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Skip Navigation LinksHome :: Back Issues :: Equity resilience is no proof that the worst is over

November 2001

Equity resilience is no proof that the worst is over


A partial recovery in US equity markets looks promising. However, as bad economic news flows in there’s still uncertainty on the broader question of whether a market bottom has been reached. Bond yield curves suggest a different story to conventional equity wisdom, which implies investors should now be positioning themselves in mid-recession for a market upturn.




On October 11, exactly one month after the attacks on the World Trade Centre that shut down parts of the financial markets for a week, the Nasdaq Composite stock index returned to its pre-attack level. The Dow Jones Industrial Average had also come back strongly from its low on September 24 but was still 400 points below its close on September 10.
In addition to equity trading recovering, equity underwriting appeared to be back in business in October. September was the first month in years in which no US companies launched an IPO. There were a few follow-ons and convertible deals, but not in any volume.
The fear was that equity capital markets, which had been suffering from reduced issuance in any case following the Nasdaq crash in April 2000, would now be virtually closed. That fear seems to have been unjustified. September was an anomaly - a reaction to the attacks and the huge political uncertainty that followed as much as a business reaction to US stock markets remaining closed for four days and several major investment banks being forced to relocate operations.
Deal flow picked up as soon as October arrived. In the second week, Merrill Lynch priced nine deals, a mix of secondary offerings and convertibles. These included a $875 million mandatory convertible for Texas Utilities - co-led by Goldman Sachs - a $427 million overnight secondary offering for Loblaw's, a Canadian company, and a combined follow-on and convertible deal for Performance Food company of $308 million.
       

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Of the nine deals Merrill launched that week, six were priced on the same night, October 11. "We haven't had that busy a day or night since late 1996," says Jeff Edwards, co-head of global equity markets.
Institutional investors, it seems, do not regard recent events as a reason for fundamental strategic changes. According to a survey of 35 of the leading global institutional investors conducted by UBS Warburg in the second half of September, 81% said they were open for primary-market opportunities. What's more, explains Warburg: "In our last survey, in April, investors had a preference towards follow-on offerings as opposed to IPOs. This is no longer necessarily the case if their other criteria are fulfilled."
Of the 35 firms, 40% are biased towards equities - although 33% remain neutral - and there is a noticeable, if slow shift away from defensive stocks. "Prior to the World Trade Centre events the majority of investors had been focused on defensive plays," reads the survey. That has reduced to 42%, while "18% are starting to look for recovery and/or cyclical stocks".
That tallies with the view of Merrill Lynch's chief US investment strategist, Christine Callies who says: "Equity market leadership since trading resumed is surprisingly similar to the general trend before September. The better-performing shares are predominantly light cyclical in character, not defensive."
Convertibles have picked up speed again. That should come as no surprise. Convertible issuance thrives when two conditions apply: low or falling interest rates and volatility in equities. Both were present in the first half of the year and led to record issuance of convertibles by a broad range of credits.
There was a lull in mid-year when volatility dropped and the Federal Reserve eased back on rate cuts, but since September 11 volatility has increased dramatically, and the Fed has made two 50 basis point rate cuts.
       

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Normally that would have served as an automatic green light for issuers, but only in October did convertible issuance pick up. The reason was simple, says Marc Paley, global head of equities at Lehman Brothers: "Stock prices were depressed for most of September, so companies were unwilling to sell any kind of equity, even with a premium." Only once stock prices had improved after the initial sell-off in the week of September 17 did new issuance pick up.
In general, continues Paley, only certain sectors ought to be in a position to issue any kind of equity-related securities. "Investors are looking at more traditional ways of measuring companies than they were in the late 1990s - looking for those with profitability, sustainability, and good management." That puts the emphasis more on, for example, utilities, healthcare and financials - there are several US demutualizations planned before the end of the year. One has already come to market, insurance and investment company Principal Financial. It was priced at $18.50 a share, right in the middle of the price talk of $17 to $20 a share, and was sole lead-managed by Goldman Sachs. The company issued 100 million shares, making it at $1.85 billion the fourth-largest US IPO this year, and the fifth-largest US financial-sector IPO ever.
It is these larger, more liquid deals, which investors now crave. It's not a new development, having been a theme for more than a year. Recent market turbulence has reinforced investors' risk aversion. Paley says: "It had been difficult for emerging growth companies to tap the markets this year, but that has been exacerbated since September 11."
Such sentiments were apparent in UBS Warburg's survey. Thirty six per cent of investors polled said that though they were still looking for a good price, a growth story and liquidity, they were much more interested in companies that could show good management and a company track record, and 22% stressed the importance of a company's balance sheet and earnings.
Some less traditional companies have nevertheless managed to tap US equity markets. The company to end the IPO drought this year is a growth company with no track record and no earnings. Given Technology, a medical technology company based in Israel, launched its $60 million IPO through lead managers Lehman Brothers and CSFB on October 3, ending the longest period in the US without an IPO since the 80-day gap between October 21 1975 and January 8 1976. "It has great technology and fills a niche," says Paley. "It's a unique company, and those are the ones which can raise money in almost any environment."
Despite a lack of revenues, Given Technology belongs to a broader sector that has, in general, been popular with investors, both in the primary market and secondary trading - healthcare. It's less of a surprise, then, that the second IPO of October was also for a healthcare company, TheraSense, which develops diabetes-monitoring technology. It raised $114 million, despite being $27 million in the red in the first half of the year.
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