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Colin McLean: the bubbly IPO market is flashing danger warnings

by Colin McLean on Dec 04, 2013 at 09:30

Colin McLean: the bubbly IPO market is flashing danger warnings

Some biases are so pervasive that adjustment is hard; optimism is such a deep-rooted aspect of investor psychology that its impact is usually missed.

A recent book, Fish Can’t See Water: How National Culture Can Make or Break Your Corporate Strategy by Kai Hammerich and Richard D. Lewis, describes the way in which an aspect of the environment or culture is embedded so widely that it becomes invisible. 

Yet though never entirely absent from markets, optimism can ebb and flow. Understanding its changing characteristics can be useful, and closer analysis reveals more troubling recent patterns.

Optimism owes its long-term persistence to its value. It is a helpful trait, along with patience, to achieve the waiting that investors need.

It takes time to capture equity risk premiums, and investors need to ride out a lot of anxiety during the journey. And a deep-seated belief in long-term economic and corporate growth underlies most equity investors.

Bias towards optimism

A bias to optimism was undoubtedly helpful for investors who held tight in late 2008 and kept faith through the 2009 recovery, even when hard evidence was limited.

But it can get out of hand, and too readily run away into exuberance. There are always some signs of this, but the most interesting indicators are not necessarily the high level of markets or even for share ratings.

IPOs are one indication of belief in growth. Twitter’s IPO might have captured the headlines, with its float at 10x book value and 50x price to sales, but many other new issues also embed a lot of optimism. 

Yet this may not represent a market extreme. The number of IPOs is still well short of the 1999/2000 peak, and the rate of activity does not by itself confirm excessive optimism.

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