The global credit squeeze is removing a crutch that has done much to prop up the U.S. stock market during the past 18 months.
The buyout boom, combined with corporate share repurchases, helped keep equity prices high by reducing the supply of stock in public markets by well over $1 trillion.
So if the current lull in deals turns into a prolonged slowdown, it could take away an important means of support from stock prices already rattled by the credit situation.
There are already signs of this happening.
For example, Macy's Inc. shares rose as high as $45.50 on July 18 after an unconfirmed report that private equity firm Kohlberg Kravis Roberts & Co. was considering a bid for the department store chain. However, no offer emerged, and the stock has since fallen to around $30.40.
In the past 18 months alone, public-to-private buyouts combined with large-scale buybacks by corporations helped reduce the float of U.S. public stock by more than $1.1 trillion, according to TrimTabs Investment Research. The U.S. stock market is now worth roughly $20 trillion.
A reduction of supply on such a scale usually drives up share prices.
It's the basic laws of supply and demand, said Anthony Chan, chief economist at JP Morgan Private Client Services. Going in and reducing the supply or increasing the demand -- of course that has upward pressure on prices. No doubt.
Since the beginning of 2006, there have been roughly $600 billion worth of public-to-private U.S. leveraged buyouts announced, while U.S. companies have said they intend to buy back up to $672 billion of shares, according to research firm Dealogic.
That has been good news for equity prices, said TrimTabs Chief Executive Charles Biderman.
Historically, whenever the number of shares (in circulation) has gone down, the price of the remaining shares has gone up, he said. ... If you have to stay fully invested but there are fewer shares available, you are going to pay more money for the remaining shares.
Not everyone agrees.
James Paulsen, chief investment strategist at Wells Capital Management, said he believed less that a reduced supply of stock boosts share prices than that buyouts simply are a sign of good economic times.
You get big leveraged buyouts in times when conditions are good and equity prices are doing well, said Paulsen. So I think it is really the conditions that drive the buying, not the buying driving the conditions.
Merger and acquisition activity in the United States hit a new record of just over $1 trillion in the first half of the year.
In recent weeks, however, the pace of deals has mostly slowed as the credit crunch appeared to put many takeovers on hold.
Central banks around the world have pumped hundreds of billions of dollars into markets in the past week to ease worries about the widening impact of losses in the U.S. subprime mortgage market, which threaten to paralyze credit markets.
Dealogic said the volume of U.S. deals last week was the third-lowest of 2007 at only $11.94 billion.
But JP Morgan's Chan believes the slowdown in deals is temporary.
It's not positive, he said, but if we were to get something that would approach catastrophic levels, I think the central bank would add even more liquidity.
Besides reducing the supply of stocks, buyout deals help stock markets in other ways, Chan said.
They promote greater efficiency and higher productivity that lead to higher corporate profits and also higher stock prices.