By Wallace Witkowski, MarketWatch
SAN FRANCISCO (MarketWatch) -- Can M&A save this stock
market?
Over the past month, tech and small-cap stocks have been slammed
as investors swapped last year's high-fliers for laggards like
energy and value stocks. Worries have increased that corrections in
stars like Tesla Motors Inc. (TSLA) , Facebook Inc. (FB) and
biotech will spill to the rest of the market. The Nasdaq Composite
(RIXF) suffered its worse weekly loss in a month.
Hang on, say some strategists. Rather than a wholesale rout,
they expect the retreat in growth stocks to only cap the advance in
the mega-cap benchmarks.
"It certainly will be a drag," said Paul Nolte, portfolio
manager at Kingsview Asset Management. "The S&P 500 won't go
significantly higher but you'll see significant dramatic sideways
action."
Plus, record cash on corporate books may see its way to
increased mergers and acquisition activity and investment -- and
that may replace growth as the next catalyst.
"The next step to that is merger activity," Nolte said. " It's a
way to grow business and earnings, where one plus one is greater
than two."
Nolte said the weakness in techs and small-caps is a result of
their outperformance in 2013, a view backed up by Bill Stone, chief
investment strategist at PNC Asset Management Group.
"You're getting a correction in techs and small caps because
those spots were the frothiest," Stone said.
The changing of the guard was at play last week. The one major
index seeing a gain for the week was the Dow Jones Industrial
Average(DJI), which finished up 0.4% to notch out a new record
closing high of 16,583.34. The S&P 500 Index (SPX) finished the
week down 0.1%.
On the other hand, the Nasdaq Composite Index (RIXF) finished
down 1.3% on the week, with the small-cap Russell 2000 (RUT)
falling 1.9% on the week. Several Russell components lost more than
25% on the week. Similarly, the iShares Russell 2000 ETF (IWM) fell
1.8% this past week, with nearly a 9% reduction in assets.
Facebook, a growth stock leader, ended Friday 21% from its
52-week high, or solidly in bear territory. Tesla is off 31% from
its recent high. The iShares Nasdaq Biotech ETF (IBB) is off 18%
from its peak.
(Read more on whether small-caps slide signals the market is in
trouble
http://www.marketwatch.com/story/small-caps-slide-reflects-a-market-in-trouble-2014-05-09.)
Stock pullbacks could prompt M&A
At the same time, U.S. companies are still sitting with record
cash on the books and are under the gun to boost earnings growth
after a muted first quarter. That could serve as a catalyst to more
M&A after years of earnings growth built on cost cutting.
Kingsview's Nolte said companies have already run though cycles of
buybacks and dividends to boost stock prices and returns but now
investors are looking for growth.
Buybacks are also falling out of fashion with higher stock
prices, according to Savita Subramanian, equity and quant
strategist at Bank of America Merrill Lynch. In a recent note,
Subramanian points out that "companies have not historically timed
buybacks well, and current valuations suggest the easy money has
been made."
Subramanian notes that over the past few years share prices of
large-cap companies on the Russell 1000 (RUI) have risen an average
0.5% a day after announcing an acquisition, compared to the
long-term average of losing 0.1%. Much of this has to do with
current cash hoards and lower interest rates as well as an
over-reliance on buybacks and dividends lately.
Tech is one area where PNC's Stone sees a potential break-out in
M&A activity, especially as it's the sector with a large
portion of hoarded cash. Health-care is another sector that could
see a rise in already active M&A activity, he said.
Stone notes that M&A deals over $1 billion rose in the first
quarter, with 54 deals compared with the year-ago period, when
there were 37. The value of the top 25 deals is even higher: $197.2
billion compared with $117.9 billion in the year-ago quarter. Those
deals, however, are being financed more with stock. Some 42% were
all-cash deals, compared with 69% as all-cash deals in the first
quarter of 2013, according to Stone.
Outside of Comcast Corp.'s (CMCSA) $45 billion agreement to buy
Time Warner Cable Inc. (TWC), some of the biggest deals this year
have been in tech and health care.
There's Facebook Inc.'s (FB) $16 billion acquisition of WhatsApp
Inc., Apple Inc.'s (AAPL) reported $3.2 billion deal to buy Beats
Entertainment Inc., along with big-ticket pharma courtships like
Pfizer Inc.'s (PFE) $106 billion bid for AstraZeneca PLC (AZN) and
a campaign to buy Allergan Inc. (AGN) for $46 billion from Valeant
Pharmaceuticals International Inc. (VRX) and Pershing Square
Capital Management.
Many of those deals have been met with skepticism, but then
again, with a low interest rate environment and growth still an
issue, companies are more willing to take on riskier deals, Nolte
said.
Retail earnings in focus
With more than 90% of the S&P 500 having already reported
first-quarter earnings, attention in the next week shifts to
retailers, which generally close out the season. It's already a
given that bad winter weather will dent those first-quarter
results, so much of the attention will go to outlooks.
Of the Dow components, Cisco Systems Inc. (CSCO) reports on
Wednesday, and Wal-Mart Stores Inc. (WMT) reports on Thursday.
Outside of S&P 500 earnings reports from names like McKesson
Corp.(MCK) , the week will mostly one of retail earnings reports
from companies like Macy's Inc.(M) , Nordstrom Inc.(JWN) , Kohl's
Corp.(KSS) , J.C. Penney Co.(JCP) , and Fossil Group Inc.
(FOSL)
Of the 13 retail subsectors, only four (Internet retail, home
improvement, automotive retail, and drug retail) are expected to
report earnings growth for the first quarter. Analysts forecast
1.7% growth across all of retail, according to John Butters, senior
earnings analyst at FactSet. Second-quarter earnings growth for
retail is expected to rise by 5.8% in the second quarter, but
that's down from the 9.8% growth expected back in late January.
"The market will likely pay close attention to any guidance
issued by retailers for Q2 to see what factors other than weather
may or may not be driving these downward estimate revisions," said
Butters.
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