Will IPO Fire Burn Out?

The new year has breathed new life into the market for stock offerings, but will the robust issuance calendar of the last seven weeks turn out to be a last gasp?

Since the beginning of 2006, equity offerings have been on a tear. Through Monday, the total number of equity issuances -- initial public offerings and follow-on offerings -- has increased 23% from a year ago, according to research outfit Dealogic. The performance of stock sold in the offerings has been equally impressive. Shares of companies issuing follow-on equity have risen an average of 5% the day after being priced this year, compared with a gain of 3.2% in 2005. Initial public offerings have increased 9.9% the day after sale vs. 7.3% last year.

The new-issue market tends to be a lagging indicator, mainly because it takes up to six months to execute a deal. IPOs require extensive regulatory filings, the hiring of underwriters, and marketing. Given the uncertain outlook for the second half of 2006, some observers say, the latest flurry might not be sustainable.

"The demand for new issuance slows when the market anticipates a decline in earnings growth," said Marc Pado, chief market strategist at Cantor Fitzgerald. "Once we get closer to a quarter that is disappointing, demand will decline, and that is the second half of this year."

For now, the deluge looks ripe to continue. Equity offerings pick up when the market gets frothy, and while some analysts believe corporate growth is bound to slow, Pado believes the rally has legs through the second quarter.

After that, the situation is less certain.

According to Merrill Lynch research, in the Global Industry Classification Standard, an industry standard developed by Morgan Stanley Capital Investment and Standard & Poor's to show performance over 24 industry groups, earnings in sectors other than energy are expected to slow to 5.4% growth in the first quarter. That's below the 10% increase in both the third and fourth quarters of last year and down sharply from more than 25% growth in the first two quarters of 2004. According to the report, 70% of the GICS sectors have seen earnings downgrades over the past six weeks, with energy, telecom and utility sectors being the exception.