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The stock market’s having quite the rally and the bullishness is nicely underscored by the S&P 500 index having hit new all-time highs 33 times since the beginning of 2014. It’s now close to a record all time high and has surpassed the 2,000 level psychological barrier. Technical market watchers often say that though an index struggles to break through a ceiling, such as 2,000 on the S&P, once it does break through, that old ceiling then becomes a floor, a new resistance level that the index doesn’t easily fall below. If it does fall below in a meaningful way, it sends a signal about the near-term direction of the market.

In addition, the market rally and bullish sentiment has also been a boom for IPOs with all manner of companies having gone public over the last few years. Record first-day surges in stock price to lofty, often unjustified valuations, even though many of these companies don’t have fundamentals to back up their stock prices.

In the month of August alone, 204 businesses held initial public offerings for a combined market value of $46.4 billion. According to the Wall Street Journal, this is the highest number of IPOs at the highest valuation since the year 2000.

I understand the broad bullish sentiment in the market. I can attribute some of it to the strength of the U.S. economy, low interest rates and stocks pretty-much being the only-game in town to earn inflation-beating returns, and strong earnings by American companies relative to the rest of the world. However, the bullishness on IPOs, especially of companies that don’t have the fundamentals to back-up their valuation confounds me a little. It strikes me as a bit of Wall Street opportunism.

Bankers feel they can make a fast buck by taking companies public and earn about 6% of the IPO value by cashing in on investor bullishness and appetite for risk while offloading less-than-solid companies into the laps of public shareholders.

I see the point. IPO valuations reflects future potential. But that’s what they also said about Pets.com and many other loss-making companies that went public in the dot-com era and then went bust.

In the same vein, I also came across an article titled “What’s going on with the boom in profitless stocks” by Jacob Davidson of Time Money. He says that for the first time since the dotcom era, get this, a whopping 83% of 2014’s IPOs have negative earnings. That’s just short of the record 84% of in-the-red IPOs in the year 2000 at the height of the dot-com bubble. So it certainly seems like we’re back in the go-go dot-com days based on IPO statistics.

We all know how badly that ended, with the S&P 500 losing half of its value when the bubble burst.

“It might come in the same box with a different color bow, but like Yogi Berra said, it’s deja-vu all over again.” source

While the Time Money article focuses on tech stocks, I think the IPO boom has been broader this time around with pharmaceutical companies, restaurants and a host of other companies cashing in on investor bullishness. Biotech’s, for example, accounted for about 22% of all 2014 IPOs year-to-date. These are companies that often have experimental late-stage drugs awaiting FDA approval. They aren’t yet making money and are burning through a lot of cash for R&D and product development.

If you look at who’s buying into these IPOs, it’s a lot of savvy institutional investors. These are trained money managers who manage public pension funds, mutual funds, etc., and appear to be willing to take on high levels of risk for potentially high rewards.

I think there’s also some of that herd mentality at play here. The fund managers are unwilling to sit out a continued surge in the markets lest they under-perform their peers. That classic adverse incentive encourages heavy risk-taking by money managers, of course, with investor money. If the market tanks, their saving grace will be to blame the losses on market factors, not on their own shortcomings.

Hot IPOs of overwhelmingly loss-making companies and 33 record highs for the S&P are, in my opinion, warning signs that the market may have drifted away from fundamental value. In addition, as I had mentioned in my commentary a few weeks ago, Nobel Prize winning economist Robert Shiller’s cyclically-adjusted 10-year price-to-earnings ratio is at about 25. That’s well above its 20th century average of 15.

There are warning signals all around us, but no one, not even Shiller can say for sure how much higher the market might go, or how much longer the bullishness might continue because the U.S. economy appears to be doing much better than most other developed economies in the world.

U.S. manufacturing grew in August at its strongest pace over the past three years. Construction spending surged in July to its biggest increase in over two years. Auto sales reached an 11-year high in August. Factory orders were up 10.5% in July, the biggest one-month increase since 1992 (although a lot of the increase was for airplanes which is a small sector of the US economy.) In August, the Services Index rose to it’s highest reading since January 2008.

There’s a lot of strength in the economy that bulls take comfort from and there don’t appear to be any real threats to the strength or stability of our nation or our markets. It’s still the place investors flock to.

No one can really say where we go from here, but like I said earlier, older investors should assess their portfolios and hedge against downside risk while younger investors should have faith in our markets over the long-run and continue to invest month after month in good markets and bad.

One last thought.

I am starting to see in my advisory practice a change in the psychology and expectations of clients. It wasn’t that long ago those clients were asking for safety and were happy with achieving safe 5-7% returns on their investments. Today with pretty much all stocks going up and earning high double digit returns, people are less worried about safety and focusing solely on high returns.

This is a big psychological shift which is a sign or a “toppy” market. Again, it doesn’t mean that the market is going to decline right away or overnight, but the general public usually comes late to the party AFTER most of the money has been made.

If you are one of these people who tend to buy high, sell low and repeat until broke, make sure you keep your emotions in check and always look to be playing. As the great investor, Howard Marks puts it: “Not losers Tennis. Watch the downside and always remember the risks you are taking.

Source: Time.com

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I've been an investment strategist and adviser for over 35 years, leading with a mission of unbiased advice to educate and protect listeners on my weekly radio show on NPR affiliates nationwide. I have been named a “Top 100 Wealth Advisor” by Worth Magazine and “Top Advisor” by Reuters.