Deal fever's amber light for market ostriches

By Neil Behrmann

January 07 - Four years ago, only weeks before the Iraq war, global stock markets were steeped in gloom.

Despite exceptional values shares were shunned and broker and investment bank employees around the world were laid off in their thousands.

Contrast that gloom with the fever of the past few months. Members of the global financial community have become adept at burying their heads in the sand. They are ignoring some worrying economic trends and arguably worse geo political uncertainties than those preceding the initial Iraq conflict.  At that time few doubted that the US and British allied command would easily win the war.

Scale of deals remarkable

Before examining today's risks and extraordinary contradictions in global financial markets, reflect on the scale of market activity in the past year. The pace of global offerings of stocks and bonds soared to unprecedented levels in 2006, according to Thomson Financial. Fuelled by the growing corporate appetite to fund acquisitions, easy access to capital and soaring initial public offerings in emerging markets, worldwide volume of debt, equity and equity-related securities soared to a record $7.64 trillion in 2006. The issuance compares to $6.62 trillion in global offerings in 2005, $5.77 trillion issues in 2004 and $5.36 trillion in 2003. Global initial public offerings, i.e. new equity listings, soared by 56 per cent to $257 billion. There was also a surge in high risk bond issues. Global junk bond issues surged by 51 per cent to $182 billion and emerging market debt issues jumped by 24 per cent to $111 billion.

Mergers and acquisitions fuel fever

Mergers and acquisitions to a large extent fuelled the global stock market boom. The average daily volume for worldwide merger and acquisitions announced in 2006 was a whopping $10 billion a day, according to Thomsons. That translates into a record $3.7 trillion in announced M&A deals shattering the previous record of $3.4 trillion established in 2000. Thomson estimates that Asian Pacific and Central Asian M & A deals soared by 30 per cent to $322 billion in contrast to a 40 per cent slide in Japanese deals to $100 billion. Worldwide, the growth of deal making was boosted by an unprecedented volume in cross-border acquisitions, greater access to liquidity and, in no small part, the explosive advance in private equity funds and deals.

The last time global underwriting M & A experienced a similar period of growth was the period 1996 to 1999. We all know what happened subsequent to that period. We also know that a boom can continue for longer than expected. Those who prematurely called the end of the nineties boom, including former Federal reserve Chairman, Alan Greenspan, had yolk splattered over their faces.

Contradictions in global markets illustrate dangers

Still some of the biggest US and European pensions are beginning to cut their equity exposure because of the contradictions in financial markets. Long US Treasury bond yields are lower than shorter term bond yields. This is a classic sign that bond market participants are expecting an economic slow down. Some economists believe that there is a 50 per cent chance of recession in the US, if the real estate market slumps. The dollar is declining because of these worries but long European bond yields are also down because of fears of economic slowdown in that region. Exporters and local industries have been squeezed by an increase in interest rates and a surge in the value of European currencies. If an economic slowdown is indeed a possibility European currencies may well be vulnerable. Oil and industrial commodities, fashionable for hedge fund and even pension fund speculators last year, are sliding as demand has failed to meet expectations.

Stock markets and leveraged funds ignore threat

Despite these concerns, global stocks - including emerging markets, highly dependent on exports to strong US and European economies - have continued their upward path. Central bankers in particular are concerned about a bubble of leveraged private equity transactions that have contributed in no small way to the rise in equity prices. They are also concerned about the massive growth in credit derivatives and hedge fund debacles such as Amaranth, which lost a staggering US$6,400 million in a few weeks.

Yield spreads between government bonds and emerging market and junk bonds have fallen well below the norm. Such trends normally mirror buoyant economies, but they contradict the low long term yields on government bonds which normally signal slowdowns.

These are just the economic and financial factors. Today's market ostriches are blocking out the geopolitical risks which are worse than 2003. Nuclear capability is spreading from North Korea to Iran which has expansionist aims inthe Middle East. The potential response from Israel and possibly Saudi Arabia is fraught with danger. Chaos in Iraq could become a full blooded civil war. Russia is using its energy resources to flex its power. Random terrorist attacks continue.


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