Bring On the Steel-Cage Match!

 | Feb 21, 2013 | 12:00 PM EST
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This commentary originally appeared at 8:20 a.m. EST on Feb. 21 on Real Money Pro -- for access to all of legendary hedge fund manager Doug Kass's strategies and commentaries, click here.

This week Jim "El Capitan" Cramer and I have been going back and forth on the investment ramifications of the heightened M&A activity. (Jimmy brought up our fracas and dueling views during Tuesday night's "Mad Money" episode.)

Here is Jimmy's first column on this subject ("No Desire to Argue With Billionaires") and my response ("The Anti-Cramer Returns!") followed by Jim's response ("Jim Cramer vs. Doug Kass") -- as he is the boss, he gets to write two pieces on the subject against my one column!

Yesterday I published a detailed analysis that suggested that retail investors' inflows into domestic equity funds do not lead stock prices -- indeed, there is nearly no correlation.

Today I undertake (with the assistance of Seabreeze analysts Nick Pollari and Kelley Hopkins) another exercise and deep dive that suggest to us that, historically, rising levels of takeover activity (what Jim calls "the urge to merge") do not statistically correlate to a new leg of higher stock prices.

We used data of the S&P 500 annual returns from 2001 to 2012 with the dollar value of M&A activity and came up with the conclusion that there is little correlation:

  • The correlation between the volume ($B) of North American deals with annual S&P 500 returns is a low 0.5029.
  • The R-squared between annual S&P 500 returns and the volume ($B) of North American deals is an even lower 0.253.
  • The adjusted R-squared between annual S&P 500 returns and the volume ($B) of North American deals (including a one-year lag) is a statistically insignificant 0.296.
  • The adjusted R-squared between annual S&P 500 returns and the volume ($B) of global deals (including a one-year lag) is also a low 0.307.

The S&P 500 had a unique relationship with the aggregate value of mergers and acquisitions over the last decade. In years prior to quantitative easing the S&P 500 appreciates during years when the total dollars of mergers and acquisitions in North America are increasing. In a centrally planned market characterized by zero interest rates, however, a disconnect has begun to arise. The volume of M&A deals in dollar terms began to decline in 2011, and yet we have seen the S&P 500 appreciate double digits in 2012 -- the first time this has occurred since 2008.

Additionally, the S&P 500 follows closely with the total number of mergers and acquisitions that take place in each year. As more companies jump on the M&A bandwagon we can see the S&P 500 continue to appreciate. From 2011 to 2012, however, we saw a minimal increase in the number of deals in North America, yet the S&P 500 appreciated substantially.

As the S&P 500 breaks out to new highs, we can find some comfort in being suspect of this rally given the M&A data. The number of deals occurring year-to-date in 2013 (as of Feb. 20, 2013) is barely more than 50% of the previous quarter and is less than 60% of the deal count for the first quarter of 2012. Just to match the first quarter of 2012 in total deals in North America, we would need to see nearly 1,500 more acquisitions and mergers within the next 40 days roughly. A lofty goal.

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