According to Bloomberg, confidence in the global economic recovery has waned, with the escalating Ukrainian crisis high up the list of concerns. In their latest survey, 40% of respondents said the global economy is improving compared with 59% in January. That isn’t a shift in sentiment you’d pick up in capital markets. Demand and pricing trends suggest investors’ default position is still confidence – or should that be opportune confidence? Lines between confidence and opportunism can blur – especially when someone mentions the printing press again.
Mission accomplished? Mission impossible…
This would seem to be the case across the Eurozone, where sovereign debt yields have reached yet new lows. In the last week, Italy’s 10-year bond yield dropped below 3% for the first time in 15 years and Portugal’s 10-year bond yield fell below 3.5%, an eight-year low. The yield on Ireland’s 10-year bond fell below that of the UK – a comparison that isn’t strictly valid, given the differing economic and inflation outlooks, but it serves to highlight the vast transformation in investor attitudes.
Clearly, confidence is necessary for recovery and investor demand provides welcome relief in Eurozone sovereign debt markets. However, as Wolfgang Münchau of the FT recently emphasised, market confidence is a poor measure of economic health. It’s too easy to confuse confidence with investor’s eye for opportunity and a lack of options elsewhere. How much of this rally is due to improving fundamentals and how much is due to hints of QE and troubles in emerging markets?
Tough to say, but it’s impossible to discount a market correction if Mario doesn’t start the presses post-haste. Fundamentals have improved – they could hardly have been worse – but Christine Lagarde warned this week against a false sense of “mission accomplished” with good reason. Upgrades in rating and outlook from Moody’s and S&P respectively last week recognise Portugal’s economic and fiscal progress. However, whilst the trajectories for growth, debt and employment are good, absolute levels are still worrisome. Portugal’s sovereign debt-to-GDP is one of the highest in the world. Eurozone unemployment is still around 12%. Many deep-rooted problems also remain. Italy has become deeply uncompetitive in the euro without an obvious route to viability, which is rousing increasing voter interest in an exit. This isn’t just an Italian problem, as we’ll can expect to see in next week’s elections.
UK primed for mega-mergers – with shareholder permission
There is reason for more confidence in the UK economy, notwithstanding increasing concerns over the hot housing market. Last week, the OECD upgraded its forecasts for UK GDP growth for 2014 to 3.2% from the November estimate of 2.4% – the largest increase for any G7 country.
EY’s 10th UK Capital Confidence Barometer, released next week, will highlight increasing UK boardroom confidence and growing appetite for large, transformational deals. This isn’t M&A for its own sake. Overall UK deal appetite has waned slightly in the last six months. However, the willingness of UK companies to engage in large deals or acquisitions above $500m is higher, following the global M&A trend for value, not volume.
Tough years of recession and slow recovery have obviously engrained management focus on value, with our survey showing shareholders increasingly adding their weight to these boardroom discussions. The rise of shareholder activism is something quoted companies should prepare for, but not necessarily fear. Initial approaches are often open attempts to engage management – not so much “enemy at the gate” as “helpful ally”. Of course, activists can lay siege if management rebuff their approach.
This type of activist campaign has largely been a US phenomenon. However, Deutsche Bank recently pointed to the potential for increasing UK activity given the favourable regulatory climate, high levels of institutional ownership and helpful markets. An attractive M&A environment, buoyant credit markets, healthier balance sheets and institutions open to intervention provide a wide scope of actions for shareholders looking to extract value.
Active PE market, but secondary market squeezed by IPOs
EY’s latest edition of Multiple: European private equity watch, highlights the increasing strength of the European PE market. Q1 closed with 143 European deals completed, compared with the 135 deals completed in the final quarter of 2013. Demand from foreign buyers also boosted trade sales to €6.2bn, up substantially on the €4.5bn recorded in the previous quarter.
However, secondary markets remain slow, in good part due to the continuing trend towards IPOs. This is contributing to a dramatic fall off in leverage buyouts after a spate of deals at the start of the year. Thomson Reuters reports that the European LBO pipeline is currently around €15bn, compared with €55bn in mid-March. There is ample funding available, but companies are choosing the IPO route or choosing instead to raise capital in the sizzling high-yield bond market.
Raise and clean!
The extensive efforts of EU banks to raise capital and cleanse their balance sheets will certainly be cheering the ECB. If banks take the asset quality review and stress tests seriously, it sends a clear message to investors that they are tougher and more credible than the previous lot. This confidence is vital to improve credit flows, especially across southern Europe. Plus, of course, the ECB will soon be taking over supervision of the biggest banks – it doesn’t want any nasty surprises.
Since the end of 2011, European banks have strengthened their capital base by €80bn, with the pace stepping up since mid-2013 as banks seek first mover advantage. According to Morgan Stanley, EU banks have raised €35bn of capital since last July – €26bn from equity issuance, €6bn from specific capital enhancing divestments and €3.7bn from unwinding carry trades. Peripheral banks have been especially active and welcome – 78% of bank capital raised has gone to Spain, Italy, Portugal and Greece. A year ago, Greek institutions were persona non grata, but Piraeus and Alpha have both raised capital as funding costs for Europe’s financial institutions drop to pre-crisis lows.
There’s still work to do. Morgan Stanley expects banks will need up to €60bn more capital, although this won’t necessarily come through equity calls. It won’t all be about the periphery either. Many German banks included in the stress tests are engaged in capital-intensive asset-based finance activities and are likely to need bolstering. Meanwhile, the clear up continues. According to the WSJ, European banks have moved $2.5 trillion of assets into “state-backed” and “privately held” bad banks since 2008. Many of these assets have already been wound down, but the hopper is still being filled. Barclays PLC became the latest to set up a ‘bad bank’ just last week.