severely undervalued when markets are in the dumps, and buy massive multibaggers when markets are picking back up again.

If you want to attend the next intro-class, the next available one is right here.