This article first appeared in Personal Wealth, The Edge Malaysia Weekly on October 28, 2019 - November 3, 2019

Global dealmaking has seen a slowdown this year and it is expected to continue into 2020, according to multinational law firm Baker McKenzie. The firm expects investors and corporations to remain cautious in the coming year as they face mounting economic and geopolitical challenges.

These challenges include slowing global GDP growth and the ongoing trade tensions between the US and China, fuelling fear of a worldwide recession. “We forecast that global mergers and acquisitions (M&A) volumes will drop to US$2.1 trillion during the year, a fall of US$700 billion from our estimate for 2019,” it says in its Global Transactions Forecast 2020 report.

“While we anticipate a similar downward trend in initial public offering (IPO) proceeds, the potential listing of [Saudi Arabian energy giant] Saudi Aramco is forecast to provide a one-off boost to capital raised next year. Therefore, we see IPO proceeds rising to US$215 billion in 2020, from an estimated US$152 billion in 2019. A broader rebound in activity should then unfold from 2021 as conditions become more transaction-friendly.”

The firm notes that macro indicators should improve from 2021 as the global economy stabilises, financial market volatility subsides and a weakening dollar improves liquidity, which will lay the foundation for a gradual rebound in M&A activity.

According to the report, deal volumes in Asia-Pacific are likely to moderate in 2020 before seeing an upturn in the following year. Transactions have cooled in 2019 and cross-border activity has been particularly slow.

This partly reflects the reduction in Chinese outbound deals due to government restrictions on outward investments. It is also the result of a broader loss of economic momentum across the region, which is linked to the slowdown in global demand.

M&A activity in Asia-Pacific is expected to decline by 18% to US$634 billion this year, then to US$529 billion in 2020. However, a modest resurgence should surface the following year, due to a stabilisation of liquidity conditions and an improvement in equity markets.

“However, there are some notable exceptions. Healthy M&A activity in Japan has been fuelled by conglomerates selling non-core assets and by companies seeking growth opportunities through outbound acquisitions. Meanwhile, the dynamic economies of Indonesia, Thailand and Vietnam remain attractive targets for overseas investors,” says the report.

“Looking ahead, domestic industry consolidation in China and changing consumption and production patterns across the region will be key structural drivers of M&A activity in the years to come.”

The report notes that dealmaking activity in Malaysia has remained fairly robust, although investor sentiment may be dented next year as the economy faces increased headwinds from subdued Chinese import demand and increased trade protectionism. But this should be a temporary setback and activity is expected to pick up again in 2021/22.

Asia’s IPO market has had a quiet year in 2019 as global uncertainties prompted companies to reschedule listings. Corporations are likely to stay similarly cautious over the next 12 months, with momentum picking up again in 2021/22.

“Overall, we expect domestic listings across Asia-Pacific to raise US$36 billion in 2019, a sobering 43% decline from last year’s total. IPO proceeds are forecast to decrease further to US$33 billion in 2020. One big exception this year has been the Singapore market, where the listings of four real estate investment trusts helped push total proceeds to an estimated US$2.4 billion,” says the report.

The analysis suggests a further softening of global dealmaking over the coming year in an environment of heightened economic and geopolitical uncertainty, it adds. Yet, the medium-term outlook is brighter, given the underlying structural trends shaping the global economy.

“This year’s M&A slowdown was expected as favourable conditions have been building for some time. Even in the US, where transactions have remained robust, there have been signs that companies are less comfortable with high valuations and rising corporate leverage than a few years ago,” says the report.

“This could indicate a downturn in the deal cycles on the horizon. As a result, we see investors becoming more selective in the coming months. However, companies will always be interested in strategic acquisitions when opportunities come along.”

From a global perspective, IPO levels have been disappointing in 2019 and a broad, near-term rebound seems unlikely, given the likely increase in overall volatility. However, IPO pipelines are healthy and some firms may look to accelerate their flotation plans, fearing a renewed slump in equity prices.

“Though investors may proceed cautiously in the immediate term, the medium-term drivers remain positive overall. Where organic growth opportunities prove scarce, companies will look to identify acquisitions that make strategic sense,” says the report.

The prospects of technology deals look strong, with firms in all sectors needing to partner technology players in the disruptive digital age, it adds. So, despite the challenges at hand in the near term, investors can remain optimistic about the future of the deals landscape.

Warning signs across the globe

According to the report, the impact of the US-China trade tensions on the global economy has been modest so far. However, new US tariffs on Chinese consumer goods could have a much greater impact as the economic outlook has deteriorated in the US as well as other parts of the world.

The consequences could be amplified through falling confidence levels and the subsequent effect on financial markets. Trade tensions are also rising beyond the US-China front line, as exemplified by Japan’s trade restrictions on South Korea.

“Adding to the gloom, bond markets have been flashing recession warnings for the US economy. The 2-year and 10-year US Treasury bond yield curve inverted this year for the first time since June 2007. Historically, such movements have proved to be a highly reliable indicator of a recession within the next year or so. However, their predictive power is debatable as the US Federal Reserve’s recent bond purchases may have distorted price signals,” says the report.

The Fed’s response to a faltering US economy has been an abrupt U-turn in monetary policy. In a shift from quantitative tightening to easing, the central bank cut interest rates in July and September. Baker McKenzie anticipates another two rate cuts this year.

In a similar vein, the European Central Bank has cut its deposit rate and resumed quantitative easing (QE) purchases. “We remain sceptical that QE or interest rate cuts can meaningfully boost demand, especially as China seems unenthusiastic about large-scale stimulus measures and is reducing its potential support to the rest of the world,” says the report.

“Elsewhere, some governments do seem willing to reverse the austerity measures introduced after the global financial crisis. It remains to be seen whether any spending increases beyond what is in their current fiscal plans will be enough to give the global economy a major lift.”

There is also a high risk of a correction in global equity markets in the coming months, ushering in a period of protracted volatility. The global equity market decline in late 2018 was offset by a rally in early 2019, but a slowing global economy does not bode well for corporate profits, equity or credit risk premiums, says the report.

“Earnings are already deteriorating in cyclical sectors and leading indicators suggest downward profit revisions on the horizon. Monetary policy easing by major central banks has buoyed market sentiment, but this may prove to be a case of hope over experience,” it adds.

“Looking beyond next year, we expect a more positive picture from 2021 onward. However, any rebound in the equity markets will likely be limited, offering only a modest catalyst to dealmaking activity.”

The outlook for emerging economic regions is conservative as well. US-China trade tensions are escalating just as Southeast Asia’s export growth finds itself in the doldrums. Over the past year, export momentum has been hit by weakening Chinese import demand, a slowdown in the global information and communications technology cycle and intensifying trade protectionism.

Southeast Asian governments are expected to ease monetary policy as a result. But the pace of rate cuts will likely be modest, given the region’s debt overhang and its vulnerability to renewed risk aversion, says the report.

“Despite the challenges besetting the global economy, it should be possible to avoid an outright recession, barring any adverse shocks. This scenario assumes that the governments will loosen monetary and fiscal policy to stabilise financial conditions and GDP growth. Underlying uncertainties affecting manufacturing should then begin to fade (or at least not worsen), staving off sharp investment contractions,” it adds.

While in the short term, the uncertain environment will sustain the recent strength of the US dollar, the currency is expected to weaken beyond 2020, which will incentivise global trade and financial balance sheets in the emerging markets. The weakening of the US dollar will be caused by the decline in interest rate differentials between the US and other economies and by a sharp slowdown in US growth next year. Oil prices are also expected to remain subdued, staying below US$65 a barrel throughout the forecast period.

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