Buying Into A Recovery

By Daniel Kadlec

Are more mergers a sign of fair weather ahead? Fred Green thinks so. Expecting a revival in corporate takeovers, Green, co-manager of the Merger Fund, has begun accepting new money from investors for the first time in two years. And his timing looks good. Last week Phillips Petroleum agreed to acquire Conoco for $15 billion in stock, followed swiftly by carpetmaker Mohawk Industries' $1.4 billion deal to buy flooring company Dal-Tile and the announcement of a $3 billion cruise-line merger of Royal Caribbean with Princess. There was even talk that cruise-line heavy Carnival might pre-empt that deal by bidding for Princess.

The high-stakes world of Wall Street mergers and acquisitions, moribund all year, is stirring. That's often a harbinger of a rising economy--and it's not the only one we're seeing. The stock market has been quietly rallying. Initial public offerings of stock remain few, but those getting to market are being snapped up fast for the first time since the last gasp of Internet mania in early 2000. And the benchmark 10-year Treasury bond, a proxy for mortgage rates, shot from 4.17% to 5% in a blink. Higher rates are a burden to borrowers--but one that usually precedes a stronger economy. "The worst is over," declares Mark Zandi, chief economist at Economy.com

That doesn't mean the good times are here. "There's still a lot of bad economic news in front of us," Zandi predicts. "Christmas is going to be tough. Bankruptcies will rise in the first quarter. People will lose jobs." The National Bureau of Economic Research is expected to conclude this week that the U.S. has been in a recession since March--confirming what most folks have felt since last winter.

One of the ironies of business-cycle dating is that recessions often aren't declared until after they have reached the bottom. But what comes next is recovery. In another irony of the times, the indicators pointing to recovery are emanating from Wall Street, even as investment firms are mired in an extended round of layoffs. Head count will be down 5% this year. Still, the Street is plainly forecasting better times. The rise in long-term interest rates indicates that bond traders expect higher demand for credit in the next six to nine months as consumers and businesses resume spending. The stock market too tends to rise ahead of the economy; led by cyclical stocks like Alcoa and DuPont, the Dow is up 21%, closing last week at 9960, a decisive shift that qualifies as a new bull market.

These moves have been spurred by a batch of government reports showing fewer jobless claims, better retail sales and an uptick in consumer confidence. A feeling of progress in the war on terrorism is also helping. But a setback in that war or in any future economic readings could cause traders to rethink their budding optimism.

In corporate planning rooms, however, hopes are likely to stay on the mend. There is little chance that CEOs planning deals will recoil. Companies seeking to divest a noncore asset or buy one that fits a strategic need can't wait forever. With stock prices no longer falling and the worst earnings news evidently behind us, bankers say, buyers and sellers of companies are better able to value assets and are eager to explore options. For example, analysts who cover J.P. Morgan Chase say the bank, stung by its exposure to investment banking, is looking for an acquisition in the consumer-lending area to diversify further.

"There's a lot more dialogue at the CEO level," says Steve Baronoff, head of global M&A at Merrill Lynch. "As CEO confidence grows, you'll see a lot more pull the trigger on deals." He notes that the deal pipeline at Merrill has begun to refill in the past month and that economically sensitive companies--including tech, telecom and media--have begun discussing deals that could take place the first half of next year.

Likewise, the IPO market is firming. Insurance company Anthem went public a few weeks ago and has soared 37%. Weight Watchers went public in mid-November, and the stock is up 32%. Magma Design, a tech IPO, has soared 45%. "We haven't seen a string like that in a long time," says Linda Killian, analyst at Renaissance Capital. Sensing a buoyant market a few months out, billionaire investor Laurence Tisch at Loews Corp. just filed to sell shares of his Lorillard Tobacco in an IPO. He too is reading the tea leaves--and seeing good things.