January 6, 2016    3 minute read

The Great Policy Divergence and M&A

   January 6, 2016    3 minute read

The Great Policy Divergence and M&A

The Fed and the ECB are diverging in their directions of monetary policy, with the US economy strengthening while Europe is declining with high unemployment and an inflation rate which has failed to reach the ECB’s target of 2%. Historically, the ECB typically followed the Fed in monetary decisions, so it will be interesting to see the knock on effects that this contradiction will have. However, 2015 has been a huge year for M&A with $4.9tn of deals announced, breaking the 2007 record. Not only that, but the acquisition of SABMiller by Anheuser-Busch InBev has led to the 4th biggest takeover in history occurring.

(Source: Dealogic)

If we look back at the history of merger and acquisition booms, we can identify their cyclical nature. Its fair to say that we are on the brink of the seventh wave, but will monetary policy bring the wave to a halt?

Screen Shot 2016-01-04 at 18.27.27

(Source: York University)

One area which will be hit by the divergence is emerging markets. They have already been hit hard by low commodity prices and reduced demand from China, and diverging policies could hit them even harder. Investors may chase high bond yields in America in terms of bonds, but also may chase Japanese or European equities due to low rates and quantitative easing. This could cause money to be squeezed out of emerging markets, having a negative effect on their economy. The plus side for M&A growth is that it will potentially lead to many more opportunities for stable companies to invest their cash reserves in emerging markets by acquiring undervalued companies.

Another facet that could be affected is the EUR/GBP exchange rate. A study conducted in 2000 by Francis Breedon and Francesca Fornasari of Lehman Brothers entitled “FX impact of cross-border M&A” demonstrated the clear positive effect that large M&A deals between countries have on the exchange rate of the countries involved. However, with the divergence set to weaken the euro, it will be interesting to see if the correlation still exists if you are looking at the effects FX has on M&A rather than the other way.

M&A activity is unique as it can survive in both a growing economic environment, but also a recession. The lack of correlation between economic growth and the number of mergers in a year leads to a wealth of other variables to directly drive the M&A sector instead.

A stable market could be considered one of the conditions needed to cultivate M&A growth. However, a divergence in opinion of central banks can cause uncertainty in the markets. If you couple this with the current state of geo-politics, there is a likely chance of volatility to increase in 2016. A volatile market can make it hard to value a company and can create a wave of negative sentiment with business executives. Executives play a huge part in M&A as if they don’t feel comfortable with the stability of the markets, it could prevent corporations to go ahead with a merger.

On the contrary, despite volatility during the second half of 2015, the force of M&A has overcome the volatility in the markets with financial advisory firms like Lazard seeing an increase in their M&A advisory work.

Monetary policy may not have a negative impact on merger volumes. 2016 should be a fantastic year for M&A. Momentum should dampen the risks of volatility, while the merger opportunities available in emerging markets should allow the seventh wave to continue to new heights.

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