Speculative Fever Grips the World

05/31/2007 12:00 am EST

Focus: MARKETS

Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

Gordon Pape, editor of Internet Wealth Builder, worries that too much liquidity has led to a rush of mergers and that too much speculation that can only end badly.

The world is awash in liquidity. Low interest rates combined with soaring profits have left many companies cash-rich and looking to spend their money on any business that appears to be undervalued and/or fits their long-term growth strategy.

What we're seeing is a global phenomenon. Rupert Murdoch is trying to buy Dow Jones. Thomson is bidding to take over Reuters. BHP Billiton is reported to be on the trail of Rio Tinto. And on and on it goes. This takeover binge shows no sign of running out of steam; if anything, the pace is accelerating.

Speculative fever has taken hold. How else can you explain the fact that Alcan stock traded as high as $90.93 after the Alcoa bid was announced, almost $10 above their offering price?

We've seen this before: In fact, it's typical of the late stages in a market cycle. Back in 2000, just as the high-tech boom was getting ready to implode, America Online pulled off the biggest corporate takeover in history when it bought Time Warner for an incredible $200 billion-mainly on the strength of AOL's grossly inflated stock, as it turned out. Today, the whole deal looks ludicrous-AOL has been reduced to a bit player on the Internet scene while Time Warner's strengths remain in its traditional businesses. But at the time, the deal made sense to a lot of people, just as some of today's takeovers appear to.

[Meanwhile], both the US Federal Reserve Board and the Bank of Canada are ratcheting up their warnings about inflation and the Bank of England has already made a move in an effort to restrain rising prices there.

A move by the Federal Reserve Board to raise US rates would probably bring this bull market to a screaming halt because it would not be a one-time event. Historically, once the Fed embarks on a tightening policy it maintains it for a fairly long time, unless something dramatic happens.

Higher US interest rates would make it more expensive to finance takeovers, especially though leveraged buyouts, and would have the effect of dampening activity and discouraging market speculation. That in turn would lead to what could be a prolonged market correction-one that we're overdue for, anyway.

So once again, I encourage investors not to get carried away by the strong market run we have been experiencing. In particular, avoid buying stocks on the basis of speculation. Stick with companies that continue to display solid earnings and dividend growth. That may seem dull but better bored than broke.

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