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Is This The Key to The Bull Market's Next Leg?

By Alex Dumortier, CFA – Jun 26, 2015 at 12:30PM

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Corporations have been instrumental in supporting the bull market, and M&A could be the next driver.

Before I look at U.S. stocks, I'll take a brief trip abroad for some perspective: It appears that China's frenetic bull market (I'm trying to avoid the term "bubble") might have come to a halt, as the Shanghai Composite index lost 7.4% on Friday, which puts it down 18.8% from its June 12 closing high and near the 20% loss threshold that defines a bear market. One lesson here: It's easier to spot a market in the throes of excess and euphoria when you're not participating in it; the warning signs were obvious and plentiful to an outside observer.  

Perhaps the ructions in China and the mounting risk that Greece will default on its 1.5 billion euro payment to the International Monety Fund next Tuesday (I put the odds at roughly 50:50) are keeping U.S. stocks in check: the Dow Jones Industrial Average (^DJI -1.03%)and the broader S&P 500 (^GSPC -1.44%) were up 0.45% and 0.07%, respectively, at 12:35 p.m. EDT. The technology-heavy Nasdaq Composite was down 0.53%. 

Nevertheless, similar to the Chinese market at the beginning of this month, the main U.S.  indexes are near their all-time highs. However, note that, even after today's rout, the Shanghai Composite is up 30% year to date and has more than doubled over the past year; the S&P 500, meanwhile, is up barely 2% on the year. 

Although some commentators suggest the U.S. stock market is itself in a Federal Reserve-induced bubble, I think that's unlikely to be the case (though I do think valuations are a bit stretched). One critical difference between the two markets: In China, individual investors' unbridled enthusiasm for stocks has been at the root of the market's surge; in the U.S., among retail investors, the current bull market is what I named in 2013 "the most mistrusted stock market rally in history." Stock market losses in 2008 took a massive, lasting toll on investors' psychology. 

In the U.S., corporations, rather than individual investors, have been instrumental in powering the stock market upward, with record levels of share repurchases. Now, companies are adding buying power to the stock market via another conduit: mergers and acquisitions.  

The volume of domestic M&A activity hit a monthly record of $243 billion in May, surpassing the $226 billion achieved in May 2007 (if one doesn't adjust for inflation), according to Dealogic data. Similarly, global M&A volume so far in 2015 is already the second-highest half-year total on record, at $2.19 trillion (behind the first half of 2007).       

Can this continue? One of the most experienced M&A bankers, Blackstone Group LP's (BX) John Studzinski, thinks so, saying on Bloomberg Television on Tuesday that "I think you're going to see a record amount of M&A activity beyond 2007 this year, next year, and potentially the year after." Tim Gee, global head of M&A at law firm Baker & McKenzie concurs; on CNBC this morning, he referred to a report from his firm that assessed that the M&A boom in developed economies won't peak until 2017. 

Still, one should perhaps take the view of interested participants in this boom with a grain salt. But if mergers and acquisitions fail to lift stock prices, perhaps we can still fall back on a proper return of individual investors to the market -- "great rotation" [from bonds to stocks], anyone?                              


Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
$33,596.34 (-1.03%) $-350.76
S&P 500 Index - Price Return (USD) Stock Quote
S&P 500 Index - Price Return (USD)
$3,941.26 (-1.44%) $-57.58
The Blackstone Group L.P. Stock Quote
The Blackstone Group L.P.

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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