Watch out! ASX IPO boom may sink the ASX bull market in 2021

ASX investors are celebrating the spate of successful floats on the ASX recently as a sign that the bull run is alive and healthy.

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Dice spelling IPO sitting on piles of gold coins

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ASX investors are celebrating the spate of successful floats on the ASX recently as a sign that the bull run is alive and healthy.

The Nuix Ltd (ASX: NXL) share price and the Cashrewards Ord Shs (ASX: CRW) share price are among examples of the latest initial public offerings (IPOs) that are trading well above their issue price.

Other examples include the Booktopia Group Ltd (ASX: BKG) share price and the Maas Group Holdings Ltd (ASX: MGH) share price.

Strong ASX IPO market a danger sign for bulls

Who cares that the doomsayers ringing the warning bells as the S&P/ASX 200 Index (Index:^AXJO) kicked off the week with strong gains? The buoyant IPO market gives confidence to the bulls that the party will last long past New Year’s Day.

But it might be a case of be careful for what you wish for. The level of IPOs and capital raisings could be the proverbial canary in the coalmine for equities, reported Bloomberg.

The report found a strong correlation between share market performance and the demand and supply of shares.

Demand and supply of ASX shares

IPOs and capital raisings increase the supply of shares as companies sell equity to shareholders. Inversely, ASX stocks that undertake share buybacks and those that are acquired remove the supply of shares on market.

The IPO party isn’t confined to Australia. The number of new floats in the US is also high with the likes of Snowflake Inc (NYSE: SNOW) and Warner Music Group Corp (NASDAQ: WMG).

While listed US companies typically back-back more shares than they sell, Bloomberg found that 2020 is different.

Capital raisings add to supply glut

The supply of shares isn’t only coming from IPOs. Companies most battered by COVID‐19, such as travel stocks and airlines, have been frantically selling shares to beef up their balance sheets.

US-listed companies have announced plans to raise about US$510 billion through initial and secondary share offerings this year. That’s 50% higher than a year ago, according to data from EPFR that’s reported by Bloomberg.

“For the first time since the 2009 crisis year, that matches the amount that companies announced they’d remove via buybacks and takeovers,” noted Bloomberg.

“For context, an average of $3 was bought back for every $1 raised over the past decade.”

Impact of excess ASX shares on issue

Why should investors care? Over the past 20 years to 2015, listed companies boosted net equity demand in 15 different years. Twelve of those 15 years saw the S&P 500 rise, a study by EPFR showed.

On the flipside, in the five years when supply of shares increased, the equity benchmark fell 60% of the time.

If the demand and supply doesn’t balance out better in 2021, the market bulls could be in for a rude shock.

The study may have been undertaken in the US, but I won’t be surprised if the ASX follows a similar pattern. After all, our market has always walked in the shadow of its US counterparts.

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Brendon Lau has no position in any of the stocks mentioned. Connect with me on Twitter @brenlau.

The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Snowflake Inc. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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