Stocks Up… Economy Improving… But How About Mergers & Acquisitions?
When the credit markets froze solid last year, it was no surprise to
see the number of announced mergers and acquisitions (M&A) fall, as
stocks hit the skids and the U.S. economy tanked.
Today, however, the stock market is on the mend. In my book, a 49%
rally off the bottom for the S&P 500 qualifies as healing.
The economy is showing signs of improvement, too. Since peaking in
April, first-time jobless claims have dropped by more than 15%.
As for the M&A market… well, it’s still suffering.
Through the second quarter, worldwide volume dropped by 40.2%. 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.
Here’s why…
Use This Number To Gauge The Health Of The Merger Market
Nothing causes stock prices to rise faster and farther 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.
And that’s in a single day! No other investment strategy can boast the same lightning fast rewards.
So how can you gauge when M&A activity is on track for a
full-blown rebound - and signal the best time to invest in takeover
targets?
One number can tell you: 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:
The historical average is 590 basis points - and when the number is
above this level, it means banks consider the lending risk to be above
average. In turn, they compensate for the higher risk by charging
higher interest rates, thereby choking off M&A activity by making
financing too expensive.
When The Spread Is Low:
If 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.
