Part of the reason behind the recent uptick in stock prices is the increase in M&A (mergers and acquisitions) activity. The thinking behind the buying is simple. If a company is willing to plunk down cold, hard cash to buy another company it means two things: First, the company doing the buying must feel comfortable with regard to the outlook for the company and the economy. And second, M&A activity means that current market prices remain attractive.
Coming out of the worst economic downturn since the Great Depression, corporate America can hardly be blamed for having cut costs to the bone and hording cash. However, we are starting to see signs that the survival mentality which prevailed since late 2008 is changing.
JPMorgan estimates that the companies in the S&P 500 are currently sitting on $3.2 Trillion in cash. Excluding financial companies, that total is $1.1 Trillion, which is a 60-year high.
In an interview with Reuters, Thomas Lee, JPMorgan chief U.S. equity strategist said "We believe one catalyst to buy (equities) is the eventual deployment of the excess cash held by S&P 500 companies."
The “mountain of cash” argument is not exactly new to the stock market as the bull camp has been espousing the potential buying demand the cash on the sidelines represents for some time now. However, this time the argument is taking a slightly different form.
Traditionally, the bulls’ contention that cash on the sidelines is bullish for stocks relates to the consumer. The idea is that investors will eventually decide to move the cash from the money market funds, which are paying next to nothing, into the stock market. But, given the generational shift we’re seeing in consumer attitudes, this argument doesn’t carry the weight it once did.
However, the mountain of cash Corporate America is sitting on just might become the catalyst the bulls are looking for. Given the recent increase in stock buybacks, dividend payouts, and M&A activity, it is becoming clear that CEO’s around the country are now more confident that the worst of the economic slump has passed and that the future is looking brighter.
According to Birinyi Associates, in the week ending February 26, the amount of authorized stock buybacks by U.S. corporations hit $13.2 billion, which is an impressive increase from the $1.07 billion of authorizations announced in the same week a year ago. In addition, the year-to-date tally for buybacks is up to $68.5 billion. This compares with the total of $125 billion of authorizations for all of 2009. However, we’ve still got a ways to go to return to 2008's level of $359.8 billion.
While stock buybacks are not as beneficial as dividends or M&A, they are seen as middle ground in terms of corporate expenditures and a sign that Corporate America is becoming increasingly confident. Buybacks do reward shareholders in the company by reducing the number of shares outstanding, thereby giving each and every shareholder a larger stake in the company. Reducing the number of shares outstanding also helps improve earnings per share, which is the key to stock pricing.
On the subject of buybacks being positive for stock prices, Carmine Grigoli, chief U.S. investment strategist at the equities division of Mizuho Securities told Reuters, "There is no question in my mind that we're at the early stages of a major stage of more stock buybacks and merger and acquisition activity. That should keep stock prices rising.... It's powerful enough to keep the equity market moving higher."
So, with Corporate America feeling better about the outlook for the economy, there is a decent chance that companies will continue to put money “to work.” And this just might be enough to fuel the next leg higher in this bull market – or at least be enough to keep the bears at bay for a while longer.
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