Plenty of investors appear interested in Alibaba. Initial indications from the roadshow for the IPO suggest that demand will far exceed the amount of shares on offer. Indeed, Bloomberg News has reported that the company plans to increase the offering prices, and hence the amount of capital it will raise.

Granted, one must always take the marketing chatter ahead of an IPO with a large grain of salt. Investors have an incentive to exaggerate their initial interest, so the banks running the IPO will be sure to allot them enough shares. The banks want a bigger deal so they can get more fees. The company wants to raise as much money as possible.

That said, the Alibaba IPO will be a very big deal, with potentially marketwide impact. At a possible $22 billion to $24 billion, it could well be the largest IPO in history. So it really matters how investors fund their purchase of Alibaba shares.

The broader market would be least affected if the incremental funds came from a healthy and sustainable increase in borrowing, associated with a greater willingness (and ability) on the part of investors to assume risk. The deployment of idle cash would also have minimal effect on the rest of the market. Although both will occur to some extent, they are unlikely to be the main drivers.

This leaves plenty of potential for downward market pressure as investors sell existing holdings in order to make room for their Alibaba purchases. Given that most investors don’t know as yet how many shares they will receive, most of the selling wouldn't materialize until quite far into the IPO process. The combined effect could be quite significant.

Hence, don’t be surprised if the Alibaba IPO leads initially to a market selloff. What's harder to predict is how long it might last. This will depend on other investors' willingness to jump in and buy the dip -- a phenomenon that has already kept the market rally going well beyond what fundamentals justify.

David Fuller's view

I am not sure about that, “healthy and sustainable increase in borrowing”, mentioned in the first sentence of the fourth paragraph above.  El-Erian is not talking about borrowing to expand commercial businesses in a growing economy.  No, he is talking about stock market leverage and I think we have already seen a significant amount of that, albeit mostly from investment banks and hedge funds, rather than private investors.  

If Alibaba gets a strong post-listing run to the upside, as is likely, that will siphon off additional funds from other stocks as investors raise more capital to increase their stake in the new issue.  Watch the Russell 2000 Index of smaller shares because it is ranging in potential top formation development and a sustained break beneath 1100 would warn of additional downside risk.   

(See also my lead item on Monday because it dealt with Alibaba.)