Barclays Wealth has pinpointed opportunities for investors to profit from the anticipated revival in global merger and acquisition (M&A) activity this year.
The financial crisis and the freezing of credit markets prompted a dramatic drop in M&A transactions to levels not seen since 2002, from a peak in 2006.
But over the past year a rebound in equity markets and valuations, the rehabilitation of credit markets and global economic recovery have created an environment ripe for M&A.
David Turner, investment strategist for Barclays Wealth, notes that companies with strong balance sheets can now borrow at some of the lowest rates ever known.
“At present, non-financial balance sheets do not look excessively leveraged, and haven’t for some time,” he said. “What has changed over the past year is the ability of the corporate sector to issue debt.”
He points out that forward-looking measures suggest equity markets on the whole appear reasonably valued in terms of earnings, dividend yields, cash-flow and book value.
“Relative to corporate bond yields, most non-financial sectors of the equity market [excluding financials] look attractively priced, with cash-flow yield spreads well above historic averages,” he notes.
“The implications of this are that corporations as well as private equity and leveraged buy-out firms can acquire targets at a price where cash flows can be used to finance interest payments on debt.”
Turner advises clients to tap into this possible trend via active long-only managers which seek to exploit M&A activity. Merger arbitrage hedge funds also offer exposure.
The research team at Barclays Wealth outlined three other themes for investors to consider for 2010: non-cyclical equities, renminbi appreciation and shorting gold.
It notes that the two most visible sector leaders in the global equity market rally to date –financial and basic materials stocks – are showing signs of running out of steam, while some of the laggard sectors are beginning to improve.
Barclays Wealth is advising clients to add positions in some non-cyclical sectors with inexpensive valuations and pinpoints consumer staples, including beverages, food products and tobacco.
“They [consumer staples] can be viewed as a defensive hedge, but not always: they can do well in a rising market, not least because they offer exposure to more positive market developments such as the revival in M&A we anticipate,” Barclays notes in a report.
It also highlights pharmaceuticals, although admits this is more of a leap of faith, and the telecoms sector, where it reckons dividend-based valuations look appealing.
Investors are urged to gain exposure to these non-cyclical sectors through ETFs in the US market or via actively-managed funds.
Separately, Barclays expects Chinese authorities to allow the renminbi to begin appreciating in 2010, having remained fixed at 6.8 to the US dollar since mid-2008.
Concerted pressure is now being placed on China by its trading partners amid accusations that its exporters have had a “free ride” on a weakening US dollar.
A stronger domestic currency would also align with China’s goal of encouraging greater domestic consumption. And it would be attractive to policy-makers as a means to relieve inflationary pressure building on the back of higher food and energy prices – effectively reducing the local price of dollar-invoiced imports.
“Asian assets, particularly equities, had an excellent run in 2009,” said Manpreet Gill, Asia strategist for Barclays Wealth. “This year we are expecting Asian currencies to follow suit, aided by strong capital flows, higher interest rates and the likelihood that China will begin to allow the renminbi to strengthen against the US dollar.”
It recommends adding exposure to the South Korean won, Indian rupee, Indonesian rupiah, Singapore dollar and Taiwan dollar against a basket of developed currencies.
All have experienced large sell-offs and only partial recoveries in the last 18 months, and Barclays believes they are set to appreciate.
Further, it believes that gold is significantly overvalued relative to fundamentals, having risen 23% in the year to December 21. Aggressive investors should consider shorting the commodity, it says.
Michael Crook, alternatives strategist for Barclays Wealth, explains: “Due to the impact of gold-based ETF demand, an overpricing of the fear premium and confusion over how monetary policy works in a zero interest rate environment, gold is substantially overvalued in our opinion.”
He acknowledges that market momentum could result in the trade losing money before it is successful, and advises investors to consider shorting gold prices by buying long-dated put options (to sell at a specified price in a specified period) on one of the gold-based ETFs or through a structured note.