Morgan Stanley, IBM, And Xilinx: Mergers, Acquisitions, And Spinoffs In Focus

An election with far-reaching policy implications—one way or the other—is less than a month away. Big banks are set to kick off what could be a challenging earnings season. Fresh outbreaks of COVID-19 have been reported here and abroad. And a Category 3 hurricane—the 25th named storm this season—is about to make landfall in the U.S.

And yet, the S&P 500 Index (SPX) and other indices find themselves within striking distance of all-time highs as a rally enters its third day early Friday. The Dow Jones Transportation Average ($DJT) has actually made new all-time highs. After touching 30 earlier in the week, the Cboe Volatility Index (VIX) has fallen 13% and starts the day with a 25-handle. Merger and acquisition (M&A) activity has picked up in earnest this week (see more below). And Treasury yields have been inching toward normalcy, and could be poised for a breakout to the upside.

If 2020 has taught us one thing, it’s that markets have the power to surprise, if not confound, even the most seasoned investor. That’s important to remember as we enter the election home stretch and prepare for the often-notable Q3 earnings season.

Is this a rally that’s got some legs? Or is it more like a market without much conviction, but one where few people want to get in the way of the upward momentum? We saw on Tuesday how things can turn back on a dime, but the quick recovery that started Wednesday and has carried through until Friday morning might hint that anyone trying to go short here faces a challenge. 

If the rally does have some staying power, this could be the first up-week for the market since August, and perhaps reflecting an expectation that some sort of stimulus deal gets done. That being said, with all the uncertainty still swirling about, we could see some pressure as the day goes on. While markets are open Monday, it is a Federal holiday in observance of Columbus Day, so it’s possible we might see some position-squaring later on. This is especially true if we end the week with no more clarity on the stimulus picture. As we get closer to the election date, it will get increasingly less likely that something can be cobbled together. 

So far, there doesn’t seem to be much in the way of people preparing for the election through sector rotation, though don’t rule that out starting around mid-month. The market’s had an amazing 53% run since the March lows, and the economy has been working its way back a little bit more slowly than the market. From Oct. 15 on, it’s possible people could start taking some profits and basically saying “I’m out of here” until after the election or even until the end of the year.

M&A Thursday—Carrying Over Into Friday 

M&A (and spinoff) activity has certainly perked up in the last few weeks, highlighted on Thursday by news of Morgan Stanley’s MS $7 billion purchase of fund manager Eaton Vance Corp EV. The headlines sent EV’s stock soaring and might have helped power the Financial sector in general, which rose 1.4% yesterday.

Word of IBM IBM deciding to spin off part of its information-technology services operations to focus more on faster-growing businesses like cloud-computing and artificial intelligence gave “Big Blue” a big lift, too, though generally, the Tech sector trailed most others on Thursday.

And shares of chipmaker Xilinx, Inc. XLNX jumped 16% in the premarket on word from The Wall Street Journal that it’s in advanced acquisition talks with industry leader Advanced Micro Devices, Inc. AMD in a deal reported to be worth $30 billion. 

When markets shift into “risk-off” mode, the appetite for M&A and initial public offerings (IPOs) tends to wane, so it’s good to see fresh activity. 

Airlines Face Possible Pressure As Stimulus Hopes Lag

The stimulus talks (and political posturing) continue. In a marked turnaround from earlier in the week—when the president indicated nothing would get done until after the election—word that Speaker Pelosi and Treasury Secretary Mnuchin have picked up talks has helped give markets a lift Friday morning. One sticking point seems to be help for the airlines.

The question is how long some of the airline stocks can keep chugging along as Congress and the White House continue to wrangle over stimulus. Thursday’s news of Speaker Pelosi wanting a bigger package than the White House—which seems focused on the airlines—hurt the market slightly around mid-morning yesterday but not for long.  

As far as the threatened airline employee furloughs go, we might be near the point of “fish or cut bait.” The speaker told airlines to hold off on furloughs because she hoped to get them stimulus money, but airlines can’t last on a promise much longer. They need something concrete they can go forward with, and they only have so much cash. They need something sooner rather than later.

At the same time, politics might soon turn against them. We’re getting closer to the election, and people in Washington might be more hesitant to do anything where they’re seen giving money to corporations but not individual voters. This isn’t a political column and there’s no position being taken here, only that the wait and see part might be getting long in the tooth for this industry. If nothing is done by the end of next week, it probably gets much more difficult to get anything done.

As the election approaches and stimulus talks drag, a few relationships in the products might be causing some head scratching. Stocks have been soaring and volatility has been falling, which makes perfect sense. 

