The Last Times IPO Volume Was This High Were 1929 and 2000. Should That Scare You?

Smart investors know to watch out for bear markets. Wise investors, however, know the signs of such setbacks aren't always obvious. Sometimes you need to keep your eyes peeled for subtle hints of trouble.

Harvard University economist Xavier Gabaix thinks we may be seeing one of those hints right now. He's observed that investors often buy into initial public offerings -- like the recent one from Space Exploration Technologies (NASDAQ: SPCX) (aka SpaceX) and the impending ones from OpenAI and Anthropic -- with money from the sale of other stocks. His number-crunching shows that historically, for every $1 removed from the market, the total market cap of the stock market falls by $5. Investment advisory outfit GMO performed a similar analysis and got a similar (but slightly worse) outcome.

And there's no denying that public offerings are flowing in earnest now. J.P. Morgan Private Bank, the wealth management division for JPMorgan, predicts a total of $260 billion will be raised this year through the issuance of newly minted stocks. That nearly eclipses the post-pandemic fundraising surge of 2021, when companies rushed to capitalize on the rapid economic recovery then underway as well as on a market that was receptive to new publicly traded companies at any price. The last time we got anywhere close to these inflation-adjusted levels was back in 1999-2000, right before the dot-com crash. Before that, you have to go back to 1929 to see anything quite like what's happening now. Of course, that's the year Black Tuesday kicked off a miserable bear market and the Great Depression.

Connect the dots. Exuberance seems to be at its highest right before everything unravels.

More to the point for investors right now, the current flood of new fundraising implies that corporate confidence -- in businesses as well as the economy -- is dangerously high, portending a fall. Indeed, some analysis suggests a tumble of about 40% within a year could be in the cards.

There's something to it

The concern stemming from the correlation makes sense, and not just because of what happened a couple of times in the past. There was a pretty good swell of IPO activity in 2014, too. Although it didn't lead to a recession or a bear market, it did precede an economic headwind and a measurable setback in the S&P 500's (SNPINDEX: ^GSPC) earnings as well as in domestic corporate profits the following year. And when Black Monday unfurled back in October of 1987, a whopping 229 companies were planning public offerings (versus about 200 so far this year), according to numbers gathered by research company EBSCO, looking to capitalize on the steep valuations the bull market of the time was supporting.

Just understand that correlation isn't causation. If the market is set for a sizable setback, it's not specifically because too many companies are raising too much money by going public. That's a symptom, not the cause.

Image source: Getty Images.

Rather, if a pullback occurs, it will be because most investors decide that stocks as a whole aren't justifying their current valuations with actual earnings -- current or projected.

That's a distinction worth highlighting because bear markets can happen with or without an explosion in the number of IPOs or the amount of money they're raising. For instance, we didn't see a bunch more public offerings in 2007 before 2008's subprime mortgage meltdown, which also ended a nice bull market. Conversely, while IPOs peaked in 1999 right before 2000's tumble, public offerings were unusually high -- in terms of total count and money raised -- for most of the 1990s. The market rallied most of that time anyway.

The point is, when you're picking stocks or deciding to be in or out of the market, you should evaluate each situation individually.

So what's the answer?

The recent swell of IPO fundraising is an important nuance to consider since it could be an indicator of what former Federal Reserve Board Chairman Alan Greenspan labeled "irrational exuberance" back in 1996, when the dot-com mania first started heating up. It's just one of many details to consider, though, and it certainly shouldn't scare you. Scared investors make rash decisions that end up hurting them in the long run. Informed investors make well-reasoned decisions that accurately weigh risks against rewards, and they make measured changes to their portfolios as that information evolves.

In other words, don't panic here. If a bear market is brewing, it won't unfurl in a single day. Use the time you've got to think your decisions through. And never say never. Again, public offerings were unusually elevated for the better part of the 1990s, but the market logged gains for most of this stretch. Something similar could happen now, in defiance of the historical odds.

It's also possible that investors' selling existing positions to fund participation in this year's IPOs won't actually send the shares of those existing holdings lower this time around. This is a very unusual market environment, after all, one in which small-time retail traders are more active and have more impact than they ever have before. If nothing else, small investors are more likely than their bigger institutional counterparts to buy stocks on a dip, buoying the market.

Still, don't ignore the sudden swell of IPOs. There's no denying that when you see something this rare, something unusual is happening. The trick is figuring out what that thing really is.

JPMorgan Chase is an advertising partner of Motley Fool Money. James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends JPMorgan Chase. The Motley Fool has a disclosure policy.