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Stocks Say 'No Deal' to M&A

Aaron Task

01/29/07 - 05:25 PM EST

Few events get Wall Street's juices flowing like M&A activity, primarily because of the fat investment banking fees. Additionally, mergers signal that corporate executives are optimistic about the future (otherwise they'd be hoarding capital) and deals typically remove some supply of stock from the market, which is bullish if demand just stays the same.

But the broader market failed to capitalize on a number of deals announced Monday and speculation of more to come, most notably unconfirmed reports of a Bristol-Myers Squibb (BMY Quote)-Sanofi-Aventis (SNY Quote) combination.

The Dow Jones Industrial Average rose 0.03% to 12,490.78 and the Nasdaq Composite gained 0.2% to 2441.09, while the S&P 500 dipped 0.1% to 1420.62, hurt especially by weakness in the financial sector.

The lackluster action reflects both the nature of the deals themselves, and angst about this week's heavy calendar of macroeconomic and earnings news.

Missing from Monday's deal activity, and deals announced thus far in January, is the kind of "blockbuster" transaction that captures the public's imagination, such as the infamous AOL-Time Warner (TWX Quote) deal in January 2000, or the January 2005 Procter & Gamble (PG Quote)-Gillette transaction.

Coming off 2006's blockbuster year for M&A activity and the re-emergence of private-equity buyers as major acquirers, everyone expected 2007 to be another busy year for deals. That being the case, a number of relatively small deals, such as those announced Monday, isn't enough to really excite investors.

"The market has reacted to that news [of M&A activity] over and over," says Bruce Bittles, chief investment strategist at Robert W. Baird & Co.

Save for the latest bid for Equity Office Properties (EOP Quote), no deal worth more than $7 billion, excluding debt, has been announced this year, according to Richard Peterson, senior researcher, capital markets, at Thomson Financial in Boston. "There is no blockbuster, but dealmakers are not on strike."

Indeed, $115 billion in deals have been announced year to date, up 20% from this point last in 2006, according to Peterson. Also, Monday's deals did enliven certain individual names and sectors:

Financials Flummoxed

The broader financial sector failed to capitalize on the deals and rumors, however, which is somewhat surprising giving the deals and buzz in the sector and the aforementioned banking fees.

The Amex Broker/Dealer Index fell 1.2% Monday as Merrill shed 2.3% amid concern it overpaid for First Republic. Meanwhile, the Philadelphia Stock Exchange Bank Index gave back 0.5% as Bank of America lost 1.1%. In addition, Citigroup (C Quote), which agreed to buy U.K.-based online bank Egg Banking for $1.13 billion, fell more than 1% as well.

Ahead of the FOMC's two-day policy meeting Tuesday and Wednesday, and a heavy slate of economic data this week, the financials were held back largely by the same issues weighing on the market last week.

"In addition to a general belief that the market may be overbought, higher bond yields and questions about the likelihood of Fed rate cuts have also been making equity investors nervous," wrote Bob Doll, global chief investment officer of equities at BlackRock, which has more than $1 trillion under management.

On Monday, the benchmark 10-year Treasury fell 5/32, its yield rising to 4.89%. Meanwhile, the yield on the two-year note rose to 4.98%, just 2 basis points from 5%, a level it hasn't closed above since mid-August.

"Should the two-year pierce 5%, an expectation will develop for other Treasuries to do the same," writes Tony Crescenzi, chief Treasury strategist at Miller Tabak and a RealMoney.com contributor.

The notion of the whole yield curve moving higher while remaining inverted (meaning short-term rates have higher yields than longer-dated maturities) could be a worst-case scenario for the bulls. Such a development would keep pressure on lenders' profits and put additional strain on the housing market, which is showing tenuous signs of emerging from its slump.

The optimistic scenario, on the other hand, is that the financial markets have already largely priced in a more hawkish Fed and faster economic growth. If so, stocks and Treasuries may rally in tandem this week, presuming no major shocks on either the macro or earnings front.

"What you've got here is a standoff between the potential of rates to go up more and money to come in" to stocks, says Bittles. "My guess is it'll be a little while longer before the market focuses on something positive, [but] I don't think it's going down and rates are not going up" dramatically higher.

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