Editor's note: "Manifesto for a New Market" is a week-long series discussing the changed conditions of the stock market in the Year 2000, how stock-picking works now and why. Be sure to check out other installments in the series by clicking on the above tile.
When the book on this era gets printed, we will see a whole chapter about how the brokerage houses figured out a way to front-load the market for
pizazz. But we will also read about how the backend produced an edifice built on shifting sand, not granite.
You know all of those delicious pops we have seen in so many
initial public offerings? Those pops are artificial. They are created by stimulating demand well beyond short-term supply. That supply is kept as tight as possible to get people jazzed about a stock.
In an era where the actual going-public event is the ultimate in publicity, the desire to have a giant pop does produce some economic benefit to the company floating the shares.
A big opening makes those who got stock feel great. It makes those who got teased with some stock buy more to round out their positions. But it creates a false sense of supply and demand because the "float," the stock that is issued, represents no more than the tip of the iceberg. Usually 5 to 10% of the total stock gets issued. The rest gets held back in order to be sure of the success of the deal.
Just because it is held back, however, doesn't mean it can't surface. It is meant to surface at an opportune moment, long after a company has been seasoned and is trading substantially higher from its offering price.
Ideally, in this era, the initial public offering serves as no more than a loss leader. The rest of the stock is kept back, to be registered, usually six months after the company comes public.
There is only one problem. Many stocks can't absorb that supply. Let's take the case of
National Gift Wrap and Toy.com
, a mythical dot-com that sells toys and gift wrap online. The company comes public with a huge pop and lots of hoopla -- but not much float at all -- in the spring. Right before Christmas, when everybody is excited about its prospects, the real deal, the massive supply from all of the insiders, gets unlocked.
Most people who were in the stock didn't know that it was artificially high, kept that way because only the tip of the iceberg was showing. Like the Titantic, the shareholder base takes a lethal hit when it brushes up against that giant floating iceberg. It collapses under its own weight when the artificial tightness disappears.
We are seeing these icebergs now come every day as one stock after another comes off its lockup and the float gets freed to trade. As many of these selling shareholders have a basis of pennies while the stocks sell for hundreds of dollars, they are insensitive to where they sell it. They are a new, post-IPO shareholder's worst nightmare.
This whole backend loading of supply is a new thing, something that has changed investing and made us all into traders, as almost
stock can withstand this onslaught of sellers, causing the holders tremendous short-term pain. So, a money manager's methodology in this new era has become something of enforced game of chicken. You have to try to get as much stock as possible on the initial public offering but as little as possible when you get to the
lockup expiration. In fact, because of the sellers' dynamics you should actually be
the stock ahead of the lockup.
This process of creating a tight supply is total nirvana short-term and pure hell later. It is something that the older managers refuse to play, but it is the most lucrative portion of a hot market. It is a key tenet in any new money manager's manifesto for the stock market in the year 2000.
Editor's note: This piece was rewritten by James J. Cramer in his weekly Take Two feature that appears on
every weekend. Please check it out!
James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund had no positions in any stocks mentioned. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column at