The headline sensitivity of the last week or two isn’t going away, necessarily, but things could get a little more company-focused starting next Tuesday when the big banks step up to report earnings. That could pull a little attention away from Washington, but any kind of COVID headlines—either good or bad—could get us soaring or sinking. Be prepared.

We’ve spent a lot of time here on airlines, but they’re obviously just one form of transit and have had a good week. Other transport stocks aren’t doing so badly, either. The Dow Jones Transportation Average ($DJT) posted new all-time highs early this month only seven months after dropping to nearly four-year lows. It’s up nearly 20% from a year ago. 

Airlines led the charge Thursday while delivery companies sank, but make no mistake—it’s the delivery stocks like FedEx Corporation FDX and United Parcel Service, Inc. UPS that really helped put a charge into transports over the last year as people rely more and more on having products shipped to their home for both work and play. UPS is expected to report quarterly results later this month after strong earnings from FDX about a month ago, and it might be interesting to hear if they give guidance for the year’s current quarter, which includes the holiday season.

And one final thing to watch—as it relates to transportation, as well as the general economy—crude oil is taking a breather from its advance earlier in the week. Earlier supply concerns—a strike in Norway by oil workers, which could take up to 25% of the country’s energy production offline, and a hurricane making its way through the Gulf of Mexico—may be ebbing a bit. Norway’s workers have apparently agreed to mediation, and though much of the U.S. oil production in the Gulf has been suspended for a few days, oil stockpiles have been trending upward, so there might be a cap to how much more we could see to the upside.   

CHART OF THE DAY: TALKING TRANSPORTS. The Dow Jones Transportation Average ($DJT—candlestick) is outpacing the S&P 500 Index (SPX—purple line) year-to-date, powered recently by airlines amid hopes for a stimulus but most of the year by delivery firms. Data source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

Looking East For Strength: Yesterday we mentioned the recent rally in copper, an industrial metal often seen as a proxy for Chinese manufacturing strength. Perhaps in line with that, analyst estimates for China’s Q3 gross domestic product (GDP) growth look better and better, especially compared with Q2. China’s economy likely expanded 5.2% in the July-September quarter, up from 3.2% during the April-June period and negative growth in Q1, a recent survey by Nikkei and Nikkei Quick News found. We’re likely to see the actual data by mid-October.

The comeback in China could be another factor helping some of the big multinational U.S. companies, and we’ll likely hear more about that in some of the earnings calls coming up from Industrial, Materials, and Consumer Discretionary firms. Remember to consider listening to some of those calls for executives’ thoughts on both the U.S. and Chinese recovery progress, as well as any new updates on how the simmering trade war might be affecting exports and imports. Strength in China’s manufacturing base, by the way, hints at strength for the Tech industry, which makes so many products there.

Airline Economics, Part 1: Investors who were around during the Great Recession of 2009 remember when “moral hazard”—where companies fail to guard against risk because of tacit government protection—became a household term. Some fiscally-minded economists and investors saw the bailouts of banks, automakers, and other industries as the rewarding of bad behavior. These days, similar logic has been applied to airlines such as American Airlines Group Inc AAL and United Airlines Holdings Inc UAL, which recently announced furloughs and layoffs of tens of thousands of employees in the absence of help from the federal government. But is it warranted? On the one hand, few could have predicted COVID-19 and its effect on air travel. But recessions are a part of the economic cycle, and many airlines went into the recessionary period with already-deteriorating cash flow. True, they spent billions upgrading fleets in recent years, but they also spent billions more on share buybacks. 

From a pragmatic standpoint, it might make sense to keep the airlines staffed and the planes flying. Air travel has been a vital link to business continuity as well as the fuel that powers travel and tourism. When pilots and mechanics take a timeout from the job force, they must get re-certified, which can take time and resources that might be better spent on other things. When the banks received government money in 2009, it came with big strings attached—many in the form of the Dodd-Frank Act. Perhaps right now the stalemate over airline bailout money has less to do with moral hazard and more to do with how to attach the strings.

Airline Economics Part 2: The re-certification issue with airline pilots and mechanics hints at another economic fundamental—one with far-reaching implications throughout the employment dynamics surrounding—and beyond—COVID-19. Labor force detachment is what economists call the deterioration of skills, loss of one’s network of contacts, and general discouragement after a period out of the workforce. It happens every time there’s a recession, a prolonged strike, and even when a parent takes a leave of absence after the birth of a child, and it’s what can turn a temporary setback into a permanent one. 

When the coronavirus struck, many elements of the labor force became detached overnight—between companies and their workers (and their customers), between schools and their students, and even between governments and their constituents. No matter what the political structure looks like three months from now, the reattachment of the labor force will be a major policy challenge, and there will be winners and losers among sectors, industries, technologies, and more. 

TD Ameritrade® commentary for educational purposes only. Member SIPC.

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