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Unmoved by the Mergers

Huge M&A activity has limited impact on the major averages, but that doesn't mean the rally is done.

The deluge of at least $65.3 billion in total merger activity couldn't drive up the major averages Monday, but that doesn't mean the bullish run for stocks is over.

With interest rates low, oil prices still under $60 per barrel, historically strong seasonal trends in place, Goldilocks-like economic data streaming in and short-term investors chasing year-end returns, the stock market's mixed reaction to the Monday's" merger mania" is not necessarily a sign of a correction at hand. Instead, the response may be a reflection of short-term money managers chasing performance.

"The deals are just two more examples of tremendous value in the equity markets," says Margaret Patel, portfolio manager at Pioneer Investments, referring to the day's two largest transactions:


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$26 billion buyout of

Phelps Dodge

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and Blackstone Group's $36 billion offer for

Equity Office Properties Trust


, which would be the largest private equity buyout ever.

Even with the recent rally, equities still look cheap relative to Treasuries, Patel says. "The continued M&A activity just shows the relative cheapness of borrowing money to buy equities," she says. "People looking for a big correction are going to be disappointed."

In recent history, announcements of massive deals drove the entire market up sharply. On Nov. 6, $20 billion in announced deals help drive the indices up over 1% each, even ahead of the dreaded uncertainty surrounding the next day's midterm elections. This Monday, however, the buyout news drove action in the relevant companies and industries, but the three major indices ended the day nonplussed.

Led by a 3.36% decline in

General Motors

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, the

Dow Jones Industrial Average

lost 0.2% to close at 12,316.54, while the

S&P 500

fell 0.05% to close at 1400.50. The

Nasdaq Composite

did add 0.3% to 2452.72 while the Russell 2000 also ended in the green, up 0.27% to 790.62.

The Phelps Dodge announcement boosted shares of the copper company by 26.8%. Blackstone Group's announced $36 billion purchase of EOP (including assumed debt) couldn't provide enough bullish sentiment to boost the indices, but it boosted real estate investment trusts across the board. Shares of EOP were up 7.65% on the day, while


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Boston Properties

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gained 3.34%, 6.38% and 2.72%, respectively. The BBG REIT Index rose 3.2%, and the Dow Jones Composite REIT Index jumped 3%.

News that

Bank of America

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is paying $3.3 billion for U.S. Trust, the private-banking division of

Charles Schwab

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, boosted Bank of America's shares fractionally, while shares of Charles Schwab gained 2%.



, meanwhile, suffered a collision of good and bad news Monday. As an

internal memo circulated through the media outlining broad, structural problems with the company's strategy, the Internet titan announced it has struck a deal with seven newspaper companies to expand its classified advertising business. Yahoo! shares fell 0.7%.

Looking at the distribution of strength in Monday's market, the hedge funds may be at work, chasing recent gains by seeking higher-beta names in the Nasdaq and small-cap segments.

Mary Ann Bartels, technical research analyst at Merrill Lynch and author of the weekly

Hedge Fund Monitor

, writes that net exposure to the equity market by long/short equity funds is below average. That's significant, because this type of hedge fund comprises 50% of the total $521 billion estimated hedge fund assets under management.

"If the market continues to rally, long/short hedge funds will not have enough exposure to equities, and they will likely move to the high beta areas of the market to gain exposure," writes Bartels. This means covering short positions in the small-cap space, which would boost the Russell 2000, and buying the Nasdaq 100 outright, she writes. The Nasdaq 100 gained 0.2% Monday.

"We look for small caps and the Nasdaq to rally an additional 5% to 10% from current levels," she writes, adding that she believes the S&P 500 will add on about 3%. The Thanksgiving holiday is traditionally bullish, as the stock market tends to close up ahead of a holiday weekend, she adds.

Bartels puts her year-end target range for the S&P 500 at 1425 to 1450, the Dow at 12,600 to 12,700, and the Nasdaq Composite at 2550 to 2650.

"This is not a call based on the technical outlook for the market, but on a liquidity buyer chasing returns into year-end," she writes.

According to Birinyi Associates' Justin Walters, the year-end rally is likely. The Dow as averaged a 3.1% additional gain through the end of the year in years the index was up more than 10% from midyear to the start of the Thanksgiving week. The Dow was up 10.7% from the end of the second quarter through last Friday. Only twice of 11 times did the Dow decline under these circumstances, according to Walters.

So, on a day where the markets seemed ready for a pullback, without any bearish forces pressuring the indices, they held their ground. If the post-Thanksgiving holiday sales hold up, a dreaded year-end crash seems unlikely.

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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