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Tuesday, 17 October 2017

Positive expectations abound

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Technicals matter, but the real story will be the return of growth.

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There are solid reasons to forecast a positive outlook for global capital markets in 2014. The all-time record new-issue activity seen in 2013 in areas such as US investment-grade corporate debt, US syndicated lending, global high-yield or Asian G3 debt may not necessarily be breached in the forthcoming 12 months, but it is likely to be matched as conditions in the US and across multiple market segments around the world remain highly propitious as the global economy gets into gear and funding levels remain compelling on the back of strong buyside liquidity.

Bond markets opened with a bang in January as rate tightening concerns propelled issuers into the market early to lock in favourable levels. High-beta issuance from emerging markets and frontier market issuers, in subordinated and hybrid debt and from the storied eurozone periphery offering chunkier returns found particular favour. Bond issuance to January 13 had hit the US$200bn level; impressive but failing to keep up with the same period of 2013, which had set a blistering pace that elicited US$240bn in proceeds in the same period,

The indigestion experienced in the middle of the month showed that even though investors have cash to put to work, their appetite will need to be managed carefully and underwriters will need to be cognisant of the need to maintain an orderly queue and to the extent possible provide clear-market conditions to minimise the need for borrowers to pay up to access capital or suffer spread-widening in the aftermarket.

The pace of debt issuance will regulate itself as the year progresses. Fears that Fed tapering would equate to a rapid-fire tightening cycle similar to that of 1994 and pull the rug from under the market have been discounted in favour of expectations of a gradually steepening US Treasury curve anchored by continued ultra-low rates at the short end and a managed rise out along the curve.

Confidence has been a key missing ingredient in the past five years and the onset of better sentiment linked to better growth – and with inflation under control – is likely to provide a boost to debt and equity markets and push corporate and bank earnings higher

A 10-year US Treasury yield around the 3.5% level at year-end from its sub-3% levels in January, albeit with the potential to over or undershoot depending on the macro numbers and Fed asset-purchase actions, seems reasonable and will not spook the professional market.

While technicals will remain a constant focus and the market will remain jittery at the sight of any reversals of expected outcomes on the data side (particularly in the first half of the year), the bigger focus in 2014 will – rightly – switch to the elements that will support the strength and sustainability of economic growth in the coming year, both in developed and emerging markets. The two are, of course inextricably linked. Better economic fundamentals in the US and Europe will translate into a more positive picture for EM.

Seeing the back of recession or at worst an end to the no-growth phase in the developed world – allied to a parallel end to the crisis-fighting stance of the post global financial crisis era created by European sovereign and bank stress – in favour of a gradual reflation of key economies will boost market confidence. Confidence has been a key missing ingredient in the past five years and the onset of better sentiment linked to better growth – and with inflation under control – is likely to provide a boost to debt and equity markets and push corporate and bank earnings higher.

Bond yields and credit spreads off their early 2013 tights and low inflation will make bonds an attractive play. At a fundamental level, growth and better earnings will also drive stock prices higher. Achieving the kinds of heady equity returns seen in 2013 will not be repeated, but strategists are forecasting a pick-up in index levels in the low double-digit area. That will be sufficient to flush out more disposals via ECM desks and will keep the IPO market busy.

In 2013, ECM activity of US$797bn was 27% higher than the previous year. IPOs outperformed, rising 40% to US$165bn. Confidence among ECM bankers and advisers is high and expectations that the supply pipeline can be executed remain bullish.

The end to the Chinese IPO ban in early 2014 led to a flood of activity in January, which will have added to the feel-good factor. In fact, of the 29 global IPOs recorded by Thomson Reuters in the first few days of 2014 (to January 13) worth a total of US$1.8bn, all but six were Chinese. And of that half dozen, only one was non-Asian.

In the event-driven space, people have been predicting an M&A boom for years. It wasn’t forthcoming in 2013 but there are signs that deal flow could gather pace in 2014. The US$130bn Verizon Wireless deal stood out as the sole deal last year in excess of US$100bn. Indeed, the next biggest were the US$27.4bn Heinz buyout and US$25.5bn Liberty takeover of Virgin Media. Below that, there were just 14 deals in the US$10bn–$20bn range and 32 between US$5bn and US$10bn.

A total of 19 deals of US$1bn and above had already launched by January 13 across multiple sectors. Corporates and private equity firms are flush with cash; the latter generating billions from disposals via a return of the IPO market and in particular a frothy ABB and follow-on environment powered by strong equity markets. Corporates will at some point have to do something of economic value with their cash other than engage in stock buybacks; the predominant use of proceeds from high levels of debt issuance.

But asset prices have remained high and it remains to be seen if buyers will be prepared to pay the multiples demanded by opportunistic sellers. Inability to reach a compromise on price has kept M&A at bay in the past three years.

Leverage levels are creeping up, though, and that could bode well. The US$16bn Suntory takeover of Beam – the third-largest Japanese outbound M&A deal of all time – set the bar at an impressive high. And if accepted, Charter Communications’ US$62bn mid-January offer to Time Warner Cable shareholders will certainly give a good sense of the art of the possible.

One thing is certain: banks remain highly liquid and stand ready to provide the firepower needed to push takeovers over the line. A layer of acquisition finance is just what the banks need. They have been eking out an existence refinancing existing lines for years now in a borrower’s market.

Taken in the round, capital markets are open for business and the case for another solid year remains fully intact.

 

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