U.S. Markets closed

Why the Nasdaq is going to 5000 this year

There have already been $2 trillion in global mergers and acquisitions announced in 2014 and in the eyes of most market watchers the deal making is just getting started. A combination of low rates, a favorable market for corporate credit, $1.3 trillion in cash on corporate balance sheets and a U.S. tax code driving so-called “inversion” takeovers is making the prospect of doing a deal more attractive now than any point in corporate history. Yes, that includes the junk bond bubble of the 80s.

Thus far inversion deals, particularly in health care, have been the main catalysts for acquisitions. Forget patriotism. America was founded by people looking to avoid taxes. It’s un-American not to minimize your tax rate. All things being equal a company like Medtronic (MDT) would like to repatriate cash held overseas but by buying Dublin-based Covidien it can save an estimated $4 billion.

Congress can complain but corporations are following the very baffling, byzantine tax-code D.C. created.

What would catalyze the frenzied portion of the M&A trend is the threat that the environment for deals is going to get worse. Congress is making noises about changing laws on repatriation or penalizing companies that move overseas for tax purposes (if possible). The Fed, which sets the core “risk-free” rate on which all debt prices are pegged is making noises about ending the six year old interest free binge sometime early next year.

As the $2 billion bid for the L.A. Clippers proved, if you want to get rich people to pay too much for something just create a deadline. Right now corporate alpha-dogs in corner offices across the country are deciding whether they want to try and do a mega-deal or put their companies up for sale. Suffice it to say most CEOs consider themselves hunters rather than prey.

Bubbles aren’t about price levels. They are mass events driven by the passion (“madness”) of crowds. We aren’t in a bubble yet because there is no particular fear of missing out. There is simply anger. When market participants and executives feel as though they can no longer afford to stay out of the merger game we’ll have a real bubble.

We’re not there yet but we’re getting close.

Nasdaq 5000

Jeremy Grantham

According to GMO’s Jeremy Grantham the M&A trend will surpass anything we’ve ever seen in history, drive the S&P 500 (^GSPC) to 2250 and create what he calls a “fully-fledged bubble” sometime this fall.

What’s interesting about the call isn’t that it’s particularly novel. There have been scores of columns regarding the M&A bubble since the start of the year. For that matter the entire concept of “bubble” has been cheapened to the point of being rendered largely meaningless.

Grantham can’t resist the crutch of distancing himself from any bullishness. Sure, he’s calling for a 15% rally in the S&P 500 but only to verify his concerns over stocks developing into a massive b-word that he’s obligated to fret over in the interest of seeming professionally responsible. The prevailing view in more sober circles is that it’s somehow more responsible to warn about an impending crash than it is to be bullish.

Where I’m from we eat what we kill and we like food fresh. That means when I say I’m bullish it’s because I own stocks and when I’m wrong I stop myself out and admit defeat. From that perspective the important thing in Grantham’s call is that the rally part strikes me as correct. Barring an outside event that craters debt and equity markets dramatically it’s going to become all but impossible for corporate executives to resist picking up the phone and doing some sort of deal.  

Based on the quarters just turned in by the likes of Goldman Sachs (GS) and Morgan Stanley (MS) where literally all of the growth came from debt underwriting and deal fees it’s a safe bet to say there will be plenty of folks in the financial industry willing to back these CEOs in their big game hunts.

So where’s that leave the market? The average deal premium in 2014 has been 24.8%, down slightly from last year but nothing to sneeze at. The rate of deals being done has risen 75% year over year, which would suggest an utterly insane yet still-likely $2 trillion. The total value of the companies in the S&P 500 is roughly $17 trillion. Given the sopping up of stock market shares outstanding, premium paid and boost being afforded the bidding companies you can justify a move of 10% simply from supply and demand.

The S&P 500 isn’t going to rally on its own. A rally of 15% on the Nasdaq (^IXIC) would take the famously “tech-heavy” index back to 5,000, tantalizingly near record highs. Bubbles need emotion and those of us old enough to remember 2000 can tell you firsthand that taking back the peak of the Nasdaq would be like revisiting high school in a time machine. It’s irresistible. It’s doable. It makes sense.

Write it down: the Nasdaq is going to hit 5,000 this year. That’s my target. My stop is a trade below 4,000 which would equal a 9.5% loss.

See you in December.

More from Investing:

McDonalds, Hasbro and BB&T on investors’ minds today

Microsoft, Facebook, Amazon, Apple  highlight biggest week in earnings

Yellen was right, market is overvalued says Johnson