Waking the bull

If you needed confirmation of the merger and acquisition boom that is taking place in the US, Warren Buffet may well have just provided it after announcing the largest takeover deal of his investment career, with the $37bn purchase of Precision Castparts Corp (PCC).

The question now is, can surging merger and acquisition activity help drive US equity markets higher?

The renowned investor has made clear his intention to 'bag an elephant'
in a large deal to help to drive growth at his company, Berkshire Hathaway.

The acquisition of PCC dwarfs his 2009 purchase of Burlington Northern Santa Fe for $26.5bn, and is a move that is as much a bet on the recovery of the struggling oil and gas industry and the US economic recovery, as it is on the aerospace industry.

One for the record books

The deal provides further evidence of the optimism in corporate America and comes on the back of a surge in takeover activity involving healthcare, financial and retail companies in the month of July, with the value of deals exceeding $430bn, which makes it the seventh busiest month for mergers and acquisitions on record.

Although the tally marks a slowdown from June's all-time monthly high of $546.8bn, it still represents a near 50 per cent rise on July 2014, and the second busiest July since records began in 1980.

Despite this increased inactivity and the broadly improving macroeconomic picture, it is still difficult not to be cautious on the outlook for US corporates as we edge closer to the first interest rate rise by the Federal Reserve, possibly as soon as autumn this year.

In the first half of 2015, 10 of the largest American multinationals had their sales reduced by a combined $31bn, with a further rise in the dollar potentially slicing more than $100bn off dollar-denominated revenues, according to industry estimates.

Although rate rises are only likely to be gradual, concerns have mounted that the dollar will continue to move higher from here, versus other international currencies.

Alongside this, there are signs that wages are beginning to accelerate, resulting in higher unit labour costs and productivity is showing a weak underlying trend. This will either put a squeeze on margins or lead to a pick up in inflation, depending on whether companies can successfully pass higher costs onto their customers.

Back to basics

It is therefore now more important than ever to focus on investment fundamentals when investing in US companies, following years of share price growth across a range of companies and sectors. By using certain themes to formulate investment criteria, we can hopefully identify those investments with the best chance of producing attractive returns.

Some of the themes best suited to counter some of the aforementioned near term concerns include: companies with earnings that will be resilient to a possible fall in economic growth, companies not majorly impacted by a strengthening dollar, and companies with pricing power and the ability to maintain or expand their margins.

Given the relatively high rating on the S&P 500, there may be limits as to how far the resurgence in merger and acquisition activity and share buy backs can have on equity markets.

However being selective and focussing on fundamentals can help to insulate investments from macroeconomic headwinds, providing us with a better opportunities of realising superior returns. 

Claire Bennison is regional director at Brooks Macdonald in Manchester

She writes a regular in-practice article on asset management for Private Client Adviser