"Show me a skyscraper and I'll show you a recession" - to paraphrase the property analyst Andrew Lawrence, who came up with a ‘skyscraper index’ showing that the tallest buildings come up right before recessions. The idea is quite intuitive -- easy money fuels lofty ambitions in the construction industry and by the time the tallest skyscrapers complete, the bubble bursts and the recession is already underway. With nearly 90 skyscrapers being built or near completion in China, the curse of the skyscraper might be imminent for the country.
Skyscrapers take years to complete, and so using them to predict the exact beginning of a stock market downturn becomes difficult. IPO ‘skyscrapers’ however, are a better and tighter predictor of an oncoming downturn.
The chart above shows the Number of IPOs in the preceding year versus the NIFTY50 average values for that month. The skyscrapers - the columns - are the number of IPOs in the preceding 12 months. We analysed data over the last decade, from January 2007 onwards and found that since that year, NIFTY50 has fallen by more than 25% twice in that time period, and both times the number of IPOs were at their peak. And the higher the number of IPOs, the higher the fall.
The first time a large fall occurred was in Jan 2008, with the Nifty crashing over 60% as the number of IPOs reached an all time high. The second time was at the end of 2010 when Nifty50 went through a downturn of nearly 25%.
IPOs in India are a means to raise capital for the company, as well as a means for current shareholders to offload their shares at a more or less fixed price. For a company owner, the right time to go for selling or raising capital is not only when growth is peaking or when the valuations are high, but also when the company owners feel that the positive gap between the actual value of the company and what the street is willing to pay is maximum.
So as this positive gap increases, more companies feel confident about getting their money's worth with an IPO. The greater the gap (with availability of the same ‘easy money’ that fuels skyscrapers), the higher the number of companies going for IPOs and sooner than later, higher the downturn.
A similar graph of Nifty50 versus the amount of money raised in the preceding year gets skewed by a few big IPOs. So the data gets skewed due to the Reliance Power and DLF IPOs.
Any guesses when the biggest IPOs of all times hit the market in India? It was in January 2008 - Jan 15-18 to be precise. Since our chart is calculated by the listing date, there is a lag in our skyscrapers. Reliance Power listed on Feb 11, 2008. The downturn was already underway by then.
One of the reasons cited by many experts is that big IPOs tend to temporarily suck out the liquidity of markets. Reliance Power IPO was oversubscribed 73 times and cornered a commitment of nearly Rs 7,50,000 crores.
The market regulator responded to this issue by making ASBA(Application Supported by Blocked Amount) - essentially a temporary lein, mandatory around October 2008, followed by changing the guidelines on how shares are allocated to avoid oversubscription in 2012.
The number of days between the close of bidding and listing had also been reduced to first 12 days in 2010 and now to 6 days from 22 days pre Apr 2010. These steps mitigate the liquidity suction problem.
India is not alone in this trend shown by the above graphs. US markets seem to largely follow the same trend. Since we don’t have detailed monthly data, the graph is not granular enough, nor do we have the same trailing 12 month aggregates, and consequently there is lag effect - the indicators still seem to work well in 2000 and 2007.
