In order to get a handle on what recently happened to the U.S. stock market, you must look in retrospect at what was driving the market up prior to the current correction. Mergers & Acquisitions and buybacks were the primary market forces driving the economy before the sudden plummet. Media squawkers aggressively exacerbated the issue of recent foreclosures precipitated by the sub-prime loan market. Consequently, the sub-prime debacle spilled over into other non-mortgage debt sectors and home sales.
More and more major investors have become nervous about debt vehicles following what was, for all practical purposes, the failure of two Bear Stern's hedge funds dealing with sub-prime debt. Then, an Australian hedge fund, also dealing with U.S. sub-prime debt, reported that it was experiencing pressure caused by failing debt. The announcement fostered increased concern over the state of the credit markets.
According to JP Morgan, collateralized debt obligation sales (CDOs), instruments that pool bonds, loans and credit derivatives into high yielding securities in order to make them more liquid, have lost favor with investors. JP Morgan reported CDO sales running at $19.9 billion so far for July (down from $50.6 billion in June). With only a few trading days remaining in July, the $19.9 billion figure is not expected to improve to any extent.
As mentioned earlier, M&A, along with buybacks, provided the U.S. economy much of its liquidity. Any slowdown in this sector will greatly weaken the stock market, thus the economy. Unfortunately, this is what is happening currently. M&A weakness, as rumored by Standard & Poor's collateral loan obligation analyst, Chris Donnelly, is pressuring the stock market to the extent that it is pushing some major current CLO mergers and acquisitions into the trash bin. The Dow is down more than 600 points inter-day on July 27, following its recent new high of 14,000 plus. The NASDAQ is falling faster than the Dow, percentage-wise. How low can it go?
As impossible as it sounds, there is some good news. It will emerge once the current implosion ends. The M&A mania was fueled by the prospect of investors with money (or the ability to borrow money) buying or merging with corporations in order to make huge profits. Some investors who intended to purchase CDO hedge fund debt got cold feet once the Dow hit 14,000 and sub-prime loans began roiling non-mortgage debt vehicles. The good news is the fundamentals for engaging in M&As have not turned negative. In fact, they are growing more positive as the market plunges to new lows. For example, if you wanted to buy a company for $6 billion and now you can buy it for $5 billion, this is good news. Bull market corrections can be particularly vicious!
At some point, the current correction will end and slowly, but surely, those M&As that were recently suspended will resume. When that happens, the bull market will continue. The only way the current correction could develop into a bear market is if the new Congress decides to tax M&As, thus making the buyout business unprofitable. In any case, protect your nest egg-sell on 15 percent principle losses and 25 percent profit losses-until the smoke clears. Stay Tuned!
