Intro

Morgan Stanley Research analysts Michelle Weaver, Michael Cyprys and Ryan Kenny discuss the resurgence in capital markets activity and how sponsors might deploy the $4 trillion that has been sitting on the sidelines. 

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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, U.S. Thematic and Equity strategist at Morgan Stanley.

Michael Cyprys: I'm Mike Cyprys, Head of U.S. Brokers, Asset Managers and Exchanges Research.

Ryan Kenny: And I'm Ryan Kenney, U.S. Mid-Cap Advisors Analyst at Morgan Stanley.

Michelle Weaver: In this episode of our special miniseries covering Big Debates, we'll focus on the improving M&A and IPO landscape and whether retail investing can sustain in 2025.

It's Thursday, January 23rd at 10am in New York.

2023 saw the lowest level of global M&A activity in at least 30 years. But we've started to see activity pick up in 2024. Mike, what have been the key drivers behind this resurgence, and where are we now?

Michael Cyprys: Look, I think it's been a combination of factors in the context of a lot of pent-up activity and a growing urge to transact after a very subdued period of, you know, call it four- to six quarters of quite limited activity. Key drivers as we see it ranging from equity markets that have expanded across much of the world, low levels of equity volatility. broad financing, availability with meaningful issuance as you look across investment grade and high yield bond markets, tight credit spreads, interest rates stabilizing in [20]24, and then the Fed began to cut.

So, liquidity pretty robust, all of that helping reduce bid-ask spreads. In terms of where we are now, post election, think there's just a lot of excitement here around a new administration; where we could see some changes around the antitrust environment that can be helpful, as we think about unlocking greater M&A activity across sponsors as well as strategics, and helping improve corporate confidence.

But look, the recent rout of market could delay some of the transactional activity uplift. But we view that as more of a timing impact, and we are quite positive here in [20]25 as we think about scope for continued surge of activity.

Michelle Weaver: We've seen rates rising pretty substantially since December. Does that throw a wrench into this at all, or do you think we see more stabilization there?

Michael Cyprys: I think it could be a little bit of a slowdown, right? That would be the risk here, but as we think about the path for moving forward, I do think that there are a lot of factors that can be very helpful in terms of driving a continued pickup in activity, which we're going to talk about -- and why that will be the case.

Michelle Weaver: Great. And you mentioned financial sponsors earlier, I want to drill down there a little more. What do you think would get sponsor activity to pick up more meaningfully?

Michael Cyprys: Well, as I think about it, activity is already starting to pick up clearly across strategics as well as sponsors. On the sponsor side, it's been lagging a bit relative to strategics. We think both of which will build, and Ryan will get to that on the strategic side. As we think about the sponsors -- they're sitting with $4 trillion of capital to put to work that's been sitting on the sidelines where you just haven't seen as much activity over the past couple of years.

Overall activity in [20]24 was probably call it maybe around 20 per cent below peak levels, and this is burning a hole in the pockets of both sponsors as well as their clients. And so, we see a growing urge to transact here, which gets to some of your earlier questions there too.

So why is that? Well, the return clock is ticking; the lack of deployment is hurting returns within funds. Some of this dry powder also expires by the end of [20]25; and so if it's not yet deployed, then sponsors won't get some of the performance fee economics that come through to them on that capital. So that's all, all on the deployment side.

As we think about the realization or exit side, we think that's probably going to lag, but we'd still expect, a steady build through this year. Today sponsors are sitting on call it around $10 trillion of portfolio of investments that are in the ground, and they haven't really provided much in the way of liquidity back to their customers, the LPs and the funds. And so, this is putting a little bit of a strain not only on the client relationships that want more money back from their private investments that haven't received it, but it's also one of the causes of what has been a little bit of a challenging fundraising backdrop across private equity funds.

Hence if sponsors can return more capital to their clients, that can be helpful in terms of healing the overall fundraising backdrop. So, look, putting all that together, we expect an expanding pace of transactional deal activity across the sponsors from both the buy side as well as the sell side in terms of our activity.

Michelle Weaver: And Ryan, how about IPOs? Have they been part of a similar trend?

