When Too Much Good News is Possibly a Bad Thing
By William Patalon III
Managing Editor
Bad news took the day off yesterday.
Or so it seemed.
On Wall Street, the Standard & Poor’s 500 index and the Dow Jones Industrial Average rocketed to record highs, with strong exports, an upbeat earnings report from Wal-Mart Stores Inc. (NYSE: WMT), and the latest set of mega-merger deals providing the fuel.
Both of the closely followed U.S. stock indexes eclipsed their previous records, which had been set June 4. The S&P 500 climbed 29.94 points, or 1.9%, to close at 1547.70. The 30-stock Dow soared 283.86 points, or 2.1%, to close at 13,861.73.
It was the Dow’s biggest gain in four years.
And U.S. investors weren’t alone. Canadian stocks hit another record high of their own yesterday, after London-based miner Rio Tinto PLC (NYSE: RTP) said it would buy Canadian aluminum producer Alcan Inc. (NYSE: AL), for $38.1 billion, outbidding rival suitor Alcoa Inc. (NYSE: AA) by 36% in a deal that would form the world’s largest aluminum producer.
Alcoa ended its own two-month quest to create the world’s largest aluminum company last night when it withdrew its own $27.94 billion hostile bid for Alcan – a move that likely makes Alcoa a takeover target, now.
Nor were Canada and the United States the only markets with the capital markets’ version of the “warm and fuzzies.” Also yesterday:
- South Korea’s Kospi Index yesterday closed above 1900 for the first time ever, after the Bank of Korea said an increase in its key-lending rate wouldn’t cause that country’s economy to sputter and stall.
- Mexico stocks soared Thursday, helped by gains in miner Grupo Mexico SA de CV (OTC: GMBXF) – gains that were clearly sparked by the Alcan deal, and by expectations that the long-running bull market in such commodities as copper will continue due to consolidations and continued demand from fast-growing China.
- British stocks rose, with the benchmark FTSE 100 Index climbing 1.3%, led by a 4% surge in the shares of BHP Billiton Ltd. (NYSE: BHP), the world’s biggest mining company. Anglo-American PLC (Nasdaq: AAUK), the No. 2 miner, saw its shares jump 2.8%.
- Europe’s Dow Jones Stoxx 600 Index climbed 1.2%, its biggest gain since mid-June, with all industry groups advancing. Commodity-related shares – including BHP Billiton – helped the gains here, too, although several European cell phone firms – including Nokia PLC (NYSE: NOK), whose American Depository Receipts rose nearly 3.8% — benefited from the international sales shortfalls that U.S. rival Motorola Inc. (NYSE: MOT) revealed earlier in the week.
Pardon my cliché, but what a difference a day ….or two …makes.
Believe me when I tell you that yesterday’s “global” rally wasn’t all that it seems.
First of all, even though yesterday’s rally was broad-based insofar as all 10 industry groups in the S&P and all 30 Dow companies rose, there’s still a problem. And I think it’s a big one. Most of the index gains I’ve cited here are really due to one thing: Takeover deals, and the expectation that these deals will continue.
Okay, that’s two things. But they’re related. And they’re important. Alcan soared because Rio Tinto outbid Alcoa for Alcan. By a lot. A whole lot. Commodity-related shares across the globe soared in sympathy. While more deals may be coming, I can guarantee that every one of these companies isn’t going to be taken out. But a lot of these stocks rallied as if additional deals are a foregone conclusion.
I believe that another key factor yesterday was a Bloomberg News revelation that militant-activist investor William Ackerman has taken a position of more than 5% in Target Corp. (NYSE: TGT), the nation’s No. 2 discount retailer behind Wal-Mart. The shares jumped nearly 7% to close at a record $70.04 yesterday, after the report surfaced.
Ackerman has taken positions in other companies, including McDonald’s Corp., and Wendy’s International, pressuring them to sell divisions, cut spending, or take other steps to better-reward shareholders.
Though Ackerman is likely looking to do the same with Target – there’s speculation he’ll pressure Target to sell its credit-card unit. – there was obviously some “fringe” speculation that this bold move means that even a company of the size and reputation of Target isn’t too big to take over.
And that brings me to my next concern about all the euphoric relief that I saw yesterday.
Look, we all know that a big percentage of the run-up in U.S. stock prices – and a smaller percentage of the share-price gains overseas, where high growth rates warrant the surges we’ve seen in such markets as China and Korea – is due to all the merger deals, and private-equity buyouts.
And there’s a limit to how much longer that can continue.
Interest rates have risen. Credit quality has deteriorated. And as we’ve seen before – in the LBO craze of the late 1980s (remember “Barbarians at the Gate?”), for example – when too much money chases too few properties, the deal quality starts to suffer. Buyout artists pay up for companies that they shouldn’t have paid anything for – I mean, there were even some they shouldn’t have paid attention to.
And like any kind of speculative frenzy, the pros move fast and early, and make the best deals. Then they’re out and on the sidelines as the amateurs move in, driving up prices for companies that towards the end of the cycle aren’t really worth buying.
Early this week, we were terrified of credit quality issues, and that the subprime meltdown would spread. It will. Indeed, it already has. The two key Wall Street debt-rating agencies, S&P and Moody’s, have either downgraded hundreds of subprime bonds, or are going to. That will drive up borrowing costs in general, as lenders demand higher compensation for risk.
That will affect the buyout market, and the housing market – at least to some degree.
And in the worst-case scenario, those two separate-but-related factors could assault U.S. share prices like a cavalry pincer movement – hitting it from two sides. The credit crunch will crimp the buyout binge, which will cause the bull market to sputter. The credit crunch will also exacerbate the housing slump, which will in turn affect consumer spending – still two-thirds of U.S. economic activity. And that will cause the retail sales that seemed to buoy stocks yesterday to slump, as well.
This is only a worst-case scenario, mind you, and it’s unlikely we’ll see it all break loose at once. Nor will it deal the U.S. economy a blow to the recessionary solar plexus.
But sitting here tonight, I do find it bothersome that none of the “experts” are even talking about the possible flipside to all of today’s good news.
