IPO Frenzy: A Hidden Leading Indicator?

 An IPO boom is seen as market's positive sentiment.

News outlets and influencers flood us with stories of high listing gains from IPOs. We often confuse it with the whole market going green forward.

But data tells a different story:

1. IPOs squeeze liquidity from market - Listings, either primary or secondary, put money in the hands of company for expansion or the shareholders; leading to a cash outflow from the secondary market.

2. Correlation - I analyzed the last 18 years (2007-2024) of Nifty 50 returns against the annual number of IPOs and amount of Capital Raised. The statistical correlation between them:

Nifty 50 returns against the annual number of IPOs +0.12

Nifty 50 returns against the Amount of Capital Raised +0.09

A correlation of +0.12 and +0.09 indicates a very weak positive relationship. In simple terms, knowing the Nifty's return for a year gives you almost no ability to predict the number of IPOs.

But this gets interesting when we try to predict the Nifty's return based on the number of IPOs in the previous year. For eg. consider correlating 2024 returns with number of IPOs in 2023. The statistical correlation between them:

Nifty 50 returns against the annual number of IPOs (P.Y.) -0.54

Nifty 50 returns against the Amount of Capital Raised (P.Y.) -0.21

A correlation of -0.50 and -0.21 indicates a moderate negative relationship.

This suggests that a year with high number of IPOs is more likely to be followed by low or negative NIFTY returns and vice versa.

This could be interpreted as a classic "market top" signal, a frenzy of IPO activity, i.e. high number of IPOs often occurs at the peak of market optimism, which is unsustainable, leading to corrections. 

This also correlated our 1st point about liquidity being squeezed from the market by IPOs.

But since the correlation is only moderate (-0.54), it should be treated as a ballpark figure.