Ryan Kenny: Yes, definitely. So, with IPOs, we're also expecting a significant resurgence off of a low base. So just to put some numbers on it. In 2024, announced M&A volumes relative to nominal GDP, we're around 40 per cent below three-decade averages; equity capital markets [ECM] or ECM was even more muted, 50 per cent below three decade averages. And the leading indicators for ECM are very similar to the leading indicators for M&A. You want a strong equity market, relatively low volatility so that companies have the confidence to go public and so that deals can price well. And those conditions are really starting to materialize already in 2024; and we saw a few big IPOs price well last year, and launch well. The fourth quarter also looks strong. We saw a significant acceleration in industry ECM activity in October, November, December. 4Q volumes tracking up over 50 per cent year-over-year.

Michelle Weaver: Let's dig a little deeper into potential policies from the incoming Trump administration. What are your expectations around antitrust regulation and its impact on M&A?

Ryan Kenny: So, Trump has announced his appointments to the FTC and to the DOJ antitrust division. And our expectation is a return to normal. And that's coming off of what was a more onerous and not-clear environment under Biden. The Biden administration's approach was to disincentivize M&A; and they did that by defining M&A market concentration in novel ways -- looking at things like labor markets, and looking at how competitiveness is defined in new ways. And these new ways of defining concentration decrease the clarity of whether a specific deal would be challenged.

So, from a CEO and board perspective, you don't want to waste the time of your management team and your board going through a deal that might not go through; in addition to the risk of prolonging the deal, and the risk of higher legal expenses during the process. So now that we're returning more towards normal, that's our expectation. We expect there will still be some deals like a challenge, but it will operate under more historical norms and so that really checks the box of getting CEO confidence up to transact more.

Michelle Weaver: And I know that dynamic you’re talking about with market concentration created quite a big drag on large M&A deals and large-cap M& A. Do you think we could start to see that come back as well?

Ryan Kenny: Yeah, expect large-cap deals to rebound even more than small-cap deals. When we started to see the activity pick up in 2024, it was led by more mid-cap corporates. And now we expect to see large deals return in force at a time when financial sponsors, like what Mike was just talking about, coming back in force at the same time -- which drives up the animal spirits when all parts of the M&A market are returning at the same time.

Michelle Weaver: And what are some other catalysts beyond the political side that investors should watch in 2025 around capital markets developments?

Ryan Kenny: So, I categorize it as macro catalysts and structural catalysts The macro catalysts are clarity on tariff and immigration policies, how that will impact GDP. Clarity on the interest rate path. And look you don't need more rate cuts to get this market moving; you can still have a significant increase, even if there are no more rate cuts this year.

But narrowing the range of outcomes is important. And I think we're already there, where maybe we get no cuts this year. Maybe we get two cuts. It's a much tighter environment than where we were over the last few years. And so that helps narrow the bid-ask spread between buyers and sellers.

Structural catalysts that are really critical this cycle are the need for AI capabilities. Innovation in tech, innovation in biotech healthcare, the energy transition, reshoring and exploring your geographic footprint in a multipolar world -- are all really critical when you evaluate the types of companies that a board would want to acquire.

Michelle Weaver: What’s your outlook for 2025? And then even beyond that when it comes to both M&A and IPO activity?

Ryan Kenny: So, in 2025, we see a strong rebound in both ECM and M&A. ECM volumes in our base case, we expect to roughly double off of a low base. M&A announcements, we expect up over 50 per cent year-over-year in 2025. And importantly, that's our base case. Even in our bear case, we model an increase in both ECM and M& A volumes, given we're coming off of such low levels.

We've had three years of light activity and pent-up demand, and pipelines have already begun to build. When we look forward beyond 2025, we think this is the beginning of a multi-year capital markets growth cycle -- with bigger deal sizes and more deal count than average, driven by three years of pent-up demand and an economy that's a third larger than 2021, which was the last time we had a capital markets cycle.

Michelle Weaver: And then Mike, what does this rebound in capital markets activity, including M&A and IPOs means specifically for retail investing?

Michael Cyprys: Overall, a supportive macro backdrop with a rebound in capital markets activity, we think should be helpful in terms of bringing more investors into the markets, including retail investors. Whether it's from corporate actions and IPOs, it helps in terms of more stocks to trade; also helps in terms of revising animal spirits.

I think that's all helpful in terms of supporting engagement across both single stock volumes and equity markets as well as options. So, all of that together, we were expecting greater investor engagement here in [20]25. And confidence as well can help boost not just trading volumes but also margin lending and securities lending. And so, all of that can be helpful as we think about our forecast for our retail brokerage coverage group.

Michelle Weaver: Mike, Ryan, thank you for taking the time to talk. And to our listeners, thanks for listening. If you enjoyed the podcast, please share it with a friend or colleague today.