Analysis: M&A surge not enough for sustainable stock rally

PARIS/NEW YORK Fri Aug 27, 2010 12:04pm EDT

A trader works on the floor of the New York Stock Exchange as federal interest rates are announced in New York, June 23, 2010. REUTERS/Keith Bedford

A trader works on the floor of the New York Stock Exchange as federal interest rates are announced in New York, June 23, 2010.

Credit: Reuters/Keith Bedford

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PARIS/NEW YORK (Reuters) - August's $200-billion in takeover announcements is unlikely to provide enough of a spark to energize equity markets fretting about another dip in global growth.

At best, the M&A revival -- fueled by rock-bottom interest rates, cheap stock valuations and big company warchests -- will help limit stock market losses as fund managers scramble to fill portfolios with shares of potential targets.

And the flip side is that the prospect of enhanced M&A activity could raise fears of more job losses and questions about whether dealmaking is driven by worries over future product demand, contributing to investor unease.

S&P 500 companies, which have been aggressively slashing costs to weather the economic slowdown, closed last quarter with $1.63 trillion in cash holdings, the highest for any quarter on record, according to Thomson Reuters Worldscope.

"Companies' balance sheets have rarely been so flush with cash," said Alain Bokobza, head of global asset allocation at Societe Generale CIB in Paris.

These companies, struggling to boost revenue in an anemic economic environment, are making waves in what is usually one of the quietest months of the year for M&A activity.

According to Thomson Reuters data, nearly $200 billion in mergers and acquisitions has been announced in August, already making it the third-best month so far this year in terms of money committed to deals.

Comparatively, the $1.5 trillion spent in M&A from the start of the year to August 23 is 20.6 percent above last year's amount. But it's over 50 percent less than the $3.1 trillion spent in the same period of 2007, when global stock markets were on their way to historic highs.

The MSCI world equity index .MIWD00000PUS has dropped 7.1 percent so far this year, hurt by a slowdown in the global economic recovery and by the euro zone's sovereign debt crisis.

DEALS CAN'T COUNTER FEAR

But while the M&A revival is seen continuing at a steady pace, analysts said it won't eclipse the mounting global economic fears that have trapped stocks in a range and propelled government bond yields to record levels.

"For now, the dominant factor on the market remains the U.S. and Chinese slowdown in growth," Societe Generale's Bokobza warned, pointing that the M&A wave has been mainly confined to the tech and resource-related sectors.

The relatively small number of deals in August, despite their big price tags, is also fuelling caution among analysts.

Data showed there were 1,863 deals globally in August until last Friday, compared with 2,961 deals in August 2009 and 3,067 deals in August 2008.

"When you look closely, there hasn't been a lot of deals apart from the ones that hit the headlines," said Jacques Henry, analyst at Louis Capital Markets in Paris.

And the fact that companies seem to be mostly motivated by the grim prospect for organic revenue growth, spending their money on takeovers instead of boosting capital expenditures and hiring workers, does nothing to calm investors' jitters about the outlook for the economy.

Instead of sparking euphoria, the wave of takeover bids is underlying companies' concerns over future demand. While the latest earnings season showed relatively robust profit growth, the tepid rise in revenues has been a clear red flag on future margins.

The rise in M&A "does confirm that the current outlook is that we're kind of stuck," said Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds Management in Menomonee Falls, Wisconsin.

JOBS WORRIES

The steady flow of bleak data on the U.S. jobs market and consumer spending on both side of the Atlantic over the past few weeks has been at the heart of investors' worries, and the prospect of an M&A tide is adding to fears over jobs.

"Whenever I hear M&A, I also think job loss," said Kim Caughey, senior research analyst at Fort Pitt Capital Group in Pittsburgh.

"In the coming months, given these large acquisitions that we're seeing right now, I wouldn't be surprised to see (unemployment) drift up."

Although it won't be the stock market's next big driver, the pick-up in M&A activity will provide support to the battered shares, encouraging fund managers to look for value in hope of rich takeover premiums.

"The return of M&A noise will prompt people to start doing stock picking again, to crunch the numbers to determine which stocks are potential targets," said Christian Jimenez, fund manager and president of Diamant Bleu Gestion, in Paris.

"Even in a downward market, you can build a resilient portfolio by picking up the right stocks."

(Graphics by Scott Barber in London, Editing by Sitaraman Shankar)

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