Will M&A “Animal Spirits” Lift Stocks?
Autumn historically marks a volatile period for the stock market and we’re coming off a dismal September. Last month, equities declined across the board.
However, merger and acquisition (M&A) activity is soaring at a record pace, a factor that’s adding “animal spirits” to the sputtering rally just when it’s needed. More about the M&A picture, in a minute.
A major factor placing a floor under stocks is Wall Street’s increasing optimism about third-quarter 2021 corporate earnings.
During Q3, the analyst consensus improved for earnings per share (EPS) estimates for S&P 500 companies. The Q3 “bottom-up” EPS estimate rose by 2.9% from the start of the quarter to its end, according to FactSet (see chart).
The term “bottom up” is an aggregation of the median EPS estimates for all the companies in the S&P 500 index. Typically, analysts reduce earnings estimates during any given quarter. However, Q3 2021 represented the fifth consecutive quarter in which the bottom-up EPS estimate rose during the quarter, which is the longest streak of consecutive quarterly increases since FactSet began tracking this metric in 2002. (FactSet is the data provider for Investing Daily.)
Seven sectors posted an increase in their bottom-up EPS estimates for Q3 during the quarter, led by the energy (+23.1%) and materials (+10.8%) sectors. Four sectors posted a decline in their bottom-up EPS estimate for Q3, led by the consumer discretionary (-5.2%) sector.
Nonetheless, stocks have encountered a rough patch lately. On Monday, the major U.S. indices declined as follows: The Dow Jones Industrial Average -323.54 (-0.94%); the S&P 500 -56.58 (-1.30%); the tech-heavy NASDAQ -311.21 (-2.14%); and the small-cap Russell 2000 -24.16 (-1.08%). The CBOE Volatility Index (VIX), aka “fear index,” jumped about 10%.
In pre-market futures contracts Tuesday, U.S. stocks were poised to open sharply higher, as investors bought the dip in big tech stocks. However, the selloff in Asian and European equities continued Tuesday, as China Evergrande Group’s (OTC: ENFRGY) debt woes worsened and spread to other property companies. All eyes are on Beijing, to see whether the Chinese government can mitigate the financial crisis.
A powerful tailwind for stocks so far this year has been M&A activity. With the markets awash with liquidity, stock prices hovering at record highs, interest rates scraping historic lows, and corporate coffers stuffed with cash, deal-making has surged around the world in every region and sector. The urge to make a deal has been unimpeded by the coronavirus pandemic, rising inflation, and other risks.
According to research firm Refinitiv, the all-time, full-year record for global deal-making was broken in the first nine months of 2021, exceeding $4.4 trillion. Technology companies, which have grown more prosperous during the pandemic, led the charge. The tech sector witnessed an unprecedented flurry of deals worth more than $671 billion. The year-over-year growth in the number of tech-based M&A deals reached 51.5%, a volume that surpassed all other sectors.
Among the technologies serving as enticements for M&A are biotech (e.g., gene editing); crypto blockchains; robotics/automation; radio frequency identification (RFID); and green energy/transportation (e.g., electric vehicles).
Many acquisition targets are smaller bargain-priced companies that can provide the acquiring company with new capabilities and markets. With cheap financing available because of low interest rates, the thinking is that if companies can’t create growth, they can buy it.
Companies are generally seeking growth from complementary companies involved in similar areas, rather than building an unwieldy empire from disparate operations.
This M&A momentum indicates a fundamentally strong market and sets the table for economic and earnings growth (and stock price appreciation) for 2022. Proactive investors who correctly identify takeover candidates ahead of time stand to benefit.
An analyst with an uncanny knack for pinpointing profit catalysts before they happen is my colleague, Jim Pearce.
Jim has developed analytical tools that help him unearth crucial data that the rest of the investment herd tends to miss. He deploys these sophisticated methodologies in his new publication, Personal Finance Pro. Click here for details.