Top 4 Things Haunting the Deal Market Today
Halloween is just around the corner and people everywhere are outfitting their homes with scary decorations to frighten passersby and trick-or-treaters on October 31st. It seems as if the markets have taken the Halloween spirit to heart, as there are many fear-provoking events and undercurrents to the current M&A climate. We’re going to list the 4 spookiest things in the market today and give them a Spook Rating of 1-5 to help you stay oriented between candy bars.
We’ve already spoken to some concerns about the Brexit earlier this year, and so far, the effects of this monumental separation have been relatively muted. However, British PM Theresa May has said by March 31, 2017, her government will pull the trigger on Article 50, beginning the formal process of extricating the UK from the European Union. At a mere 5 months away, this deadline is approaching frighteningly quickly. There is the possibility for contention in Scotland, should their parliament decide to hold another referendum on leaving the UK so as to remain in the EU, which would throw quite the wrench in the Brits’ plans for post-EU success. The specter of a so-called “Hard Brexit” in which financial firm passporting is no longer allowed has also sent shivers up the spines of many market participants. Without this regulatory pass-through, British financial firms would have to apply for legal oversight in all remaining 27 European Union members separately, in a Frankenstein-esque patchwork of approvals and rules. To their credit, the UK government is trying to keep things under control and soothe market concerns, but the potential for havoc to be wreaked by the Brexit vote is enormous.
US Presidential Election
(Currently, subject to change with polls)
In case you’ve been living under a rock for the past year or so, the US Presidential election this November has proven to be a jarringly contentious one. International trade agreements have pulled a Dr. Jekyll/Mr. Hyde transformation in terms of their public perception, going from seen as a good thing to something to be spurned. Trump’s fiery anti-trade rhetoric has been particularly hexing for the Mexican Peso, whose value has moved in inverse-lockstep to his polling numbers.
Figure 1 – Mexican Peso Value vs Trump Support
With current polls showing Clinton as having a significant advantage, the spook rating on this particular potential shock to the markets has been markedly decreased. Markets, especially large undertaking like mergers and acquisitions, like consistency and predictability, and Trump’s campaign has been antithetical to these. However, it should be noted that there is still the haunting ghost of Reagan’s win over Carter in 1980, despite Carter’s significant outperformance in the polls, so no outcome should be completely discounted.
Rising Interest Rates
The Federal Reserve has been signaling a second rate hike for some time now, and the data has, generally, borne out positively. It should be noted, however, that the market turmoil that struck fear into the hearts of investors in February this year was blamed largely on rate-hike expectations for the rest of the year, and that it took several months for these concerns to be allayed. This was similar to the “taper tantrum” of 2013 when the Federal Reserve Board’s announcement of the winding down of their QE program caused Treasury yields to spike. While markets going into a valuation tailspin would be welcomed by large funds and companies sitting on record amounts of dry-powder to fuel M&A activity, those looking to divest could be forced to take a considerable hit should market expectations get out of control. The silver lining, however, is that the “zombie” companies that have been kept afloat by easy credit could fall, reinvigorating the creative destruction process and allowing for a more efficient distribution of capital than has been seen due to low rates.
Future of the Euro Area
While the Brexit is an event linked to this, there is a much more frightening undercurrent to what’s going on in Europe today. Recently, 7 years of hard work towards a free-trade agreement between Canada and the EU was derailed by a single region in Belgium refusing to agree to its terms. It is difficult to think of regions more alike in terms of social and economic mindsets as Canada and Europe, so prolonged struggling to get this deal through doesn’t bode of this deal doesn’t bode particularly well for similarly-styled deals with other nations with whom they may not see eye-to-eye on significantly more issues. It also highlights the turmoil of a large, complex, and sometimes dysfunctional organization of states like the EU; combined with growing political and social unrest from a refugee crisis of unforeseen size, a yet unresolved sovereign debt overhang for several of its peripheral members, and the much-ballyhooed issues with its financial system, whether due to negative rates affects its banks’ ever-important Net Interest Margins or certain larger players’ legal troubles, the European Union could be in for a perfect storm. As the region makes up the world’s second-largest economy, fallout from any hardships it endures will be felt globally.
There you have it – the four spookiest things in the markets today. Hopefully, most of these will end up like the witches and ghouls adorning homes at this time of year – little more than decorative and harmless little distractions. Even still, it’s always good to keep your wits about you and hopefully, this list will keep you aware of potential scares for the market. In the meantime, as we knock on the door of tomorrow, let’s hope we’re greeted with Treats, rather than Tricks.
 Real Clear Politics, Investing.com