Deal frenzy drives stocks

NEW YORK (CNNMoney.com) -- Big deals have helped power the stock market's recent rally, but the best days of the buyout boom may be over.

Merger activity has been on a tear this year, with the value of deals announced through Wednesday jumping to $544 billion in the U.S., according to deal tracker Dealogic. That's up from $411 billion at the same time in 2006 - which turned out to be a record year for mergers and acquisitions.

The deal-making has helped the market claw its way back from a sharp selloff in late February. The Dow rose to a record high of 12,803.84 on Wednesday, topping the old high set on Feb. 20.

Market analysts attributed the rebound in stocks to a variety of factors, including a strong start to what was expected to be a bleak earnings season as well as recent signs that consumer spending is holding up well despite slowing economic growth.

But a focal point for the market has also been deal activity. Big deals are encouraging to investors because they can be a sign that other companies may get bought - typically at a premium to their stock prices, analysts say.

"M&A always makes investors feel good because it gives them the feeling that there are attractive buying opportunities in the marketplace," said Alfred Goldman, chief market strategist at A.G. Edwards.

Fueling the latest round of mergers and buyouts: Private equity firms that buy companies with mostly borrowed funds and try to grow or turn around the target and eventually sell out for a profit, usually within three to five years.

This year's buyout deals have been big and frequent. Deals announced in April alone include the proposed $25 billion buyout of college loan provider SLM (Charts, Fortune 500), better known as Sallie Mae, as well as the $29 billion takeover of credit-card and payment processor First Data Corp (Charts, Fortune 500).

Those multi-billion dollar deals came even after private equity firms went on a buying binge in the first quarter. In that period, private equity firms accounted for nearly 26 percent of overall U.S. deal activity, and three of the top 10 deals announced involved private equity buyers, according to Thomson Financial.

Investor enthusiasm for private equity funds shows little sign of slowing. Hungry for big returns, investors are pouring money into private equity shops. Research firm Private Equity Intelligence expects private equity funds to raise a stunning $500 billion this year, topping the record $432 billion raised in 2006.

But industry players who convened for an annual private equity conference hosted by industry magazine Buyouts this week weren't celebrating the boom in the industry as much as they were worrying about market conditions.

Competition has gotten so intense for deals that prices paid for companies are rising, they lamented. And eager lenders are financing many deals that shouldn't even get done in the first place, a sign that the market may be headed for a downturn, they said.

Daniel D'Aniello, co-founder of private equity powerhouse Carlyle Group, said at the conference that some portfolios may have loaded up on too much debt, and he cautioned about a turn in the credit markets, saying it was "naive" to presume lenders would keep lending at favorable rates forever.

A tightening of credit, which has been the fuel behind the buyout binge, would rein in the shopping spree. It would also remove a powerful force in the world of mergers - and a key support for stocks.

But few these days are willing to predict when the flood of cheap debt will dry up. Some in fact don't see any signs of a coming pullback in buyout activity, arguing that unlike the last buyout boom of the 1980s, when private equity was a more exotic investment vehicle, it's become much more mainstream today.

"There is a structural demand for private equity coming from pension funds and other types of investors who want to move away from day-to-day portfolios," said Tom Sowanick, chief investment officer at investment adviser Clearbrook Research.