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Global Rally Shines on Wall Street

Liz Rappaport

The stock market rallied Monday, working off some of last week's pressures on the coattails of strong overnight trading sessions in Asia and Europe and of approximately $20 billion of merger and acquisition announcements.

U.S. M&A activity is running at the second-fastest-ever pace year-to-date, up 15% from 2006 levels, says Richard Peterson, analyst at Thomson Financial. "It looks like this quarter is headed for a $400 billion-plus quarter ... better than $4.4 billion a day in deals, or an average of $185 million every hour 24-seven," he adds.

Europe's enthusiasm for a merger between banks Barclays(BCS Quote) and ABN Amro(ABN Quote) spilled over to U.S. shores. ABN jumped 14% while Barclays slipped 0.28% on the news.

Investors also cheered the potential for a competing bid for Texas utility TXU(TXU Quote) by Blackstone Group and Carlyle Group. TXU jumped 2.9% on the news, while lawn care and pest control company ServiceMaster (SVM Quote) added 12.5% on news of its private equity buyout.

Also, Community Health Systems(CYH Quote) is planning to acquire Triad Hospitals(TRI Quote) in a $6.8 billion deal. Triad rose 5.3%, and Community Health shed 5.5%.

In reaction to those and other deals, the Dow Jones Industrial Average added 1%, or 116 points, Monday to close at 12,226.17, while the S&P 500 finished 1.1% higher to close at 1402.06. The Nasdaq Composite closed up 0.9% Monday to close at 2394.41.

Impressive, but "today's stock market action was the easy stuff," says Marc Pado, chief market analyst at Cantor Fitzgerald. He notes that the S&P 500 and the Dow rebounded but couldn't narrow in on last week's highs. On March 12, the S&P reached 1410 intraday, and the Dow reached 12,385.

"We have to surpass that to really feel good about the rally," he says, calling Monday's move "insignificant" from a technical perspective.

Other naysayers noted that market internals were tame compared with the rally on March 6, not to mention the intensity of downside action on Feb. 27 and March 2. Of the 2.75 billion shares traded on the Big Board Monday, 84% were to the upside, and advancing stocks led decliners by 24 to 7. In Nasdaq trading, a less impressive 60% of the 1.6 billion shares traded were to the upside, while advancers led by less than a 2-to-1 margin.

Subprime Scenarios

Ultimately, worries that the subprime mortgage market will spill over into the broad economy continue to dog some investors' confidence. And that's where the focus is likely to stay in a week filled with housing-related data and the two-day Federal Open Market Committee meeting, at which the central bank is expected to keep the fed funds rate at 5.25%. (The Bank of Japan ends its meeting Tuesday and is also expected to keep its overnight borrowing rate unchanged at 0.5%; resulting weakness in the yen was another factor in Monday's global stock rally.)

On Monday, the National Association of Home Builders/Wells Fargo Housing Market Index slid to 36 in March from 39 in February, only slightly taking the wind out of Monday's rally. But still on the tips of traders' tongues and at the tops of strategists' research reports are comments about the housing market and the subprime mortgage market. Fears of a credit crunch abound, while hopes that the housing market itself may be stabilizing hang from a thread.

Tuesday brings data on February's housing starts and building permits to feed the anxious hoard, and Friday brings February's existing-home sales. Analysts expect a modest increase in housing starts and a slight decrease in building permits and existing-home sales.

On the subprime front, lender Fremont General(FMT Quote) told employees they may be out of a job in two months, Bloomberg reports, sending its shares down 9.3% on the day.

Elsewhere, Accredited Home (LEND Quote) shed 18% on reports of a possible delisting, while NovaStar Financial (NFI Quote) slid 8% on news its top five executives received restricted stock two days before the subprime lender said it would cut 17% of its workforce.

Such news is no longer igniting broad-based panic in the stock market. But it still stings investors as they worry about potential ramifications across the credit spectrum -- both for individuals (read: consumers) and for corporations.

Some contrarians are fed up with the drama. "Right now we have a subprime crisis that ended three weeks ago despite 6,000-plus stories that it's going to get worse, and a stock market that has barely corrected 5%," writes James Bianco, president of Bianco Research. "These are the perfect scenarios for contrarians to make money."

Bianco believes the subprime market's problems are thus far contained within that sector, "but the safety of the crowd is powerful," he adds.

Standing out from the crowd is a research report from independent fixed-income research house CreditSights, titled "Leveraged, Long, and Liquid."

Harkening back to prior liquidity-crisis-inducing events, namely the Russian debt crisis and Long Term Capital Management, CreditSights' analyst Peter Petas says subprime is not turning into a liquidity crisis or a credit crunch -- yet.

Contagion or systemic financial risk come about only if a huge risk-appetite shift causes Wall Street banks to pull back on credit lines extended to leveraged market players -- namely hedge funds. Thus far, that hasn't happened, Petas writes, adding that brokers could take anywhere between a 3% to 15% hit on earnings and "retain considerable flexibility and resources to deal with market volatility."

Others note that credit remains available in most parts of the market. As reported here, bank credit facilities to high-yield, or speculative-grade, companies hit a record high in February and are on track to better the record by the end of March, says John Lonski, chief economist at Moody's Investors Service.

The question is what would cause Wall Street to tighten credit, and what impact would that have on market liquidity, Petas writes. The cause is impossible to know, he writes, but the impact would be huge.

With the proliferation of both hedge funds and derivatives, Wall Street's exposure to leveraged players has increased, writes Petas. He adds that risk tolerance models might be skewed given the lack of market volatility over the past five years. "Most of the models do not adequately anticipate the potential effects of a large de-leveraging event."

Petas believes that brokers make 95% of their money from 5% of their clientele and that most of that 95% is in hedge funds.

"The one lock in our view is that banks and the Street will behave as they have every time in the past": They'll cut lines of credit, make their margin calls and protect themselves as best they can, he writes.

But until we see that kind of activity anywhere but subprime, the crisis isn't upon us. On Monday, traders seem to be embracing that notion.