M&A, Buybacks Are Ignoring Potential Of Higher Interest Rates

In a new report, analysts at BNP Paribas discuss the disconnect between rising corporate bond yields and the elevated level of M&A deals and buybacks. According to BNP, buyback levels, M&A deals and corporate bond yields cannot all continue to rise for much longer.

Ignoring borrowing costs
In recent months, global equity markets seemed to have been ignoring rising corporate bond yields. Usually, this type of increase in yields would put downward pressure on share prices. The major breakdown in equity markets around the world over the past several trading days may finally be the type of pressure than BNP predicted in its August 19 report.

“Higher yields put a brake on valuations as the present value of future cash flows is lower, but also because rising yields offer more opportunities for investors, and fewer are likely to feel ‘forced’ into equities just to get dividends,” BNP explains in the report.

Pre-crisis M&A activity levels
BNP points out that both the total value of M&A deals and the premium payed by the buyer (over 30 percent) are both near all-time highs. The last time the M&A market saw this level of activity was 2007, a fact that should serve as a strong reminder of what can happen when liquidity is withdrawn.

What now?
BNP sees a recipe for equity market weakness brewing, and notes several reasons why stocks might not continue producing the same returns they have generated in recent years. With many companies now borrowing money to improve earnings via buybacks and acquisitions, rising borrowing costs could really put a damper on economic growth. Rising rates in conjunction with lackluster recoveries in both the U.S. and Europe leave valuations looking “stretched for the most leveraged part of the market.”