Sense and sensibility

Market sensibility means we have to take a deeper dive into the underlying data to get a clearer understanding of what’s going on. We find that corporate sense is keeping M&A in fashion, debt markets are beginning to show the strain in places and it’s all about windows…..

And the volatility continues….

It’s been another rollercoaster week, with sterling falling to its lowest level against the dollar since 2009, oil prices jumping around un uncertain supply signals and equities still following in response.  The S&P has already had 20 days when it’s moved up and down by more than 1% – that’s more than three days each week, more than the whole of 1993 and 1995 and the highest pace since 1932.

It’s always tempting to assign market moves and volatility to one headline cause each week, but we come back to the problem of concurrence and causation we mentioned last week with respect to negative interest rates and market stress. It’s also hard to pick one factor when investors have a widening variety of interconnected concerns to choose from.

Oxford Economics survey of their clients’ top three downside risks for the next two years taken earlier this month (February 2nd -10th) put China (90%) well ahead of oil prices (56%), the Eurozone (47%) and geopolitics (46%) – although there is a clear interplay between these factors. BREXIT garnered 18% of responses – below currency wars (25%).

If sterling falls, is this in response to the EU referendum announcement, the prospect of falling inflation as oil prices dip again or the fact that Mr Carney is reacting to these factors and more when he sounds a more dovish note on interest rates? It could be all of the above and more. The market is assessing a number of factors when it indicates 2020 for the first UK rate rise – not least the ‘negative’ moves of other central banks. The Bank of England might argue that 2020 is too far into the future, but can we really argue that markets are showing more sensibility than sense in making this assumption?

 The problem with dismissing any prediction these days is what might have seemed outlandish at the start of the year now seems possible. The expected date for the first UK rate rise has obviously been on a backward march for years. Who’d have predicted this time last year that almost 40% of European government bonds would trade with negative yields or that cheap oil would start to look like a danger to the global economyBloomberg’s 20% world isn’t looking so unlikely.  When anything seems possible, concerns are easily amplified.

 …but companies are dealing with it….

Despite all of this, M&A remains in fashion.  This isn’t obvious from the headline numbers, which show deal values well down on 2015. But, if we take out the ‘mega-deals’, i.e. deals over US$10b, the figures for 2016 and 2015 look virtually identical. After a period of transformative M&A, it makes sense that we’re now seeing companies rationalising and engaging in disposals that no-longer fit their current model.  Difficult IPO markets are making M&A a more attractive option. Distressed M&A is on the agenda, even if volumes in oil & gas have been lower than expected thus far. It also still makes good sense for companies to continue to do deals in a world of low economic growth and where there are disruptive challenges to core business models. M&A isn’t the only way to address these challenges, but it remains one of the most effective ways whilst investors remain receptive.

 These drivers should ensure that M&A doesn’t drop off a cliff in 2016. Deals are also many months in the making and the tap won’t be shut overnight. But if market disruption continues to dent economic confidence, this could temper the ability – if not the appetite – for some companies to transact.  Debt markets appear healthy, but – in a reverse of the M&A data – it’s the mega-deals that are dominating and hiding lower activity elsewhere.  The US investment grade bond market is running just about level with 2015 in value terms; but in 2016 much of this value has come from small number of large issues.  Eighty-five investment grade companies have sold debt to US investors this year, the fewest since at least 1995. The average deal value in 2016 is over now $1.8b, according to Dealogic, more than double the average through the same point in 2015.

Companies in investment grade – beyond the A-List credits – might just be waiting out market jitters. Or it may be that the pipeline is diminished by falling M&A volumes and refinancing activity. It’s too soon to call a significant change in attitude here. But in in high-yield, there is a more fundamental shift.  Companies with non-investment grade credit ratings have issued just $11.8b in bonds so far in 2016, down sharply from the $45b issued over the same period last year.  Margin pain has been most intense in the energy and mining industries, but all but one of the US high-yield sectors tracked by Barclays has fallen in value this year – tobacco is the only exception.

Can we mention refinancing? 

It’s almost beyond a cliché now to talk about the amount of debt awaiting refinancing.  We’ve been looking at these figures for years and each time the peak is pushed back as companies take advantage of ever loosening markets…until now? Further central bank loosening into negative rates might tighten markets.  At the very least, we’re now seeing rising global growth concerns sap confidence in high-yield. When the worm does turn, it will come as a rude awakening. Even this current tightening will feel unusual and difficult.

For the record,
there is around $1.2t in US junk corporate non-financial debt maturing between now and 2020, according to Standard & Poor’s , including $79.5b coming due this year, $134.1b in 2017 rising to a peak of $401.5b in 2020. In Europe, there’s around half this amount $43.7b maturing this year, $61.6b in 2017 and a peak of $156b in 2020.

 Windows of opportunity

For activities that need market approval in 2016, it’s still all about windows. There is obviously the potential for significant upside, if the clouds clear. Otherwise companies need to be ready to take advantage of calmer moments that appear even in the most turbulent times and take advantage of the continuing appetite for issues with a compelling proposition.  It’s been one of the worst years on record in terms of delayed or withdrawn IPOs, but some deals have still got away.