Over recent years, IPO markets have experienced volatility. According to researchers (Angelini & Foglia 2018; Tran & Jeon 2011), these fluctuations may be driven by macroeconomic indicators (Angelini & Foglia 2018).
Economic indicators provide data on the current and past performance of an economy. They can be divided into leading and coincident indicators.
Interest Rates
Interest rates play an essential role in shaping the investment climate and can have profound effects on all aspects of business. Low rates make borrowing money cost-effective and promote consumer spending and corporate investment, while high interest rates make financing more costly and slow economic activity.
Investor sentiment plays a significant role in influencing the valuation of new IPOs. When investors feel positive/optimistic about the market, they will likely invest more readily in stocks resulting in higher valuations for new offerings.
Companies looking to launch an Initial Public Offering can employ hedging strategies in order to reduce the impact of interest rate fluctuations on their borrowing costs and stock prices. Lower interest rates tend to coincide with more IPO activity since lower costs make financing their growth with debt more accessible than equity financing options.
GDP Growth
Economic conditions have an effect on how many companies go public. Initial Public Offerings (IPOs) tend to occur more frequently during times of strong GDP growth, low inflation and favorable interest rates; when these conditions exist, investors feel confident enough to purchase stocks and push demand and valuations upward. Conversely, economic downturns reduce stock prices leading to decreased investor trust.
IPO activity has long been tied to government policies. For instance, during the Trump administration greater clarity regarding monetary and geopolitical policies may increase investment sentiment in emerging industries, leading businesses to invest more heavily in their operations and eventually in themselves. TMT companies, industrials and financials typically experience increased IPO activity after an election cycle has concluded.
This research shows that economic cycles impact initial return and long-run performance of initial public offerings (IPOs). This finding is consistent with previous studies and theories such as asymmetric information theory, signaling theory, impresario hypothesis, window of opportunity theory, and spillover effect theory; additional factors like capital markets or corporate governance could also have an effect on an IPO's performance.
Unemployment Rates
Unemployment rates provide investors with vital insight into the health of an economy. Unfortunately, as with other economic indicators, unemployment rates tend to be lagging indicators and report after specific economic shifts occur - making it hard to ascertain exactly what effect changes in unemployment rates may have on economic performance, especially when interpreted differently by different people.
Markets closely track unemployment rates to assess the strength of labor markets and anticipate economic growth. A higher unemployment rate can decrease investor trust and ultimately slow investment spending.
As for IPO activity, it seems the labor market remains strong while low interest rates continue to support companies considering going public. Historically, post-election years tend to see an uptick in IPO activity among healthcare, TMT, and financial service companies alike.
IPO Activity
Economy plays a critical role in IPO timing, impacting cash inflows and risk-adjusted discount factors which determine when companies go public (Tran & Jeon 2011). A robust economy bodes well for IPO activity as investors become more welcoming of new stocks (Tran & Jeon 2011).
But many enterprises encounter pricing constraints when considering floating their shares, as the IPO price ceiling imposed by the market limits their profitability. Therefore, many opt to postpone their IPO until it appears to have been priced accurately by their investors.
Studies conducted previously have demonstrated that initial public offerings (IPOs) at the start of an IPO wave tend to be undervalued while later listed ones tend to be overvalued, due to investors gathering more information about other enterprises and their market characteristics before investing in new ones.