In 2004, the Standard & Poor’s 500 index finally rose to a level not seen since the month preceding the Sept. 11, 2001, terrorist attacks and the fall of the twin towers in New York City. Examining the current economic and business landscape, one can’t help but notice the emergence of another set of two towers-the towering trade (current account) and federal budget deficits.
As we look to make the most of the opportunities that exist for our businesses and investments in 2005, the impact of three central themes should be carefully considered: the rise of corporate merger and acquisition activity; the recent weakness of the U.S. dollar; and the seemingly unrelenting rise of commodity prices.
Will the rise in corporate mergers and acquisitions be our white knight or our poison pill?
With Comcast’s earlier attempt to siege Disney’s Magic Kingdom with a $54 billion hostile bid, K-mart’s snuggling up to Sears’ softer side in an $11 billion deal and the recent announcement of Oracle finally winning PeopleSoft, is it time to ride the merger wave?
According to Xcitek.com through the third week of December, 21-one new deals had already been announced.
Not surprisingly, corporate takeover activity slumped during the recent bear market as CEOs were afraid to acquire target companies experiencing a decline in earnings. At that time, purchasing potential targets with declining stock prices also limited the appeal of such transactions. Furthermore, the takeover activity decline was exacerbated by a target company’s reluctance to "sell out" at depressed prices.
Now, after a three-year lull, corporate takeover activity is again on the rise. At last count, according to Thompson Financial, 6,891 acquisitions valued at $609.3 billion had been announced – that’s up 40 percent from 2002, when announced deals totaled $433.5 billion. With continued low interest rates, a recovery in stock prices, a turnaround in corporate earnings and a renewed desire by corporations to grow through acquisition, big deal-making has returned.
One way for investors to capitalize on this activity is to engage in merger arbitrage. Merger arbitrage, or exploiting price discrepancies created by special situations to generate profit with limited risk, regardless of whether the market itself advances or declines, certainly has investment appeal.
However, engaging in merger arbitrage requires a high degree of expertise and analysis and a tremendous amount of time and money. Merger arbitrage success truly lies in one’s ability to capitalize on many small returns over time. Therefore, individual investors should consider a mutual fund for merger arbitrage investing. Be sure to read the fund prospectus to understand the risks and costs associated with this type of investing.
On the flip side, merger mania does not necessarily imply good times lay ahead for the broad stock market. In fact, industry observers point to history showing that good times for deal-making were often closely aligned with peaks in stock prices.
Who can make hard cash with a soft U.S. dollar?
Many attribute the U.S. dollar’s recent decline to the problem of the United States’ towering and growing "twin deficits," the trade deficit and federal budget deficit. Simply stated, the United States imports far more than it exports, and the recent recession and the war on terrorism have led to record levels of government debt.
Generally speaking, the potential beneficiaries of a soft dollar are U.S.-based multinational firms (especially those that heavily export manufactured goods) and U.S. investors in international investments.
Potential losers are multinational corporations based in stronger currency countries, which currently include the Euro zone, Canada, Japan, Australia and Britain, that derive substantial profits from exporting their goods to the United States. In addition, foreign investors in stronger-currency countries that own U.S. domestic investments could also suffer losses from a weak U.S. dollar.
The longer-term implications of a sustained dollar decline can be far-reaching. The U.S. bid to solve its trade deficit problems by allowing the dollar to remain weak could affect world economic growth and set off further currency devaluations, trade pressures and financial instabilities-all with dangerous consequences.
Recognizing this and depending on what you would like to accomplish, it would be prudent to have either an exit or entrance strategy in place.
Will few gush over soaring commodity prices?
One way to potentially profit from this trend is to invest in the stock of mining companies directly. Alternatively, a mutual fund that specializes in commodities may be selected. The effect of rising energy and other commodity prices on the economy will be important to monitor.
Recently, reports of higher steel prices are expected to impact profits for auto makers. Almost all businesses and consumers are starting to feel the effect of higher energy prices, which act like a tax on the economy. For businesses, increased energy prices can translate to higher operating or manufacturing costs, which in turn may crimp profits.
As consumers shell out more money at the pump and to their utility providers, they are left with fewer discretionary spending dollars to make purchases that could help businesses and the over-all economy.
We begin this year, like many, with more questions than answers. By acknowledging some key themes that may impact business and investment profits this year, we can begin thinking about and developing proactive measures to help us produce the results we desire.
Adrian Zilvetti is a financial consultant at Disciplined Financial Services Inc. in Brookfield.
January 21, 2005, Small Business Times, Milwaukee, WI
