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The rally that followed the market meltdown in March 2009 was one of the biggest rises the stock market has ever seen. Yet while many believe that a sluggish economy and continuing economic problems mean that a stock market crash is imminent, recent events suggest that the solution to the market's doldrums may lie not in consumers but in corporations and what they decide to do with their money.
Opening their pocketbooks
Ever since the credit markets froze up in late 2008, many companies have been hoarding cash. The experience of not being able to raise capital at any price during the worst of the market meltdown reminded companies just how valuable cash can be, and they learned their lesson well, with many companies setting aside billions of dollars for no obvious purpose. Although investors have criticized Apple (Nasdaq: AAPL ) , among many others, for hanging onto cash generating almost no income rather than returning it to shareholders in the form of dividends or stock buybacks, that hasn't stopped those cash balances from continuing to grow.
Now, though, we're starting to see just what some of that cheap cash can do. Intel's (Nasdaq: INTC ) proposed buyout of security software maker McAfee (NYSE: MFE ) for $7.7 billion will use up just a portion of the chip giant's $18 billion in cash and equivalents as of last quarter. Similarly, after having gone through bankruptcy and received capital infusions, General Motors actually has a healthy amount of cash on its balance sheet, and it will use $3.5 billion of it to pick up subprime lender AmeriCredit (NYSE: ACF ) .
Moreover, the credit markets have healed so much that companies now have access to borrowing for even really huge deals. BHP Billiton (NYSE: BHP ) doesn't have nearly enough cash to pay for its now-hostile $39 billion offer to pick up PotashCorp (NYSE: POT ) , but it arranged $45 billion in loans to put itself into position to make the offer. Similarly, Reynolds Group Holdings will pay $6 billion for packaging maker Pactiv (NYSE: PTV ) despite already having $3.8 billion in long-term debt.
The gloom is over
What does all this merger and acquisition activity say about the market? You can draw several positive conclusions.
Perhaps most importantly, a rise of M&A activity shows that the markets are functioning far better than they were a year or two ago. Even though some argue that banks still aren't lending and that credit isn't as available as it should be, companies are finding ways to get attractive deals done, and to a large extent, they're getting the help from the financial markets that they need.
The deals themselves also suggest that companies see value in the stock market. It's important not to overemphasize this point, though; just because companies are making targeted strategic acquisitions doesn't mean that they believe that the stock market generally is undervalued. But with cash earnings next to nothing, there's a huge margin of safety built into any deal a company may consider. Moreover, with the roaring bond market encouraging financing, companies may rightly believe that now's the best time to get deals done.
A step in the right direction
Regardless of what you think about the terms of each particular deal, the fact that they're happening at all is an unqualified positive for the market. With scary unemployment figures remaining stubbornly persistent, it's unrealistic for economists to expect consumers to lead an economic recovery. The alternative is for cash-rich companies to step up and make investments into growing the economy again.
That may seem risky, but shareholders should applaud companies that take these risks. Buyouts and the new investment that they will create going forward have the best chance of providing new jobs that will pull consumers out of their recession-induced malaise. And with the Federal Reserve repeating its commitment to low rates, the opportunity cost of taking a shot on even speculative investments has never been lower.
By itself, merger activity won't lift the stock market permanently. But as a catalyst for scared investors who are waiting patiently to get back into stocks, these deals are an important symbol of just how well-received future economic growth will be.
More skeptical of what the future will bring? Nick Crow has found seven stocks worth shorting.