by Louis Basenese, Advisory Panelist
When the credit markets froze solid last year, equities hit the skids, the economy tanked and so did the number of announced mergers and acquisitions (M&A).
But now the stock market’s on the mend. In my book, a 49% rally off the bottom for the S&P 500 qualifies as healing.
The economy’s showing signs of improvement. First-time jobless claims have dropped more than 15% since peaking in April.
As for the M&A market, well, it’s still suffering…
Through the second quarter, volume dropped 40.2% worldwide. Deals involving U.S. companies fared worse, dropping 57.5%, according to Thomson Reuters. And July marked the first month in over a decade when not a single deal worth $5 billion or more was announced.
But if you’re serious about investing, you need to know when the M&A market is on the upswing and should be tracking it religiously.
Why?
Because nothing causes stock prices to rise faster and further than an unsolicited takeover offer.
In fact, if we invest in a company before a deal is announced, we stand to pocket an average gain of 43.5% to 53.7%, according to the numbers crunchers at FactSet MergerStat. In a single day! No other investment strategy can boast the same lightning fast rewards.
Tracking M&A Market Activity With High Credit Spreads
If you’re looking for one number to predict a full-blown rebound in M&A market activity – and signal the best time to invest in takeover targets – try high-yield credit spreads. The spread is simply the difference in interest rates between junk bonds (the typical vehicle used to finance M&A) and comparable U.S. Treasuries.
- When the spread is high – above the historical average of 590 basis points – it means banks consider the risk of lending to suitors to be above average. In turn, they compensate for the higher risk by charging higher interest rates, thereby choking off M&A market activity by making financing too expensive.
- On other hand, when the spread is below the historical average, it means banks consider the risk of lending to be low. In turn, they charge lower interest rates, which encourages M&A activity as companies capitalize on the cheap financing to go on buying sprees.
Right now the spread stands at 857 basis points. At first blush that seems terrible, until you look at this chart.
