2020 M&A Forecast - Economic outlook for 2020

The economic backdrop for M&A is positive, but conflicted. The world is still awash with easy money, but valuations are high and economic momentum is easing.

Weight of money globally provides a positive backdrop to deal-making. A protracted period of very low interest rates and quantitative easing by several advanced economies has unleased massive amounts of capital — both from cheap debt and investors hunting for better returns. A third of investment grade bonds now have negative yields, so this is not surprising. It means there’s still a lot of capital chasing returns and looking to make deals.

However, the economic backdrop is less rosy than in recent years. This is in large part due to the simmering US-China trade war; its fallout on other economies which are entangled through complex supply chains; and maturing economic cycles more generally.

In New Zealand, the economy has been slowing since mid-2017. It’s growing at a reasonable pace, better than most peer countries, but still slower than in recent years. A recession is possible, but not likely. It would need some kind of catalyst: a severe drought in New Zealand or worsening global economic and financial conditions. Throughout the expansion phase of the past decade, following the Global Financial Crisis (GFC), the cycle has felt different. It has been characterised by relatively slow growth, unusually low wage and price inflation and interest rates never returned to what we considered ‘normal’ before the GFC.

Instead a new normal has set in: a combination of low growth, low inflation and low interest rates. We have not seen such a combination sustained in living memory. This combination appears likely to last for many years to come.

Structurally low interest rates coincide with a demographic surge of Baby Boomers hitting retirement. They will switch from saving for retirement and running businesses, to investing in retirement and exiting their privately held businesses. Very low interest rates are likely to support both aggressive demand for risky assets and a supply of new businesses into the market. The impact on valuations is hard to decipher, but deal activity looks structurally underpinned.

Recent regulatory changes for New Zealand banks will see them hold more capital and change their lending behaviour. It will make banks more cautious in their lending to farms and businesses, meaning previously bank debt-funded deals may now enter the wider deal making space.

The New Zealand economy is losing steam gently. The Reserve Bank of New Zealand has cut interest rates, but at current very low interest rates, these changes are having little impact. The main tool to manage the economy is now fiscal policy, but there’s unlikely to be a big boost until 2021, after the election in late 2020. But when that happens, the scope is positive. By global comparisons, New Zealand has a very strong fiscal position and a long list of projects that will make the economy go faster.

The New Zealand economy will be rudderless in 2020. Monetary policy isn’t getting traction and fiscal stimulus is far away. Combined with slowing growth at home, growing global economic and geopolitical risks, and little prospect of effective economic stimulus, deal-making may prove a little harder in 2020, but the long-term outlook is very positive.

Foreword by Shamubeel Eaqub; Economist, author and commentator.

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