Four Reasons For Buying Into Better Growth This Year

OCEAN CITY — One of our themes for 2014 is increasing business confidence built off a stronger global economy that results in companies reducing their cash piles. In the first few months of 2014, a surge in merger and acquisition (M&A) activity is one reflection of this trend. After a pick-up in 2010, M&A deal volumes have failed to accelerate despite more positive projections, including our own.

We expect 2014 to be a stronger year, however, because many of the headwinds that have held back deals for the last three years are diminishing. We believe the industries that should benefit the most from this upswing can be found within technology, industrials and financials as well as the more defensive healthcare sector.

Large U.S. companies are generally awash with cash, reflecting the inclination of corporate executives in recent years to manage their businesses for economic disappointment, political uncertainty and changing regulations. We believe this mindset is changing, with companies now deploying their cash piles in numerous ways. We have highlighted expectations of growth in capital spending and more recently we discussed a growing emphasis on returning cash to investors in the form of dividends or share buybacks. We believe that this year M&A is likely to become a third means of deploying corporate funds to grow earnings. There are four reasons why M&A activity is likely to rise in 2014. First, U.S. economic growth is expected to be higher in 2014. Household and business spending look set to grow more quickly and the fiscal drag is likely to be diminished. The mean consensus estimate for growth of U.S. gross domestic product (GDP) in 2014 is 2.7%, which would be a significant jump from last year’s 1.9%. Historically, improving U.S. economic growth has coincided with a rising number of M&A deals.

Second, equity markets have recovered to historic highs and there has been a strong relationship between higher equity markets and greater M&A activity.

Third, political uncertainty has diminished. We believe the fiscal and regulatory uncertainties that have dominated Washington over the last three years have weighed on corporate activity. This year should bring a turn as budget battles have passed relatively smoothly and threats of other conflicts have receded.

Fourth, investors no longer want cash returned to them to the same degree as in recent years. BofAML Global Research’s latest Global Fund Manager Survey found a declining number of investors wanting cash returned to shareholders, with more of them looking for increased investment.

Perhaps the most important impetus behind growth in M&A activity this year is the way the market has been rewarding deals. BofAML Global Research found that in the U.S. in 2013, shares of companies that were acquired returned well above the index. Surprisingly, shares of the acquirers also outperformed the market, a less common occurrence. We believe investors are rewarding companies seeking to grow earnings — even inorganically — whereas in the past they often saw deals as value destroyers for the acquirer.

(A Merrill Lynch Wealth Management Advisor who can be reached at 410-213-8520.)