Fire up the hype machine

Everyone is talking about SpaceX

The idealistic view of the investment world is that we are all fiduciary professionals, doing the best we can to build optimal portfolios for our clients.

The cynical view is that we are all salespeople.

It’s a spectrum, and I hope your own advisory team tilts more towards the former than the latter. But ultimately, the truth is that this business is all about selling. We don’t sell tangible things. We sell dreams of getting rich. Some might say, we monetize greed.

And the Grand Prix of firing up the animal instincts is a big, fat, monster IPO.

SpaceX is it, baby. It’s got everything: Elon, rockets, and AI. I’m not sure you could come up with a more buzzy new issue in a lab if you tried.

The company’s own filing describes its mission as “to build the systems and technologies necessary to make life multiplanetary, to understand the true nature of the universe, and to extend the light of consciousness to the stars.”

Those are what the consultants call “stretch goals.”

And here I am, investing in companies that make chocolate bars and potato chips.

Going along for the ride

You wouldn’t think it would need any help, but the index providers are scrambling to get some of that sweet, sweet SpaceX exposure.

The Nasdaq 100 is futzing around with it’s “fast entry” rules to be the first to include the company’s shares in the benchmark. This will cut the mandatory post-IPO waiting period from three months down to just 15 days. Not to be outdone, the S&P index committee has talked about cutting it’s traditional year-long waiting period in half. Can’t have the fast money investors chasing the other guy’s index!

Essentially, this means that index managers will be forced to buy shares in the company, valuation be damned.

For a stock being issued with a very low public float, this can greatly enhance the post-IPO pump, as pre-IPO investors will be loathe to take their profits too early, lest they miss the index-inclusion bump. The combination of hype, a very low float, a lack of sellers, and an imminent index inclusion mean that the valuation on SpaceX has the potential to quickly get very, very silly. (I mean, more silly than it already is.)

To be clear, the timing isn’t a coincidence, and it’s speculated that this was probably a move by Nasdaq to win the SpaceX listing over the NYSE.

And hey, that’s actually fine with me. I’m cool with letting them operate in the way they best see fit. But if you’re an index investor, you need to understand what this means. I wrote about this back in December of 2020, in a post titled The S&P 500 Index Committee Doesn’t Care About You (incidentally, about the index inclusion of Tesla, another Musk company).

As I wrote in that piece:

I think it’s important to point out to investors who believe they can hang their hat on a passive strategy… there is no such thing. Instead, what you are doing is delegating your stock selection to a committee.

They’re not making a judgment call on the quality of a company, the strength of a balance sheet, or the stability of a business.

They are making zero effort to determine if the company they’re adding to the benchmark is a quality business, or if the price being paid is reasonable.

Why would you hire them to decide where your money goes?

They don’t care about you. But you can’t blame them. It’s not their job.

But this isn’t just about passive investors.

Because active managers are often benchmarked against those same passive indices, they can have no choice but to play the same game.

Back to SpaceX.

From The Information:

(Active) Fund managers fret that if they sit out the SpaceX offering and the shares soar, their performance will look dismal. If they buy in and the shares fall, they’ll have safety in numbers because they’ll look like everyone else. That’s particularly true for long-only institutional investors who manage money against benchmarks, said Karen Snow, former head of listings at Nasdaq, who now runs Rose & Co. Capital, a capital markets advisory firm.

“At the end of the day, institutional investors are rational. They get paid to be rational. Do they have to participate? Yes,” said Snow. “If you don’t participate, the risk is way higher.”

Musk and his bankers are well aware of the buying pressure they’re putting on fund managers. They’ve got something like $75 billion worth of stock to sell. And if Musk’s army of small investor followers know big buyers are waiting to pounce, they’re likely to bid up SpaceX’s share price in the first days of trading.

This will be a big story as the year progresses, and don’t forget that we are also expecting IPOs from Anthropic and OpenAI in the coming months. Both stand to “benefit” from the change in the Nasdaq and S&P index inclusion rules.

Everyone thinks they can play the bubble game and get out just before it pops. Some people will succeed. Most won’t. If you decide to play the game, make sure you know when to take profits and walk away. As the old saying goes, if you don’t know who the sucker is at the table, it’s you.