Animal Spirits Unchained: Is it time for new offerings, mergers, and acquisitions?

"The markets are moved by animal spirits and not by reason."--John Maynard Keynes.

Both stock and bond market investors were quick to price in President Trump's commanding win with equities rallying and fixed-income yields climbing as he secured all seven battleground states and the popular vote. The red tide rolled on as Republicans flipped the Senate and retained a wafer-thin House majority.

The Trump rally that had boosted bitcoin, small caps, and equities in general from mid-October until Election Day went into hyperdrive in subsequent days as energy, financials, cyclicals, and healthcare stocks rallied as well. Broadening of market participation--particularly after the narrow Magnificent Seven leadership in the early months of 2024--tends to be a constructive sign for the durability of any rally.

Fixed-income traders were mostly cautious, particularly at the intermediate and longer end of the curve. Shortly after election results became clear, the 10-year U.S. government bond yield touched nearly 4.5%, up from just 3.6% in early fall. Bond traders focused more on the potential for either growth in hyperdrive, tariff-induced reinflation, and/or some combination of both.

One notable offset to the more subdued mood among many bond traders: spreads (the differential in yield between less risky government bonds and riskier corporate paper) tightened to a 25-year low. Spread tightening tends to indicate confidence in the durability of growth and a corresponding lack of stress on riskier entities. The vibe seems to have shifted.

Corporate America has been cautious for much of the past two years as viewed through the lens of M&A, IPO, and weak bank lending activity. Given persistent predictions of a recession, and with Federal Reserve policy rates in restrictive territory, managements primarily focused on preserving margins via inventory control, patient hiring, pricing changes, and streamlining input costs.

The Federal Trade Commission under President Joe Biden had blocked a number of large merger and acquisition attempts, including Kroger and Albertsons, Microsoft and Activision, and Tapestry and Capri. This cast a shadow on management's willingness to attempt tie-ups.

Increased regulatory and oversight restraints, volatile markets, and the fear of impending recession have kept many companies private, exacerbating a long-term trend. At the peak in 1996, there were 7,300 publicly held companies versus 4,300 today.

While the decline in the number of publicly held companies has been dramatic, it does not correlate to a lack of business formation. A recent PwC update quoted PitchBook data that said private equity companies held 27,000 portfolio companies at the beginning of 2024, more than half of which had been on the books for four years or more. At mid-year, the bulk of those companies were still private.

Whatever side of policy debates anyone takes, the vibe change matters. The combination of humming innovation--think AI, alternative fuels, robotics, vaccine creation, medical technology, storage and transmission technology, and virtual reality--could mean the timing is ripe to tee up a cycle of new offering, merger, and acquisition activity. A host of Wall Street investment banks have indicated they are prepping for that very suite of activities early in the new year.

Our opening Keynes quote about the disconnection between animal spirits and reason could become the case as it has in the past (biotech in the mid-1980s, LBOs in the late 1980s, Internet tech in the late 1990s, housing in the mid-oughts). Fundamentals and a host of other fiscal and monetary policy moves must fall into place for the situation to remain hospitable to dealmaking. But the starting point is advantageous: U.S. GDP growth (2.8% in Q3) has trended above the rest of the developed world for many quarters. U.S. productivity growth has averaged 2% for the past five years, well above the rest of the world and the long-term U.S. average. The Fed has started a rate-cutting cycle, inflation is decelerating toward longer-term norms, and the jobs market is in better balance than two years ago.

If the incoming administration and Congress can tread a fine line to keep the framework helpful versus harmful, those animal spirits might have the opportunity to purr louder than they have in recent years.

Positive deal markets, especially when coupled with solid growth underpinnings, tend to be conducive to continued constructive performance in equity markets. The broadening of activity to other areas, such as small caps, industrials, financials, and cyclicals, is also helpful. For more than a year, volatility has been exceedingly low and markets have not experienced even a normal (5% to 10%) pullback in their upward march. The potential for interim headline-induced choppy market action is high as the incoming administration, along with new departmental and congressional leadership, starts on a clean-slate agenda. Yet the unleashing of animal spirits should create a conducive long-term backdrop despite any interim volatility.

Carol Schleif is chief investment officer at BMO Family Office. "BMO Family Office" and "BMO Wealth Management" are brand names used by BMO Bank N.A., BMO Family Office, LLC, and certain affiliates providing investment, investment advisory, trust, banking, and securities products and services. These entities are all affiliates and owned by BMO Financial Corp., a wholly-owned subsidiary of the Bank of Montreal (BMO). Investment products are not FDIC insured, not bank guaranteed, not a deposit, and may lose value. To learn more, visit www.bmofamilyoffice.com. Views and opinions expressed are Schleif's and do not necessarily reflect the views and opinions of BMO.