May 3, 2016 / 8:22 PM / a year ago

M&A slowdown clouds Wall Street view on stocks

4 Min Read

A man enters the employee entrance of the Pfizer World Headquarters building in the Manhattan borough of New York, U.S., November 23, 2015.Brendan McDermid/Files

NEW YORK (Reuters) - Worldwide merger deals have declined sharply from the frenetic pace that pushed them to record levels in 2015, a sign that could reflect broader weakness in the U.S. economy and vulnerability for U.S. stocks.

Previous merger and acquisition activity bursts peaked in 2000 and 2007 and preceded big stock sell-offs. During frothy markets, M&A activity tends to accelerate because companies see opportunity in purchasing growth rather than creating it from within. Investors reward them for their risk taking.

But as bull markets weaken, companies start to look too expensive and investors recoil from the acquiring company's decision, sending its shares lower.

So far in 2015, the dollar value of completed deals is 22 percent below the same period last year. The number of deals is down 13 percent, as expectations of higher interest rates and more government regulation is making mergers seem more expensive and risky.

A couple of high profile deals have fallen apart this year with Halliburton (HAL.N) scrapping plans to acquire Baker Hughes BHI.N and Pfizer (PFE.N) giving up its planned takeover of Allergan (AGN.N). Both deals collapsed under regulatory scrutiny.

"It does concern me that M&A has fallen; that suggests market participants are less optimistic about the future and unwilling to spend their cash or exchange their stock," said Michael Yoshikami, CEO at Destination Wealth Management in Walnut Creek, California, which manages $1.5 billion in assets.

Another worrisome indicator: In 2016, the value of deals rose sharply relative to world gross domestic product, hitting 6.2 percent of GDP after years near or below 4 percent. In the 2007 peak, M&A deals were equivalent to 7.2 percent of global GDP.

Deals completed this year are worth $935 billion globally, a 22 percent drop from the near $1.2 trillion deals made last year to May 2, according to Thomson Reuters data.

"Whether it is correlated or causal, we have seen M&A peak as economic activity is rolling (over) as well," said Art Hogan, chief market strategist at Wunderlich Securities in New York.

U.S. economic growth braked sharply in the first quarter to its slowest pace in two years, while last month the International Monetary Fund cut its global economic growth forecast for the fourth time in a year.

Market Nearing a Limit

Analysts also point to the sharp decline in stock prices at the beginning of this year as a reason for a slowdown in M&A, as it makes it harder for the parties involved to agree on a fair price.

But saturation may be playing against more deals as well - last year's 37 percent increase in deal value followed a 40 percent increase in 2014.

In a reversal of a trend for most of 2013-2015, investors are not rewarding the companies that are buying up the competition.

"Over the last few years you saw acquirer's announcements met with pretty positive returns in the stock market, it was not just the target (company) moving higher," said Dan Suzuki, senior equity strategist at Bank of America/Merrill Lynch in New York.

"The performance this year has been more mixed, and I think that means the market is getting a little bit more skeptical on deals," he said.

The total value of worldwide M&A last year was a record $4.53 trillion, but the nearly 45,200 deals fell short of the 2007 record of almost 46,700. Some companies rushed to close deals in 2015 to get ahead of tighter regulation and higher interest rates, said Wunderlich's Hogan.

Worldwide deals last peaked in 2007, as did major markets, ahead of the 2008-2009 stock selloff and the biggest economic contraction in the United States since the Great Depression. The previous deal peak was $3.4 trillion in 2000, just before the dot-com bust.

Click here for related graphic: here

Reporting by Rodrigo Campos; editing by Linda Stern, Bernard Orr

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