Date
30 March 2017
A trend of rising rates could stifle buybacks and M&A deals and diminish a key driving force of the US stock market but hopes of more spending under Donald Trump have kept investors excited. Photo: Reuters
A trend of rising rates could stifle buybacks and M&A deals and diminish a key driving force of the US stock market but hopes of more spending under Donald Trump have kept investors excited. Photo: Reuters

Buybacks, M&A deals: Are US stocks running out of steam?

The Dow Jones Industrial Average has set new record for 12 straight days, the longest streak in nearly three decades. The US market has already rallied more than 10 percent since the election.

While part of the strength can be attributed to optimism about a stimulus policy under Donald Trump’s administration, recent gains can also be viewed as an extension of the strong market in place for years.

US stocks have jumped more than two times since the financial crisis, including dividend.

Among other factors, the huge rally to a large extent has been driven by buyback and M&A activities.

Following the financial crisis, rounds of quantitative easing have pushed interest rates to an extremely low level.

Such low borrowing costs incentivized companies to buy back shares to support share prices. Also, they have actively sought M&A deals to achieve growth, which also indirectly pushed up share prices. The correlation factor between US benchmark stock indices and M&A activities is as high as 0.78.

The Fed ended QE3 at the end of 2014 and embarked on a rate hike in late 2015. It’s expected that the Fed might accelerate raising rates this year.

How is this going to affect buyback and M&A activities, and thus the outlook for US equities ?

Figures suggest both activities are cooling off, although they remain at a relatively high level.

Powered by QE, S&P 500 constituents spent nearly US$590 billion in share buybacks in first quarter of 2016, up more than 180 percent from US$209.4 billion in the third quarter of 2009.

But amid rising rates, the number of buyback deals and the dollar amount involved have both been pulling back. M&A deals have shown a similar pattern.

If the Fed accelerates its rate normalization, that would further squeeze share buybacks and M&A deals, which means a major driving force for a US bull market is diminishing.

This article appeared in the Hong Kong Economic Journal on Mar. 2

Translation by Julie Zhu

[Chinese version 中文版]

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RT/RA

Hong Kong Economic Journal chief economist and strategist

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