The hidden market risks of SpaceX's IPO

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Earlier this week, we explored whether the IPO boom, led by SpaceX, is a sign that the market environment that's getting a bit too frothy. In keeping with the IPO theme, let's dive into some of the potential risks these offerings pose to the broader market structure.

One concern here should be liquidity needs. Let's use SpaceX and the $75 billion the firm will seek to raise when it's expected to go public on June 12.

That money will need to come from somewhere, but there are very limited amounts of cash on the sidelines that investors can draw on. Bank of America's private wealth management clients, for instance, are sitting on record low cash levels of 9.9% of their portfolios, while also allocating a record 66% of their money to stocks.

This means that to fund their purchases of SpaceX shares, investors could sell their holdings in other areas of the market, creating downward pressure where outflows occur.

Liquidity-sensitive stocks like those in the growth factor might be first in line to take a hit, but where exactly that selling ultimately happens is a mystery, says Bob Doll, the CEO of Crossmark Global Investments and the former equities chief at BlackRock.

"Logically, you would think if I'm going to buy a stock in that space, I'll probably sell a stock in that space to make room for it rather than selling some utility or energy company," Doll told Business Insider on Tuesday.

"That's logical, but these tech owners, they just want to own more, so maybe they do sell their Procter & Gamble," he added.

Volatility in other parts of the market is likely to be even more pronounced when SpaceX and other large firms are added to the Nasdaq 100 and other indexes, according to MSCI research.

Since the tech sector will grow with their inclusions, others -- like the consumer discretionary and healthcare sectors -- will necessarily have to shrink, meaning index funds will have to sell off some of those holdings.

The reweighting within the tech sector will also affect those names. MSCI estimates Nvidia, Apple, and Microsoft will see the largest outflows as a result of the new inclusions.

When the reshuffling is all said and done, Doll said another market structure impact will be unprecedented levels of concentration.

The AI megacaps could soon make up around half of the S&P 500. As Asher Regovy, the chief investment officer at Magnifina, put it in a recent report, that leaves the market exceptionally vulnerable to one event, like a bad earnings release that sends shock waves through similar stocks.

So, what can you do about these risks? Doll said he's not too worried about potential liquidity events stemming from these IPOs, as they'll be short-lived. He's also not overly concerned about concentration at the moment, since tech-sector valuations are still at reasonable levels.

That outlook in mind, he said he has exposure to both defensive stocks and to the AI trade, with a focus on firms that have high return on equity, or profitability levels.

"Valuation levels are high, uncertainty is high, so I'm gonna lean on the companies that are delivering the goods," Doll said.

For those specifically seeking to reduce concentration risk in their portfolios, UBS told its clients last week to lessen dependence on mega-caps by adding exposure to Japanese, Chinese, and Swiss stocks, as well as emerging markets, European consumer discretionary, and global health care stocks.