Could June once again herald a shift in the capital landscape? Once again we have a major UK poll and significant central bank meetings against a backdrop of oil price uncertainty. So this week we look back at June 2016, look forward into June 2017 and explore why deal making shouldn’t, but may stutter later this year.
365 days ago…
A year ago today we wrote a blog entitled ‘Pivotal June’ – a month that lived up to its billing. It started with the ECB extending its QE programme into investment grade corporate bonds. There were seeds of Eurozone revival before this move, but this programme undoubted provided a leg up. Less dramatically, OPEC didn’t limit production until November and the Federal Reserve postponed its expected US rate rise in a now familiar pattern of soft-data delay. But then there was BREXIT.
We’re still a long way from being truly able to judge the full effect. Negotiations haven’t begun and we won’t know until Friday who in the UK will lead them. But, even now we can talk about the impact on the course of UK monetary policy – including a loosening of monetary policy, the reshaping of the UK economy via weaker sterling, an unexpected general election and profound changes to the UK political landscape that it solidified, if not inspired.
Clearly other forces and events have played out since that make it tough to say this was the pivotal month. But, what I think we can say is that economically and politically we’re in a very different place.
Two days until…
So what are those changes? The global economy is growing faster. Oil is trading in a low – but relatively stable – band and the price is withstanding shocks. Earnings are rising. But, this positive picture still relies on ultra-supportive monetary policy – that hasn’t changed. One in 25 UK businesses would struggle to handle an increase in interest rates of as little as 0.25%, according to research from R3. The risks are also higher from political polarisation and social disquiet linked to growth that is still below trend – despite this support. And terrorism and rising geopolitical tensions never far enough from the headlines, as we’ve seen all too vividly of late.
What could move markets further? A UK general election always has the potential to shift the narrative. Even an incumbent victory inspires some policy change – even without a BREXIT sub-plot. And what we have now is the potential for even greater policy change – or do we? The spread between the major parties in some polls has narrowed to low single digits, but in others it remains in double figures. The changing political landscape has challenged pollsters’ models and the varying ways they deal with this means we have very wide range of outcomes.
And, not only is the outcome now difficult to call, but also the resulting policies and market reaction. I don’t think we can say for certain that any result guarantees a hard or soft BREXIT – especially given that the UK isn’t the only party in the negotiations. Neither can we predict capital market reactions with any accuracy. Once again, the pound is showing the strain, but this is no longer just a simple in-or-out equation. Investors will probably have their eye on other policies as well as the gap between soft and hard data that we noted a few weeks back moving in favour of the more bearish hard-data.
JPMorgan argued last week that a soft-BREXIT centre-left coalition could be positive for the pound. But sterling dipped after a YouGov poll suggested we could see a hung Parliament and one-week options, which now capture the election date, are showing the most bearish sterling stance since the Brexit vote a year ago. So, almost whatever the outcome, we can expect the pound to move – it’s just hard to say in the long term which way! As for equity and debt markets, areas like utilities that exposed to policy change are likely to react, but we’ve seen the shock absorbing capabilities of loose monetary policy – both actual and expected- after previous elections.
But still with a cushion…
Since the Bank of England announced its QE extension last year, the average gap in yield between sterling corporate bonds and government debt has shrunk to 1.3% compared to 1.6%.
There’s no sign of policy movement here, but as in June 2016 eyes will be on the ECB and the Fed. The ECB meet later this week and are highly unlikely to move policy, but are likely to tighten their language. The Fed, like the ECB, has no great inflation imperative and there are still minor but increasing doubts around what looked a dead-cert of a June US rate rise after some softer data. The dollar is now at its lowest level since last November. Déjà vu? Overall, the tightening narrative feels weaker and traders have lowered the odds Fed will lift rates three times in 2017 below 50%. It’s a clouded picture and June will hopefully bring some clarity – although yes, we’ve been here before.
The still loose monetary outlook means the outlook for M&A remains broadly supportive on the capital side, whilst there is still the compulsion from below-trend growth and disruption. PE is sitting on cash – as are companies. All this has been enough to inspire deals, despite a background of economic and political uncertainties in the last few years. Year-to-date global M&A levels remain consistent with last year and this pace should continue. The UK figures out today show a significant fall in the total value of successful domestic and cross-border M&A in Q1 2017, but – as the release notes,
“the value of inward M&A activity recorded in 2016 was unusually high and dominated by a small handful of very-high-value transactions….the total number of successful M&A involving UK companies has remained broadly stable since the 2008 to 2009 economic downturn.
So, it’s too soon to call a shift in M&A trends, but it is worth thinking about the impact of QE on valuations, a long standing and increasing concern. Put simply, with QE inspiring equity markets to record levels, it’s getting harder to make the valuation sums add up – which of course makes any uncertainties loom much larger in the rear view mirror.
Earnings are improving and if we do see the hard data move towards the soft data – if not in the UK, then across Europe and the US – then this will help bridge some of the gap in some deals. But, it seems as if companies and investors may also have to adapt to what is an acceptable return in this 3% growth world. Companies also need to focus on the narrative their represent around deals, the financial and non-financial imperatives.
Companies involved in UK public transactions need ensure that the Quantified Financial Benefits Statement (QFBS) process works smoothly, so they can make the most of synergy opportunities and present a strong narrative to their investors. Our analysis of QFBS since the changes to the Takeover Code shows the benefits of a robust evidence base and a well prepared management team.