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M&A Helps Market's Mojo

Merger buzz surrounding both Google and Cablevision kept stocks near all-time highs.

While the bond market sleeps, the stock market stirs.

Monday's news of North Korea's nuclear test would normally have a bigger impact on bonds, but it was only stock traders at work on Columbus Day, and they sent the market up again.

With earnings season set to begin Tuesday, the bullish start to the week is either the calm before the storm or a sign that traders see only blue skies ahead.

The major stock indices finished the day in the green, as the

Dow Jones Industrial Average

surpassed its intraday record high of 11,870 briefly. The Dow ended up 0.06% to close at 11,857.81, while the

S&P 500

finished the day up 0.08% to close at 1350.60, and the

Nasdaq Composite

ended Monday up 0.52% to close at 2311.91.

Perhaps the day's M&A activity was enough to distract buyers from the disquieting political news.

Google

(GOOG) - Get Alphabet Inc. Class C Report

was

nearing a deal to buy online video phenomenon YouTube for about $1.6 billion, while paving the way with agreements with

Warner Music Group

TheStreet Recommends

(WMG) - Get Warner Music Group Report

and Sony BMG Music Entertainment to distribute video content. Google closed up 2.02%.

A relatively old media company,

Cablevision

(CVC)

, dusted off its plans to buy out its public shareholders. The Dolan family, which controls Cablevision, announced plans to buy the company for about $7.9 billion, or $27 a share -- a 17% premium over the stock's average range over the past two weeks. Cablevision closed up 10.74%.

The Dow's climb on Monday was powered by gains in

McDonald's

(MCD) - Get McDonald's Corporation (MCD) Report

,

AT&T

(T) - Get AT&T Inc. Report

,

General Motors

(GM) - Get General Motors Company (GM) Report

and

Caterpillar

(CAT) - Get Caterpillar Inc. Report

, which each added more than 1%.

The M&A news comes as investors begin to turn their eyes to earnings season, which kicks off Tuesday with

Alcoa

(AA) - Get Alcoa Corp. Report

announcing third-quarter earnings after the market's close Tuesday.

General Electric

(GE) - Get General Electric Company (GE) Report

,

Yum! Brands

(YUM) - Get Yum! Brands, Inc. (YUM) Report

,

Pepsico

(PEP) - Get PepsiCo, Inc. Report

and

Genentech

(DNA)

also report earnings this week.

On investors minds this season is not only quantity, but quality of earnings. With record amounts of stock buybacks still happening, underlying revenue growth will come under more scrutiny. Buybacks reduce the number of shares outstanding, which drives up the earnings per share, and therefore, the earnings part of its price to earnings ratio.

In the first and second quarters of this year, 20% of the companies in the S&P 500 could attribute at least 4% of their earnings per share increases to share buybacks, according to Howard Silverblatt, quantitative strategist at Standard & Poor's. So, if a company had a 12% increase in earnings per share, 4% of that may have come purely from reducing the number of shares outstanding.

Buybacks have been popular because they can increase EPS during the quarter, and the shares remain in the company's control when they buy them, says Silverblatt. Companies were pressured to reward shareholders with their huge cash balances, so they bought back stock, but the end result is still unknown, says Silverblatt. It depends on where those shares end up -- as part of an M&A transaction, reissued back into market, or as part of executive compensation packages, he says.

On top of close scrutiny of earnings, the stock market's bullish sentiment levels leads some to expect even minor earnings disappointments to provide an October correction.

"This could be one of those markets where even minor revisions in outlook could cause big revisions to a stock price," says Margaret Patel, portfolio manager at Pioneer Investments. "But that sets us up for a nice year-end rally. That's the good news."

Given the decline in energy prices, the earnings landscape may have changed as well. Some companies, like chemicals companies, might see better margins from the flattening of raw-materials prices, as prior price hikes may have stuck despite lower costs. By the same token, energy and mining companies that benefited from high costs of raw materials and energy could come out with some disappointments.

"It is really about expectations," says Marc Pado, chief investment strategist at Cantor Fitzgerald. "And as is the case with markets, if it is already anticipating good news, what is on the table to bring this market to the next level?" Pado says the market needs economic growth, and while the economic landscape may be more benign than many had feared, it is slowing. Pado believes the earnings comparisons will get harder and harder, with the real trouble coming in the first quarter of 2007.

Thomson Financial expects the S&P 500 to show 13.9% year-over-year earnings growth in the third quarter of 2006, with the largest contribution coming from the financial sector. Financials are expected to show 29% year-over-year earnings growth in the third quarter, overtaking energy as the main driver. Energy led earnings for the past eight quarters in a row, says John Butters, analyst at Thomson.

On Tuesday, the markets will begin anew for the week, contending with both a bond market and the beginning of earnings season.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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