MarketWatch: How Treasury's Jack Lew Could Kill Stocks

By SIMON CONSTABLE

Who’s going to sink the stock rally?

A lot of people assume it will be Federal Reserve Chairwoman Janet Yellen who sooner or later will start to raise the cost of borrowing. But equally important could be Treasury Secretary Jack Lew.

Why? These two people hold wrenches that could potentially monkey with mergers and acquisitions activity. Frenetic deal making on Wall Street tends to go hand-in-hand with a firm stock market.

Doubt me? Just look at the chart below plotting the dollar volume of U.S. deal activity (as tracked by Dealogic) and the S&P 500. Deal flow goes up, so does the market. Deal flow drops, so do stocks. There’s certainly a correlation.

Deals are affected by many things including management optimism. But a couple of things stand out. One is the cost of borrowing money.

Low interest rates are certainly favorable for M&A, explains Bob Bruner, dean of the Darden Graduate School of Business Administration and co-author of the book, “Deals from Hell.” Or put another way, when the cost of borrowing money is cheap then it can make sense to buy other businesses.

As rates rise the favorability of borrowing to do such things will be lessened. But as we have heard, Yellen’s Fed will likely raise rates starting next year.

The other thing is tax rates. Even the casual observer knows that tax rates drive deal activity. U.S.-based Pfizer’s thwarted desire to buy UK-based AstraZeneca  for $120 billion was no doubt driven by the desire to avoid 35% U.S. corporate tax rates and switch to much lower British taxes. It’s known as tax inversion. Although, the Pfizer-AstraZeneca deal is off for the time being, other companies such as Eaton, Chiquita Brands and Applied Materials have all successfully retreated to lower tax countries, or are well on the way. Others are considering the move.

Although tax inversions are eminently possible now, politicians are increasingly banging the drum to stamp them out. That job will fall on the Internal Revenue Service, part of Lew’s Treasury. It could be that tax inversions get legislated away by Congress. Or alternatively the folks at the IRS could simply eliminate them using new interpretations of existing laws.

So there you have it. A potential nightmare scenario: higher interest rates and a clamp down on tax-led deals could dry up the deal flow.

When it does, expect stocks to languish.                    

See original story here.