Here are three facts I present to you in graphic form:
Long-term bond yields have been falling around the world
One example below is the US 10-year bond. Since December 31, 2013 its yield has fallen over 12%: from 3.03% to 2.65% on April 30, 2014.
US 10-year bond yield
And this phenomenon has been widespread. As Deutsche Bank has reported, Dutch yields are close to 500-year lows. French yields are almost at their lowest since 1746. Spanish rates are at all-time lows dating back to 1789. Italy is at 70-year lows.
Global mergers and acquisitions have been on the upswing
As you can see on the Dealogic/Goldman Sachs chart, global M&A announcements are up almost 30% from a year ago, with an estimated value of $3.5 trillion and—as the trend line shows—have been rising steadily since 2009.
Global M&A has been on a persistent upward trajectory
LHS: Global M&A Announcements ($bn); RHS: Y/Y Change in Announcements (%)
These data include megadeals like Comcast bidding for Time-Warner; Activis buying Forest Laboratories; Suntory buying Jim Beam; Volkswagen buying out Scania’s remaining minority investors; and Pfizer launching a late-April bid for Astra-Zeneca; plus lots of small deals.
Individual investors are on-the-margin buyers of US equities
The third factual observation comes out of a Bank of America/Merrill Lynch study. It shows that, since the end of 2012, cumulative net buying by private clients—the green line—has been in sharp upswing.
Cumulative net buys by BAML client types
This compares with a mild downturn at hedge funds (the blue line); and a very sharp downturn by institutional investors (the red line).
Why is this interesting?
Conventional thinking has it that:
- Bond investors buy aggressively when things are reasonably gloomy economically. To them, a slow economy means monetary ease and low inflation, therefore rising bond prices and falling bond yields.
- Corporate CEOs make the big M&A moves when the business environment is positive and their (and their boards’) animal spirits are running high.
- Private investors buy when the smart money leaves the table and are the last trade before there is no one else left to trade to—perhaps an unfair, but a longstanding characterization.
What’s interesting is that the facts are not quite aligned with the conventional view.
Why is smart bond money buying bonds and smart insider-savvy money at corporations buying other companies? Don’t gloomy bond investors have exactly the opposite mindset to acquisition-hungry CEOs? And don’t acquisition-hungry CEOs have more in common with optimistic individual investors?
We don’t think so. Here’s why.
The link between bond managers and CEOs
The first thing we think is going on is that bond managers and corporate CEOs are not at odds. They actually share a common worldview: they both think they see the onset of a slow world.
Bond investors are acutely attuned to a slower economic heartbeat, so there’s no surprise there.
But don’t animal-spirited CEOs need to be optimistic about the future to make big bets? Here we have our doubts. We at UNIO believe that what is driving M&A activity is not so much confidence in the future as much as concern that revenue and profit growth will be harder to come by.
Revenue growth will struggle precisely because the economic landscape will be slow. Profit growth will be grinding because—at 50-year highs in profit margins—it will take every ounce of extra revenue to bring extra growth to the bottom line. We think CEOs and boards sense this problem lies ahead.
Enter M&A. Acquisitions conveniently add top-line growth and a few years of merger-related cost-cutting which can boost profit margins. An economy that is out of the financial-crisis woods of 2009 certainly boosts CEO confidence. But, we think, the main motivation of M&A is as an antidote to corporations’ perception that their organic growth will be slow and hard to come by.
Give me the evidence and nothing but the evidence
So where does the private investor fit into this picture? In our view, one of the most important characteristics of most private investors is that they are comfortable when they have evidence and very uncomfortable when they don’t.
If you look back at that Bank of America/Merrill chart you will notice it took private investors about 3 ¾ years (March 2009 through December 2012) to get comfortable that the economy was on its feet; that corporate earnings were solid; and that the stock market had definitively left its horrible 2007-2009 meltdown past behind. By December 2012, the evidence was unassailable and they bought. And since no intervening crisis has challenged that that evidence, private investors keep buying.
The market is not a courtroom, it's a landscape
The problem is that the stock market—and markets in general—are not typically courtrooms where we wait to see what’s presented to us and then make up our minds in the jury room.
Markets tend to be more like complex ever-changing landscapes—hills, valleys, rivers, mountains, forests—that are never quite the same from one year to the next. What’s over that mountain or around the river’s bend is not clear. Evidence is fragmentary. It presents itself dynamically as you move through the topography. And it helps quite a bit to have an acute sense of awareness of what invisible twists and turns might lie around corners.
With that, I think the following is happening: bond managers and CEOs are putting money behind the proposition that what lies around the bend is a slow economy.
Private investors are putting money behind the past few years’ evidence that the economy and markets are strong—and if a little weak now—will resume their strength in the months and years ahead.
Two story lines are being woven with real money in real time: one story about the changing topography of markets; and the other a story about the evidence being presented in the courtroom.
That’s our take on what these three facts mean.
– John A. Allison