The stock market could lose one of its key supports as interest rates rise, warns National Bank Financial.

NBF notes that the global boom in mergers and acquisitions has been a driver of the 2007 equity rally. Worldwide, M&As worth US$2.3 trillion have been announced year to date – two-thirds of the record $3.5 trillion announced in 2006. “However, this M&A boom is now at risk from rising interest rates,” it cautions.

“In 2007, a large proportion of M&A deals have been financed with borrowed money,” it says, noting that the proportion of cash-only deals is about 69%. That compares to only 25% during the last M&A frenzy of 1999-2000. “In principle, the cash can come from the acquirer’s own reserves. However, since few companies keep tens of billions of dollars in their war chest, most of the large deals have large debt components,” it says.

“Private equity funds have been particularly active lately on the wings of low interest rates. The lower the interest rate, the more they can borrow and the bigger the companies they can buy,” it adds.

“However, higher rates seem to have spooked prospective buyers,” NBF says. “In the last month, the U.S. 10-year rate has risen 55 basis points and the weekly value of global M&A announcements has plummeted to the lowest this year.”

“If higher interest rates deprive stock prices of the lift they have gained from M&A speculation, the stock market will lose a propeller. The “private equity put,” which gave investors the feeling that stock prices would be supported by the willingness of private equity to take public companies private, might experience its first stress test,” it concludes.