Economic signs point to slowing M&A activity

Mergers and acquisitions activity in the U.S., particularly in the manufacturing sector, will gradually decline in the second half of 2019, and this downward trend will continue for the foreseeable future.

The positive effects generated by an environment of low inflation, low interest rates and an expanding economy are being mitigated by rising uncertainty about future risks to the global economy.

This outlook is based on a complex and an ever-changing set of circumstances that I will try to briefly explain. I do not think these conditions will change overnight, but they could be substantially different by the end of the year. Consider yourselves warned.

After hitting a peak in early 2018, the trend in overall global manufacturing has been steadily downward. The J.P. Morgan Global Manufacturing PMI came in at 49.4 in June. This marked the second consecutive month the index fell below the breakeven level of 50, and it was the lowest level in more than six and a half years.

As always, there is some divergence in rates of decline among the various segments of the global manufacturing sector. Plastics processors that supply products for investment — better known as capital equipment — and intermediate goods segments have likely suffered the sharpest declines in recent months. The consumer goods segment is still holding up, but demand is decelerating.

The manufacturing data for the U.S. is generally better than the global data, but here, too, the trend in the manufacturing data is decelerating. I am becoming increasingly concerned that this deceleration in both the data from U.S. manufacturing sector and the data from the total U.S. GDP is occurring during a time of declining interest rates and a rising stock market.

The graph of U.S. mortgage rates is a good representation of what I mean. Interest rates hit a cyclical peak at the end of last year — about the time of the now infamous hike of 25 basis points in the Fed Funds Rate. But overall interest rates have declined by more than a full percentage point since that time. Despite this decline in interest rates, growth in real U.S. GDP has settled back to the trend rate of around 2 percent.

It is widely anticipated that the Federal Reserve Board will lower the discount rate by a quarter of a percent at its next meeting, which is scheduled for July 31. There has been a lot of debate in recent days about the necessity, the causes and the effects of such a move, but ultimately the aim is to stimulate economic activity in the U.S.

It is a long-believed tenet of classic monetary policy theory that lowering interest rates will decrease the cost of capital and thereby increase the demand for money. There is mounting evidence coming from both Japan and Europe that this is not always the case. Nevertheless, President Donald Trump and his advisers are adamant that the Fed must lower the discount rate, saying this will accelerate the pace of growth in the U.S. economy.

Only time will tell, but I do not think such a modest decrease in the discount rate at this time will have any noticeable effect on economic growth this year.

The Fed's anticipated move will push down rates at the short end of the yield curve — loans with only a short time until maturation — but the rates most often paid by businesses and consumers are based on the interest rates for 10-year Treasury notes or 30-year Treasury bonds. As the chart shows, the long-term rates are already quite low by historical standards.

It is hard for me to believe that another 25 basis points on the short end is going to do much to change the long-term outlooks for either consumers or businesses. And as it pertains to mergers and acquisitions, I do not believe it will have any noticeable effect.

That's because executives and investors cannot adequately identify and assess risk in the current environment. There is always some risk involved in any large business transaction, but right now there are just too many unknowns.

The main sources of unmeasurable risk for global executives at the present are diminished global trade activity, particularly between the US and China; uncertainty stemming from Brexit; the sluggish economic growth in Europe; and Iran. These issues are not new, and that is rapidly becoming main part of the problem. These concerns are taking on the appearance of being chronic and increasingly intractable without a significant disruption to global economic growth.

My nonscientific survey of the stories published in Plastics News indicate that the plastics industry has certainly experienced a rising trend of cross-border mergers and acquisitions in recent years, but these numbers will likely be down this year. The number of cross-border mergers and acquisitions across all industry sectors so far in 2019 is down substantially when compared with the first half of last year. Prior to this year, the overall number of cross-border deals had been steadily increasing.

Not every transaction needs to have foreign buyers or sellers, and I am not predicting that the number of deals will crash to zero. But many industries, especially plastics, are increasingly global, and the global marketplace is always more active when there is a deeper number of participants. Right now, a lot of potential buyers and sellers are choosing to remain on the sidelines.

In my opinion, this uncertainty about geopolitical risk combined with the shortage of adequately trained workers are currently the major impediments to U.S. economic growth. And this uncertainty will not be ameliorated by anything the U.S. central bank can do, either at the end of this month or for the remainder of this year.