U.S. stocks fell for a third straight session as the fear that the economy might fall into another recession outweighed more merger and acquisition news.

Stocks started the session almost 1% higher, but market participants showed their lack of conviction after the S&P 500 hit 1081.  

Defensive sectors Utilities, Healthcare, and Consumer Staples posted gains.  Energy also managed a small gain despite the price of oil tumbling 1%.

Volume remained weak and for the seventh time in two weeks NYSE volume failed to break 1 billion shares.

Market Activity for August 23, 2010

Takeovers Continue

Merger Monday is back in style.  Hewlett-Packard made a $1.6 bid for 3Par, which is 33% higher than the offer Dell made last week.  Meanwhile, HSBC is reportedly in talks to buy 70% of South Africa’s Nedbank for around $7 billion.  No doubt the M&A activity is a net-positive factor for the market. But as yesterday demonstrated, it’s not necessarily a reason market participants will buy.

The Fed has shouted from the roof-tops that rates will remain low.  Corporations are responding by deploying cash that has sat idle on balance sheets earning unacceptable returns.  Not every company will deploy cash through acquisitions.  Most will launch stock buyback programs and increase their dividends. 

Stock buyback programs allow companies to boost earnings per share without actually improving business.  One could argue that stock buybacks signal that a company has doubts about their ability to expand market share or grow revenues, and thus the company repurchases stock rather than investing in new plants and equipment.  If businesses aren’t going to use cash to grow revenues, then I’d prefer for them to directly return cash to shareholders via dividends.

Futures Lower Ahead of Data

Futures are lower ahead of housing, manufacturing, and consumer confidence readings. 

Housing brought the U.S. out of seven of the last eight recessions, but we won’t see improvement in the housing markets until excess supply is substantially reduced and unemployment improves – both will take a long time. 

The supply of homes for sale may rise to as much as 12 months, about twice the level of a healthy market.  As for the labor market, profit per employee-hours-worked and productivity growth suggest that employment could improve, but ultimately businesses will need to be comfortable the macro outlook and have more visibility on healthcare costs and taxes.

Brent will be back tomorrow.

Have a great day!

Peter Lazaroff, Investment Analyst

Phone: 636-449-4900