Economy Going Nowhere: Listen To The Dealmakers

by: John M. Mason

For four years now, I have been looking for a boom in the mergers and acquisitions business. It seems as if the times were ripe for this. There was a group of corporations in very good shape that one could see doing the buying. There was another group of corporations that were troubled and looked like exceptionally good targets for takeovers. The healthy corporations had lots and lots of cash on hand and interest rates were extraordinarily low. The economy was in the recovery stage of the business cycle.

In the past these were always signs that mergers and acquisitions were going to take off. Yet, although some business is taking place, so far the M&A activity has been very, very disappointing. This sector has been another "green shoot" that has not produced.

Michael de la Merced reports in the New York Times:

"Despite a strong start that yielded four blockbuster transactions in one week, the first half of 2013 was the slowest first six months for mergers in four years. Deals worth about $996.8 billion were announced in that period, a sum that was down 13 percent compared with a year earlier, according to Thomson Reuters.

The number of deals announced worldwide for the first six months was 16,808, the fewest for the period since 2003."

Corporations have "dry powder" but they are not rushing into battle! While a lot of talking has been going on, only a disappointing number of deals have been closed. I believe that there are three primary reasons for this.

First, future economic growth is tenuous. The year-over-year rate of growth of real GDP in the first quarter of this year was only 1.6 percent. The year-over-year rate of growth of industrial production for May of this year was only 1.6 percent.

The Federal Reserve has been particularly optimistic in its recent growth forecasts stating that real GDP growth will be 2.5 percent for all of 2013 and will exceed 3.0 percent growth in 2014. This would mean that in the latter half of 2013, real growth would have to be much more than 3.0 percent to achieve the Fed's projection for this year.

As economist Martin Feldstein writes in the Wall Street Journal:

"It is difficult to see how this can happen. U. S. exports are declining in response to weaker growth in other countries and a stronger dollar. The sequester and the higher tax rates that took effect on Jan. 1 will continue to reduce aggregate demand. These forces will more than offset the favorable but small effect on GDP from increased residential investment."

I can't see economic growth topping 2.5 percent, year-over-year, in the coming 18 months.

Corporate profits have not been rising. Given growth projections for the economy and the continuing recession in Europe and slower growth in China, it is hard to project much improvement in this area in the near future. Reasons for combining firms because of strong corporate performance do not seem to be in the books.

Second, there is concern that high stock prices along with higher prices in other asset markets just represent "credit bubbles" that have been created by the quantitative easing of the Federal Reserve. This would mean that current market valuations would be inflated and cause acquiring firms to pay prices in excess of real value. Also, given the fact that the Federal Reserve might begin to "taper" bond purchases in the future resulting in higher long-term interest rates does not present a favorable future for putting deals together at the present time.

Third, there is still a great deal of uncertainty of how the Obama Administration will take to merger boom. During the four plus years that President Obama has been in office, corporate business has constantly taken a watchful stance with respect to how the administration acts toward business. Up to this point in time, the Obama administration has never been able to lift the cloud of uncertainty that hangs over Wall Street, specifically, and the business community, in general.

Some areas of the market are not all gloomy. Health care is one area that is still quite busy but a lot of this activity relates to the coming implementation of the new health care laws. The oil and gas area will probably remain active because of all the re-structuring that is taking place around the world connected with the natural gas revolution. And, telecommunications will also perform better than average due to the constant innovation and consolidation that is taking place in information technology. And, some sectors of the market, like consumer products and non-residential real estate, organizations might even benefit from the asset bubbles being created by the Federal Reserve.

Still, I believe that overall merger and acquisition activity in the future will remain modest. The economic environment is just not one that is conducive for corporate executives to "bet big" on new organizational combinations. They have to be pretty sure of what they are getting into if they are going to make the leap.

Mr. de la Merced makes the point that many of the executives that are running corporations at this time road through the recent Great Recession in important positions and have memories that will cause them to be more risk-averse than they might be otherwise. And, the current economic and political environment is not helping them become more aggressive risk takers in this area.

This points up the circular problem that exists in the economy today. Merger and acquisition activity is not picking up because of slow growth in the economy, but the slow growth in the economy is being held up because corporate executives are not actively pursuing more corporate consolidations. But, we as investors need to be aware of what the market is telling us.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.