Supply kills.
When people talk about what can cause a top in the market, they invariably chatter about how the Fed can hurt stocks with higher rates. They grouse about valuation. They even hang on every word of the Fed chief, Janet Yellen, who when asked yesterday whether stocks were too high, gave a less than enthusiastic "no," but nonetheless refused to put the kibosh on the market.
But they almost invariably never talk about the real bull slayer: increased supply of stock, particularly from the initial public offerings and gigantic secondaries that contain huge chunks of insider stocks.
When we examine what caused the now almost-forgotten decline in the highfliers from March to, May I would say the primary culprit came from a rash of initial public offerings of second-rate quality and a massive amount of insider selling from some of the hottest stocks out there. Those include the once-beloved security software company FireEye (FEYE), which sold 14 million shares at $82 and quickly plummeted to the mid-$20s, as well as the e-commerce and big data plays Rocket Fuel (FUEL) and Splunk (SPLK), both of which plunged more than 50% after their offerings.
At the height of the market, we were seeing four or five IPOs a day, many distinctly lower-quality biotech and software-as-a-service companies where if you bought at the opening you were quickly decimated.
Not only that, but we heard about prospective $10 billion deals, the likes of AirBnB, Dropbox and Box, all of which seemed a little pie-in-the-sky given the pounding that similar public stocks were taking every day. But after almost daily shellackings among the like-public companies, in a matter of days these deals were shelved and the initial public offering window slammed shut.
Supply had diminished, at last as potential sellers found levels that no longer appealed to them.
Just as supply kills, a lack of supply coupled with a change in demand given lower prices can re-charge a bull market, and that's exactly what we have seen over the last month.
Lately we've seen sporadic and positive IPOs where you actually made money buying the pop at the open, including the deals for JD.com (JD), the fast-growing Chinese Internet company, and Arista Networks (ANET), the best-in-breed networker. That's because sellers were willing to give a little, bankers sensed that the public had taken too much of a beating, and buyers were no longer overwhelmed. The quality of offerings was much higher than at the top of the market.
Now, however, the market has rallied enough that we are seeing a return to a level of supply that is making me uncomfortable. Yesterday we had five IPOs -- way too many for me -- and only two made you money. The other three truly stunk up the joint. Today we caught three IPOs and, fortunately, they were all good ones, particularly, Markit (MRKT), a company that dominates the pricing and reporting of many complex and abstruse financial instruments. That deal is so good, with such exceptional bloodlines, including the backing of General Atlantic, that I would still buy it up here. I backed a GA deal before, TriNet (TNET), which turned out to be one of the real stalwarts in the market. I believe this deal will be a good one, too, in part because General Atlantic has two terrific members on the board and they did not sell stock on the offering.
Nonetheless, once again, there is too much supply coming on to the market with a huge slate of deals for next week. We are hearing talk of a revival of the shelved big deals. We haven't seen big secondaries yet, but that could be next. All I can say is that this supply, above all, is worth watching and worrying about. If it keeps up or gets hotter and heavier, we must be on heightened alert and be ready to lighten up before supply wreaks its havoc again.
