Stock Market Predictions: Can Corporate Takeovers Tame the Bear?

Sam Subramanian PhD, MBA

With the stock markets taking a breather, calls that the worst for U. S. equities is yet to come are growing louder. Bearish calls usually cite the possibility of a collapsing dollar, rising inflation, or plunging commercial real estate values.

In recent weeks, corporate takeover activity has intensified. Disney (DIS) will fork out $4 billion to purchase Marvel Entertainment (MVL). Cadbury (CBY) continues to call Kraft's (KFT) $17 billion offer inadequate. Dell (DELL) has offered nearly $4 billion for Perot Systems (PER). Unilever (UL) is working to acquire Sara Lee's (SLE) personal care business for nearly $2 billion.

Can corporate takeovers continue to remain strong to prove the bearish stock market predictions wrong in 2010?

Here are some factors that can have a bearing on corporate takeover activity.

Corporations flush with cash. Corporations have slashed payroll expenses and are generating tons of cash. The U. S. Commerce Department has reported companies posted annualized cash flow of more than $1.5 trillion in each of the last three quarters, the most on record since 1947.

Growth stronger in emerging markets. As consumers in most of the developed world de-leverage, even well-managed companies are struggling to grow organically. Meanwhile, emerging economies continue to grow at a rapid clip.

Equity valuation reasonable. S&P 500 companies are expected to earn $66.83 a share, implying a forward P/E of about 16. The forward P/E looks attractive against the backdrop of subdued 1.4% core inflation rate and a relatively low 3.5% yield on 10-year Treasuries.

Corporate Takeover Activity Can Remain Strong

A combination of excess cash, challenges to growth, and reasonable valuation provides sufficient reason for businesses with strong balance sheets to become acquisitive.

Modest valuations make it easier for acquisitions to work. Companies can boost their earnings by eliminating key rivals or by deriving synergies. Acquisitions can also help corporations expand their geographic footprint and increase their exposure to high-growth emerging markets.

As cash keeps piling up on balance sheets, companies can look to ways to use this cash to shore up growth. If not, they run the risk of their cash hoard making them takeover targets as buyers load up on debt to purchase cash-rich companies.

Stock Market Predictions

While possibility of rising inflation and commercial real estate defaults are threats to be concerned about, increasing corporate takeover activity is among the more potent forces bulls can bank on.

In recent transactions, action has revolved around cash generative defensive groups like food and beverage. If confidence in financial markets improves, takeover activity should broaden to other sectors as well.

Takeover activity can gather momentum if companies fear being left behind in the race for growth. Equity valuations will start to embed the take-over premium on likely targets when investors get inkling that strength in takeover activity is real and here to stay. This can set the stage for equity prices to steadily climb in 2010 rather than quickly crash.

If this scenario of gradually rising equity prices punctuated by short and shallow pullbacks unfolds in 2010, 'buy and hold' may well become the mantra again. Plain vanilla ETFs like DIAMONDS Trust 1 (DIA), SPDR S&P 500 (SPY), and PowerShares QQQ (QQQQ) can become staple diets for many investors.

Despite growls from the bears, leveraged short ETFs like UltraShort Dow30 (DXD), UltraShort S&P500 ProShares (SDS), UltraShort ProShares QQQ (QID) will be unable to repeat their 2008 performance. The leveraged short ETFs will however play a useful role as trading and hedging vehicles.

Both bulls and bears will do well to keep pulse of corporate takeover activity to get a handle on the market’s direction.

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