M&A may boost equity markets in 2015
|While global equity valuations no longer offer the compelling opportunities they did earlier in the bull market, they do not appear to be near the extremes that have preceded major bear markets in the past. Returns are likely to be moderate going forward, however, as the global recovery and bull market continue to mature|
Global equity valuations in aggregate look neither unusually cheap nor excessively expensive. But the balance between US and developed non-US equities has shifted somewhat. Whereas a year ago US large-cap stocks appeared more attractive, we now see better values in international markets.
There is good reason for optimism about some emerging markets, as important structural reforms are taking place in China, India, Mexico, and elsewhere. One wild card in the 2015 outlook is the potential for an upswing in mergers and acquisitions (M&A).
M&A activity has accelerated in the US, with acquirers taking advantage of strong balance sheets, cheap borrowing rates, and improving confidence to grow their businesses. Outside the US, corporations have been reluctant to pull the trigger, despite an abundance of potentially attractive deals. Even a modest improvement in business sentiment could cause global M&A activity to heat up, boosting public equity prices.
The global earnings outlook
Europe: The eurozone recovery, while shallow and sputtering, appears intact. Further easing by the ECB seems likely, and easier fiscal policies in the core countries are now a possibility as economic weakness has spread even to Germany. Earnings growth, which has lagged the US, seems to have stabilised, and the potential for upside surprises is now greater.
US: Earnings growth has been stellar this cycle despite modest economic gains, as corporations have carefully managed labour and capital costs, resulting in record profit margins. Moderate sales growth and good cost management could produce 5%-6% earnings growth in 2015, a modest deceleration from the 8% growth we are seeing from S&P 500 companies in 2014.
Japan: Perhaps the most encouraging upside might be the growing adoption of more shareholder-friendly policies by Japanese corporations. We also see a growing focus on productivity that could boost earnings for years to come.
Asia Pacific ex Japan: The 2015 outlook will depend heavily on whether China can manage its transition to a more consumer-driven economy without a drastic slowdown in growth. So far, growth appears to have stabilised in the 6% range, and the banking system’s credit problems, while significant, appear manageable.