foxex: M&A and Small-cap Stocks Push Markets Higher

Chart Advisor | Focus on the Price

By John Jagerson, CFA, CMT

Wednesday, April 24, 2019

1. The bidding war for Anadarko Petroleum

2. S&P 500 pauses while Russell 2000 climbs higher

3. Bullish U.S. dollar could be worrisome

Major Moves

How much is a stock worth? It depends on who you're asking.

For example, at the closing bell on April 11, Wall Street had determined that Anadarko Petroleum (APC) was worth $46.80. This was up slightly from the stock's low of $40.40 the day after Christmas but well off of the stock's 52-week high of $76.70, established on July 10, 2018.

Miraculously, by the end of trading the next day on April 12, APC was suddenly worth $61.78.

Why? Because Chevron (CVX) said it was when it offered to buy APC for $33 billion, or $65 per share.

Side note – the reason APC didn't close for the day at $65 to match CVX's offer is traders always try to build in some risk premium in merger and acquisition (M&A) situations like this. They know that just because a company announces an acquisition bid doesn't guarantee it's going to happen. Rarely will you see a stock that is being acquired trade at the offered price until the deal has been finalized.

But wait…we found out today that CVX was wrong. APC is not worth $65 per share. It's worth $76 per share according to Occidental Petroleum (OXY).

OXY rolled in this morning with a new offer to buy APC for a combination of $38 per share plus 0.6094 shares of OXY stock per share of APC stock.

So how much is APC really worth?

Before Wall Street knew about CVX's offer, APC was worth $46.80. Once it knew about the offer, APC was worth $61.78. Now that it knows about OXY's offer, APC is worth $71.40.

In other words, as new information came out, Wall Street reassessed and went with the highest bidder at the time.

So why was CVX willing to pay $65 per share for APC, and why is OXY willing to pay $76 when the market believed the stock was only worth $46.80 before the acquisition offers? Because these companies believe they can achieve greater profitability with APC's assets than APC could on its own thanks to the "synergies" that will be created by combining companies.

Are CVX and OXY correct?

Certainly, there will be some cost savings by reducing management costs – you only need one CEO, one marketing department, one HR department, etc. to run a combined company after all – but only time will tell if the synergies are actually going to materialize.

Until then, if these companies are willing to pay a premium for the stock, Wall Street will be happy to push the price up and sell it to them.

Russell 2000 & S&P 500

The S&P 500 barely moved today.

The index only had a range of 10.78 points and closed a mere 0.22% below where it opened.

If I had seen this type of price action in another circumstance, I might be more concerned this candlestick formation was a spinning top doji signaling the end of the uptrend. However, seeing almost nothing but spinning to dojis for the past few weeks – all while the S&P 500 has been drifting higher – makes me a little less nervous about a looming bearish pullback.

My confidence is bolstered even more seeing the Russell 2000 close at 1,588.132 – challenging the resistance level that could turn out to be the neckline of an inverse head-and-shoulders bullish continuation pattern. Small-cap stocks, like those that make up the Russell 2000, tend to advance when traders are confident in the future strength of the market and pull back as traders become nervous.

Today's bullish move in the Russell 2000 indicates traders are confident, not nervous. And if they are that confident, today's spinning top doji on the S&P 500 is just a likely to be a stepping stone on the way to the index establishing a new all-time high.

Mergers vs. Acquisitions: What's the Difference?

Mergers & Acquisitions: Path to Profitable Trades

Risk Indicators - U.S. Dollar

The U.S. dollar (USD) broke higher today as traders flock to the strength of the U.S. financial markets – buying U.S. stocks and U.S. Treasuries hand over fist – and run away from the Brexit-induced geopolitical instability in Europe and the United Kingdom.

While seeing a strong USD reinforces the narrative that the United States is doing relatively well compared to the rest of the global economy, it can also have a negative impact on multi-national firms that generate a large percentage of their revenue overseas.

As the USD gets stronger, revenue generated in other currencies become worth less once they are repatriated to the United States and are converted from the currency of origin into USD.

For example, if a company generated €1 in revenue one year ago, it could exchange that €1 for $1.22. However, if that same company were to generate the same €1 today, it could only exchange it for $1.11. The revenue generating capacity of the company didn't change, but it is suddenly earning $0.11 less than it was a year ago because of the exchange rate.

We're not deep enough into this earnings season to know if this is going to be a major threat for Q1 2019 earnings, but if the USD continues to strengthen, traders are going to become increasingly concerned we could feel the bearish impact in Q2 or Q3.

Countries Most Affected By A Strong U.S. Dollar

How the U.S. Dollar Became the World's Reserve Currency