BofA Merrill Lynch: The Four “Canaries In The Coalmine” Died

By Wolf Richter: On the Nasdaq and the New York Stock Exchange combined, 251 companies have gone public this year as of September 26, up 73% from last year. Their IPOs raised $77 billion, nearly double the amount raised last year at this time. It was the second largest amount in history, behind only the year when all IPO craziness came to a head and finally blew up, the infamous year 2000, which, for this period, clocked in at $84 billion.

IPOs are risky. Especially those IPOs that are pushed out in all haste while the IPO “window” is open, and the window stays open only a short while. For early investors, such as venture capital funds, it’s the moment to exit and take their cash and run. And the “public” is buying. That “public” isn’t actually the people for most part but institutional investors, such as mutual funds that then stuff these shares into people’s retirement funds.

The “IPO window is open” is a euphemism. It means that desperate and crazed investors buy anything even if it doesn’t pass the smell test, they’re buying without looking, they believe in all the hype and forget to do the math. No earnings, no problem. Sky-high valuations, no problem, even if the company is only good at burning investor cash. Risks don’t exist. This is an opportunity. Buy, buy, buy. That’s a “healthy IPO market,” another euphemism. It’s healthy, but for whom?

Then the window closes, the money dries up, and these young companies that keep burning cash suddenly have trouble raising more, and many of them will turn into financial sinkholes. Everyone knows that – except when the IPO window is open and amnesia reigns.

And it doesn’t matter that a mini-revolt is already brewing in the venture capital world, though they’re still throwing money hand over fist at their portfolio companies – 47 of which have “valuations” of over $1 billion, with Uber sitting at $18 billion, and Snapchat, which still doesn’t have any revenues, at $10 billion.
Even VCs are now complaining vociferously about the excessive cash burn rate of their portfolio companies. It started with Bill Gurley, a partner at Benchmark and investor in Uber, among others, who lamented the “excessive amount of risk” piling up in Silicon Valley, where “the average burn rate at the average venture-backed company” is at an “all-time high since ’99 and maybe in many industries higher than in ’99” [read.... ‘Excessive Amounts of Capital’ Doom the Startup Bubble].
He’d struck a chord, and others chimed in. On Thursday, it was Marc Andreessen, founder of long-forgotten Netscape, which had made him rich and a VC. In a series of 18 tweets, he warned: “When the market turns, and it will turn, we will find out who has been swimming without trunks on. Many high burn rate companies will VAPORIZE.”
And he offered other party-pooper messages: “New founders in last 10 years have ONLY been in environment where money is always easy to raise at higher valuations. THAT WILL NOT LAST.” His final and most eloquent tweet: “Worry.”
That warning hasn’t sunk in yet, not in the startup space, apparently, where exuberance continues to reign, and where new money continues to replace old money that had vaporized. The IPO window is still open, and large corporations are still buying startups at ludicrous valuations, and everyone looks like a genius and is getting rich.
But elsewhere, the exuberance is fading under a hail of warnings, including from Michael Hartnett, Chief Investment Strategist at BofA Merrill Lynch, who warned in a report that the four “canaries in the coalmine” had died:

Commodities, Emerging Markets, High Yield bonds, and Small Cap stocks are four classic “canaries in the coalmine,” high beta, cyclical assets, lead indicators of shifts in the economic and interest rate cycle. We believe the poor performance of all four assets in the past 12 months indicates an inflection point in global liquidity, the end of ZIRP, and a trough in volatility.

In the past, all these “inflection points” had been triggered by “policy announcements or policy concern,” similar to the Fed’s current process and verbiage of tightening, and that “a dive in the canaries” in 2008 and 2011 coincided with a “vicious spike in market volatility.” These two bouts of “market volatility” were a historic stock crash in 2008 and a near-20% plunge in 2011(before the Fed threw another round of QE at stocks to re-inflate them.
This “market volatility” is a twisted euphemism for big losses. And so:

In our view, the end of excess liquidity means the end of excess returns and the end of excessively low volatility. We think 2015 looks a good year for bulls of volatility. That is not a prediction of a market crash, although we believe the risk of a greater than 10% correction in the market rises substantially as ZIRP ends.

Hartnett has a list of things to go wrong, blow up (overleveraged European banks), get stuck in the mud, or collide. But instead of recommending with some urgency to get the heck out of the coalmine, he remains mysteriously bullish, as if being bullish no matter what your own research finds were an obligation on Wall Street these days.
This “market volatility” would close the IPO window, and Andreessen’s warning would become reality. He’s been through this before. Depending on how long it lasts and how deep it goes, it would dry up the new money that would have replaced the evaporated old money, and it would drain some of the craziness, the blind exuberance from the markets as investors are starting to think and do the math again, and valuations would deflate. And it would get much tougher for companies to make it. That’s what “market volatility” does. A nerve-rattling prospect when we live in a Fed-designed investor paradise.

Others are seeing it too. In the past, they were early, but they were right.

Source 

X art by WB7