Taking Stock

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By Tony Crowell
By Tony Crowell
Brexit Backlash

The beat goes on. After a shakeout following the British vote to leave the European Union, worldwide stock markets surged. U.S. stock and bond markets, still viewed as the global standards, led markets in Europe and Asia. Fortunately, fresh economic news and corporate quarterly earnings reports support rising price levels.

New market highs, particularly after more than a year of tepid stock behavior, are historically bullish. Even after an impressive 9% rally from the “Brexit” lows, many investors and commentators worry how all-time highs can blossom in a global atmosphere of uncertainty, angst and even fear. One reason not to fear this fear is the historical observation that stocks like to climb “a wall of worry.”

Sentiment acts as a contrarian indicator of market behavior and second quarter surveys and technical data show investor sentiment at its lowest level of bullishness and highest level of uncertainty since soon after the Financial Crisis of ’87. When the “Brexit” lows passed without disaster and new economic data showed rising retail sales, manufacturing and employment, investors took heart and have been encouraged by the first shower of earnings reports.

With 10% of the S&P 500 reporting at this point, two-thirds reported earnings beating estimates with sales above estimates for half of them. Investors remain skeptical. Intel (INTC-$34) and recent recommendation Snap-on (SNA-$126 reported earnings that handily beat estimates but sales missed very slightly and their stock prices dipped around two percent. Both are buys.

Improving economies, a surging stock market and low interest rates provide a favorable environment for tenders or takeovers. We have two all-cash proposals, both mentioned in prior columns, ARM Holding, plc (ARMH-$66) and Monsanto (MON-$106. Unlike buyouts for stock, their stock prices pending closings of the deals will be less affected by overall market gyrations. (Usually, all-cash takeovers also reduce commission costs.)

The ARM buyout is “friendly;” its Board has entered into a definitive agreement with Tokyo-based Soft Bank for sale at 1700 pence, ($22.41). Its stock trades here in depositary receipts equal to three shares, thus the takeover price converts to $67.23, only $1.25 above current market. That’s a modest “merger arbitrage” spread, which could get boosted either with an increased price to assuage unhappy shareowners or by an improving exchange ratio with the British pound, which has dropped sharply.

ARMH also declared a dividend of $.15 a share to be paid in October. Regulatory approval is usually the biggest barrier to completion of any of these deals. This seems minimal on this deal and the companies anticipate closing this fall. Including the dividend, closing in four months, for example, would produce a 6% annualized gain on today’s prices.

There is no definitive agreement for the Monsanto deal; in fact, there is no agreement of any kind. Bayer AG made a $122 all-cash offer in May, which Monsanto rejected summarily. It then increased its bid to $125 a share, which Monsanto also rejected as “financially inadequate.” (Its stock was languishing in the low 90’s before Bayer entered.)

The usual pattern under these circumstances is that the target’s management makes efforts to find an acceptable “white knight” with whom to merge, hoping to block the unsolicited bid. Lacking success, a sweetened offer often emerges which, in this case, would probably have to be at least $130 for success. It is rare that no deal of all develops and Monsanto looks like a reasonable value with the possibility of significant upside by yearend.

Earning reports will continue to ignite price flurries. Starbuck’s (SBUX-$57) and Honeywell (HON-$118) earnings are due tomorrow and I might lighten our positions to add to the two new merger arbitrage deals. Each justifies 5%-10% positions of investor holdings. Overall, investors should try to use market volatility to add or initiate buys of large growth stocks, while closely monitoring the progress of their earnings.

Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1995. [email protected]/949.494.1376/800.697.2622/www.crowellroberts.com

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