Takeover Fuel Begins to Flow as S&P Bull Run Makes History

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Mergers put a floor under energy stocks in 2015, they pushed biotech to records and breathed life into food makers. And yet their influence on U.S. equities is, by one measure, only beginning to be felt.

At $1.1 trillion, the value of completed takeovers in the last 12 months represents just over 4 percent of U.S. market capitalization, data compiled by Bloomberg and Credit Suisse Group AG show. That’s more than half the level in five previous bull markets -- even though the Standard & Poor’s 500 Index’s six-year advance just became the second-longest of the last half century.

As a source of demand for U.S. stocks, companies already dwarf mutual funds, thanks to $2 trillion of buybacks announced since 2009. Their role would expand should the old rate of takeovers be restored. The pace of deals is showing signs of growing: volume for March and April was the highest since any two-month period since at least 2003.

“There’s more and more money coming into the market from these types of deals, and you could make the argument that the demand side for stocks is building,” Bruce Bittles, chief investment strategist at Milwaukee-based Robert W. Baird & Co., which oversees $110 billion, said by phone. “It’s definitely a bullish element.”

The Standard & Poor’s 500 Index has rallied more than 200 percent since March 2009, with equities adding almost $17 trillion over a stretch that has lasted 2,275 days. That’s long enough to eclipse the 1974-1980 advance and leaves this rally second only to the 1990s Internet bubble in duration.

The benchmark gauge increased 0.3 percent to 2,114.47 at 4 p.m. in New York. It declined 0.4 percent last week.

Deal Volume

M&A is gathering steam, with the $558 billion in announced deals in March and April rising above $400 billion for the first time since June 2007, data compiled by Bloomberg shows.

Measured against the size of the market, though, the rate of takeovers remains low by historical standards. That’s a sentiment signal that suggests stocks have room to run as chief executive officers become more optimistic, according to Credit Suisse strategists led by Andrew Garthwaite.

“Market peaks typically occur when the value of M&A activity as a share of market cap is more than double its current levels,” Garthwaite’s team wrote Wednesday in a client note. Takeovers “boost both EPS and increase demand for equities,” they wrote.

Corporate Actions

For money managers like Jim Welsh of Forward Management LLC, the increase in M&A spending isn’t necessarily a positive for the longer-term health of the bull market. The low interest rates fostered by the Federal Reserve have companies looking for quick fixes to deeper problems, he said.

“It’s kind of like getting fat by eating your own leg,” Welsh, who helps oversee $5.5 billion at San Francisco-based Forward Management LLC, said by phone. “Instead of investing in their business and trying to figure out how to generate more revenue growth, companies are buying someone else to cut expenses. You might be able to survive for a while, but longer term it’s not a good strategy.”

The measure of M&A activity as a percentage of U.S. equity market capitalization is also potentially misleading because a large increase in stock values could overwhelm any increase in corporate deals, according to Welsh.

The takeovers that have occurred in 2015 have been bullish for the industries where they happened. Energy companies in the S&P 500 have snapped back more than 5 percent since Royal Dutch Shell Plc agreed to acquire BG Group Plc for $70 billion on April 8. They’d fallen 21 percent in the previous eight months.

Biotech Activity

The Nasdaq Biotechnology Index has climbed 52 percent since the end of 2013, a period in which mergers in the industry occasionally made up close to half of all U.S. M&A. Mylan NV has tried to buy Perrigo Co. three different times in April, most recently for $32.7 billion. Now Teva Pharmaceutical Industries Ltd. has proposed acquiring Mylan for $40.1 billion.

“The interest in M&A, particularly in biotech, has continued to drive the sector higher and has made valuation a secondary factor,” Robert Stimpson, a fund manager at Akron, Ohio-based Oak Associates Ltd., which manages about $900 million, said by phone.

An index of consumer-staple stocks in the S&P 500 increased more than 1.8 percent in the two weeks after March 25, when Kraft Foods Group Inc. announced a merger with H.J. Heinz Co. in a deal backed by 3G Capital and Warren Buffett’s Berkshire Hathaway Inc. Kraft’s shares soared 36 percent on the date of the news.

M&A Basket

Investors have long sought stocks with a higher likelihood of being taken over, even though it’s taken companies awhile to oblige. Goldman Sachs Group Inc. maintains a 187-company basket of shares it deems as having at least a 15 percent probability of engaging in strategic M&A over a 12-month period. It’s returned 59 percentage points more than the S&P 500 from the time it was created in October 2009 through mid-April, according to Goldman.

Gigamon Inc., a network solutions provider, and Pharmacyclics Inc., a clinical-stage biopharmaceutical company, hold the two biggest weightings in the Goldman Sachs basket.

“A lot of M&A activity is an indication that the bull market is still alive and well,” said Stimpson. “It shows that there’s still a tolerance for risky assets. The fear that ends up killing a bull market is just not there yet.”

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