With the S&P 500 (.SPX) up more than 60% since the market’s March low, an investor might be excused for booking profits, moving to the sidelines and waiting for the next big swoon.
After all, despite last month’s surprising improvement, the unemployment rate remains stubbornly high, consumers are cautious, real estate remains troubled, and new financial fears, like Dubai’s credit crisis, continue to arise.
But before hitting the sell button, consider what a few portfolio managers and analysts have to say. They point to a number of signs coming out of corporate suites that, if not all-out bullish, are still quietly encouraging for the economy, profits and stocks in 2010.
“I really do believe, based on the flow of data, that we are headed out of recession and into a sustained recovery,” said Fritz Meyer, senior investment strategist at Invesco AIM.
Just what are companies doing that supports that conclusion? A number of managers and analysts spoke about five related themes.
Rising cash. Companies acted a lot like consumers in the recession, hording cash, cutting spending and waiting for better times. As a result, cash at S&P 500 companies hit a record high $833 billion in the third quarter of 2009, up by more than 25% from the end of last year.
“This cash amounts to 85 weeks of companies’ net earnings and it’s just sitting in the bank,” said Howard Silverblatt, senior index analyst at Standard & Poor’s.
Now managers will have to put that money to work or face pressure to return it to stockholders. As anyone with a money market account can tell you, the interest rate for that cash is near zero.
“A CEO put it this way — the Fed is making it very difficult to keep cash on the balance sheet,” said John Roth, manager of Fidelity’s New Millenium Fund (FMILX .
So these companies won’t sit idle for long. Analysts say new cash is being committed to projects, and even hiring. Last month’s employment data were the best since the start of the recession.
“Slowly but surely, companies with rock-solid war chests are going to be more willing to put that money into mergers and acquisitions, dividends and share buybacks,” said Brian Ferguson, manager of Dreyfus Strategic Value Fund (DAGVX .
When will this river of cash begin flowing?
“As we begin 2010, we could begin to see aggressive deployment of the cash,” Fidelity’s Roth said.
To get a piece of it, an investor would have to be in the market – not on the sidelines.
Mergers mount. While big mergers like Comcast’s estimated $30 billion deal to buy control of NBC Universal make headlines, a surprising number of smaller deals are ramping up too.
“Bankers are telling us that companies in every sector are in talks,” said Nadia Damouni, editor of dealReporter Americas, a mergers and acquisitions publication.
Aside from ballooning cash reserves driving this trend, two other factors are at work. First, companies are easily raising low-interest debt to help finance deals. Second, the stocks of takeover targets are at reasonable valuations relative to pre-crash levels. So a deal becomes a way to quickly build market share.
“We are in the early stages of what looks like the mother of all M&A waves,” said Dreyfus’s Ferguson. “It’s a strong signal that corporate confidence has improved.”
Focusing solely on takeovers can be challenging for an investor, since it’s hard to pinpoint takeover targets. Still, a few specialized funds, such as the Merger Fund (MERFX | run by Westchester Capital Management, focus on this area. It is up 7.9% year-to-date.
Dividends, buybacks return. Cutting dividends was a quick and easy way for companies to conserve cash in the recession, as shareholders seeing dwindling payouts could attest.
Silverblatt said the S&P 500 cut a total of about $88 billion in dividends over the past two years, compared with the previous annual high of just $5.9 billion of cuts in 2007.
But the third quarter may have marked the bottom. “It looks like we may have turned the corner on dividend cuts,” Silverblatt said, though he doesn’t expect dramatic improvement soon.
A more direct route to return money to shareholders might be through stock buybacks, since they offer more flexibility to companies. Although buybacks also dropped sharply in the recession, they are now up around 40% from the second quarter 2009, according to S&P figures.
IPO upswing. Initial public offerings also picked up this fall, which many managers took as sign of market health.
“Rising IPOs is always a good sign because it shows that investor risk tolerance is back,” said Invesco AIM’s Meyer.
Investors have become willing to bet on the growth prospects of new companies, even though the effects of the recession have lingered.
But perhaps more importantly, the increase in IPOs showed that the market could sustain new issues. “It’s a sign of health in the capital markets,” said Dreyfus’s Ferguson.
Insider buying. It’s always a bullish sign when insiders are buying their own stock – something that picked up noticeably after the market hit its March low but which has resurfaced more recently.
“Buyers are outrunning sellers at the moment and that’s definitely a net positive sentiment,” said Scott Martindale, senior managing director at research group Sabrient Systems.
Sabrient uses data on insider buying and analyst upgrades to create an “insider sentiment index” of the top 100 companies where these trends are strongest.
An exchange-traded fund, the Claymore/Sabrient Insider ETF , tracks the index. Since the market low in March the ETF has risen 105%.
Maybe those insiders know something, after all.