As 2021 ended, it was impossible once again to separate epidemiology from economics. Omicron was sweeping across the world and it appeared likely that even more revisions to growth forecasts would appear throughout 2022. But as we go to press, it looks like that threat has receded and the hope is that new variants will not result in full lockdowns again. They may well have an impact, but we won’t know to what extent, until they appear.
The past two years have been unrepresentative of any ‘normal’ economic cycle. With the deepest recession in recent history recorded in 2020 and then the huge upswing of the recovery in 2021, it’s no surprise that people are feeling a little giddy. OECD forecasts had global growth at 5.6% in 2021, continuing above trend at 4.5% in 2022, before settling to 3.2% in 2023 – still a strong number.
The key concern is inflation. In December 2021, the UK published a consumer price index number of 5.1% – the highest in more than 10 years and even higher than economists’ worst-case forecasts. Prices of goods leaving UK factories jumped a whopping 9.1% in November 2021. The Producer Price Index in the US surged to 9.6% and Eurozone inflation hit 4.9%, with Germany most concerning at 6%.
Supply disruptions have pushed up commodity prices. From mid-2020 to November 2021, oil prices more than doubled. Gas and electricity prices have soared, which is feeding through to household expectations of higher near-term inflation. Until recently, most central bankers insisted that these inflationary pressures would prove temporary and start to wane in 2022. There are certainly base-effect impacts contributing to the higher year-on-year numbers and this will reduce in Q1 2022. However, inflation will continue to be the biggest economic worry. As one economist said: “The only thing that was transitory about inflation was our forecasts.”
It’s inflation that’s led central banks to signal rate rises and, in the Bank of England’s case, real action through its first interest-rate rise in more than a decade – moving from 0.10% to 0.25%. Still an exceptionally low level, but in a market that’s been used to easy monetary policy for a long period of time, the speed at which further rate rises might be required could be a shock. As it stands, the market is pricing in UK rates rising to 1% by the end of 2022. In the US, the Fed has signalled a slightly more aggressive monetary tightening approach. In Europe, the European Central Bank has remained more dovish.
Cash for deals
So, what does the end of easy money and an environment of higher inflation but potentially slower growth mean for M&A activity? Globally, M&A topped $6trn in 2021 – a record. There remains plenty of capital from fundraising in 2018 and 2019, and corporates and private equity are driving activity. The US dominates, but Europe showed a 50% year-on-year growth in deals.
Private equity has $2trn of dry powder, while public companies have record amounts of cash on their balance sheets. Surveys of advisers also forecast a continuation of the strong 2021 trends throughout 2022, with mid-market private equity in particular expected to be extremely active.
Lofty valuations do not seem to be putting buyers off. The mean enterprise value to revenue was 3.6x revenue for Q3, up from 3.3x in Q2. Competition for deals as well as hot sectors, such as technology and software (6.1x), is again pushing that average higher.
Structural changes in the economy post pandemic may also change the shape of deal activity – how consumers shop and spend, how and where employees work, how companies adapt supply chains to reduce vulnerabilities and how investors allocate capital for social and environmental returns. This may lead companies to consider more non-core disposals, to concentrate resources on areas redefined by their post-COVID-19 strategy.
Economic uncertainty is a reality faced every year by investors and businesses as they set budgets and make forecasts, but 2022 seems set to be a particularly difficult one. Perhaps it will be a few more years before we can write an economic outlook without considering epidemiology after all.
Jackie Bowie, European head of real estate and co-head of European business, Chatham Financial – a member organisation of the Corporate Finance Faculty.