If 2013 was the year of the buyback, 2014 is the year of the jumbo deal.
Corporations are finally putting their record cash hoards to work amid a resurgence in mergers and acquisitions, a trend that bodes well for the stock market. Deal making is back at pre-crisis levels, with AT&T Inc.T -0.65% being the latest to join the fray following its $49 billion bid over the weekend for satellite-TV provider DirecTVDTV +1.25%.
So far in 2014, companies have announced 19 so-called jumbo deals—acquisitions of at least $10 billion apiece—the most on record at this point in a given year, according to Dealogic, whose data go back to 1995.
Investors have rewarded the latest round of deal making, a trend that analysts at Bank of America Merrill Lynch predict will keep propelling U.S. stocks higher into the second half of the year.
“While cash return factors—share buybacks in particular—have been among the best performers over the last few years, we think the next leg of the market will be driven by corporate spending,” says Savita Subramanian, head of U.S. equity and quantitative strategy at BofA Merrill Lynch. “We see many reasons for a pick-up in spending, but performance may be the biggest catalyst.”
After getting burned during the financial crisis, companies spent the ensuing years hesitant to dip into their cash coffers to undertake riskier strategies. Instead firms boosted buybacks and dividends in an effort to reward shareholders.
That appears to be changing, especially as corporate America’s buyback binge has started to lose its luster.
Ms. Subramanian says companies that increased their spending on capital expenditures and M&A activity have outperformed the market this year, while those that have spent heavily on buybacks have underperformed. The S&P 500 Buyback Index, which measures the 100 stocks with the highest buyback ratios, is up 0.8% this year. That’s less than half the S&P 500’s 2% year-to-date gain. The buyback ratio accounts for the amount of cash paid for common shares over the past four quarters, divided by the market capitalization of the common stock.
“Investors now want growth, not buybacks,” Ms. Subramanian says.
