This Catalyst Could Make Stocks Rally

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.

Fool contributor Dan Caplinger is always in the mood for a rally. He owns shares of Apple. Apple is a Motley Fool Stock Advisor pick. The Fool owns shares of and has written puts on Intel, which is a Motley Fool Inside Value recommendation. Motley Fool Options has recommended buying calls on Intel. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy catalyzes the flow of information to you.


Read/Post Comments (3) | Recommend This Article (6)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 20, 2010, at 11:19 AM, gfbjohn wrote:

    What businesses should invest their idle cash in? Well, their market research is based on what available spending money consumers have, which these days is anemically meager, given the 27% un-/under-employment rate. As long as so many people don't have jobs, they don't have income to turn around and spend to confirm business decisions of how much of what to make.

    So what we should ask businesses to invest in would be to start by setting up an online forum by which people could register all their needs, wants and desires, which would be found in aggregate to be an order of magnitude beyond what businesses produce today.

    The next thing is to set up online training so people can spin themselves up to fill the jobs right here in the US (as opposed to letting production get offshored) to build and maintain the infrastructure that would support producing to address the discovered greater underlying, currently "unvested demand" just waiting to launch us into a new golden age.

    It is time to get demand in front of supply, instead of waiting for squeamish, reluctant, cash-hoarding businesses to timidly venture out and try to produce what they think and guess and what we want, based on research of what cash we have.

  • Report this Comment On August 20, 2010, at 11:54 AM, Tygered wrote:

    It is nice to read an optimistic article once in awhile on Motley Fool. I personally hope your optimism is justified as my portfolio could really use a rally. :)

  • Report this Comment On August 21, 2010, at 11:48 AM, nietzschesport wrote:

    But wait! The bears will say -What about the Hindenburg Omen! The Death Cross! Count Chocula! I'm on the line to Intel(INTC) to warn them of their foolish 7 billion investment in McAfee(MFE)--Don't they know that we are going to DOW 100 and unemployment will be 40%?!!! which will happen sometime in the next 6 weeks within 6 hours and 6 minutes? How dare they invest in such perilous times. Fools! What does Intel know about investing? They should have subscribed to Robert Precher's newsletter

    nietzschesportfolio.blogspot.com/

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