Time to Heal, Time to Deal

Summer is now for all practical purposes over, and the "summer rally" of 2009 is very much a thing of the past. For a month already, we have actually been in a state the old time technical analysts called correcting in time. The actual rally was 2+ weeks starting when Intel kicked off that long string of better than expected earnings reports. It only took the Market a dozen or so sessions to amend its previous error in judgement, rash emotional creature that it is, and price its constituent parts as if most of them have a future after all. It has been marking time ever since, in a mode much like it was in for about six weeks leading up to the aforementioned catalytic data point. The news continues to be, on balance, quite encouraging, but an economic recovery that is anything short of perplexingly robust is already in the price of stocks. 

At times like these, most investors are either fretting about or hoping for a big pullback in stock prices. We have gains that we are not 100% confident won't melt away in the next Market downdraft, and there are stocks we wished we had bought when the fire sale was on, but didn't, or only bought nominal amounts. (One needs to learn to live with the fact that an investor can never do enough of a really right thing.) What most investors don't seem to understand is that however "ahead of itself" a Market like this might seem, there is no rule of nature that says that it has to go lower for a time before it can rally further. We might have a catalytic event which triggers a sell-off of greater magnitude than the 2-3 day, 2-4% variety we have seen along the way, but it will probably have to be "event driven". Stocks never go in a straight line for very long, and do indeed tend to get ahead of themselves (in either direction). The remedy for this is called "correction", and can occur in time (i.e., a stint of aimless meandering) as well as in price. 

Considered through the lens of seasonality, this past week should have been a snoozer. In terms of the slight net decline for all five trading days, that would seem to be the case. A day at time, though, market action was anything but somnolent. It had opened the previous Friday in a state that left it badly in need of a breather. A spate of "concerns" cropped up over the weekend to facilitate a sharp drop over the next dozen or so trading hours. The action on the last two days before LD Weekend, days which more so than nearly any other are dominated by the kind of money that doesn't rest, strongly suggested that if the path of least resistance has any kind of slope to it, it continues to be upward. That said, I expect the Market to continue to correct in time, i.e., go more or less sideways over the next several weeks. Q3 earnings releases will likely further validate the non-demise of global economic activity, but whatever recovery is likely to occur in that slice of future that is discountable by the Market is already pretty much in there. We will likely see some lively days in anticipation of the earnings season, but with nowhere near the effect that was rendered in late July. 

My sense is that the driver of any kind of meaningful short term gains is in the late stages of shifting away from "anticipating economic recovery lifting all but the most waterlogged of boats" and towards deal heat. After a very long dry spell, M&A activity seems to be perking up. We should not be surprised that both buyers and prospective sellers have shied away for the past two years at least. That seems to be changing, however. Capital markets have definitely come unstuck. Deals can be done, and after such a long hiatus, deals definitely will be done. The private equity crowd has been transfixed by the prospect of participating in the next wave of bank consolidation, eager to waddle up to a trough reminiscent of Resolution Trust Company circa 1992. That the rules of engagement for this subsidized bacchanalia have been worked out at a pace akin to the effects of the Stimulus package has kept this bit of wealth redistribution in neutral, but that is about to change. At the very least, the boys will be able to decide how much to allocate to this bit of taxpayer largesse, which will clarify how much "dry powder" will be available for other adventures. 

Over the rest of 2009 and probably into next year, M&A activity will be in something of a catch up mode and so more or less constantly in the headlines. This means that during this time period, which will likely be followed by a meaningful correction in price as well as time spanning a good part of 2010, the performance of one's portfolio is likely to be all about take-outs and revaluations premised on transactions involving similar companies. Stock picking will seem to matter much more than just being in stocks, which has been the most important thing since the tide turned six months ago. A more honest understanding of how one fared in the last third of 2009 might be garnered from the old maxim about how its better to be lucky than smart. Either way you want to account for it, I see deals and the ripples they produce as the thing that will for any given investor determine whether 2009 was an exemplary, or merely good, year to have owned a pile of stocks.