In the typical M&A cycle, tightening monetary policy and liquidity weighs on corporate earnings and growth. But as of yet, there's been no material effect on earnings or sales as a result of tightening. Some sectors have experienced a decline in sales due to commodity and currency impacts but overall, underlying economic growth and labor market conditions remain sufficient to pre-empt a significant decrease in earnings for other sectors.

Clearly, Bridgewater believes that the M&A boom isn't over yet; good news for equity investors. Three-and-a-half decades of data supports Bridgewater's conclusion that equity markets continue rising into the M&A peak. The average price increase in the year before an M&A peak is about 10%. In the year after the peak, equities fall around 25% on average. Despite the recent volatility in equity markets, corporations continue with M&A, buybacks, and financial engineering. Bridgewater concludes:

"As mentioned the normal linkages suggest a continued, self-reinforcing buildup in activity that would be supportive to the equity market and the economic expansion in the short term, with increasing vulnerabilities to an eventual tightening of monetary policy or weakening of the economy down the road."

Eoin Treacy's view

The pace of M&A activity has indeed picked up over the last year as corporations rushed to lock in the lowest funding costs and tightest spreads seen in years. The threat of tax harmonisation and a cross Atlantic trade agreement (TTIP) between the USA and Europe is an added incentive for corporations to use their cash while they still have it. The cost of M&A activity has increased in line with valuations. The first signs of stress in funding such endeavours with debt are now evident if the tepid response Dell’s proposed acquisition of EMC has received is any measure. 

The total value of M&A activity is closing in on the peak value of 2007 near $2 trillion but if the correlations in the above report hold good the prospect of the wider stock market ranging rather than trending lower would be bolstered. 

The Russell 2000 Index remains a relative laggard not least because small caps are among the most interest rate sensitive. It will need to break the progression of lower rally highs evident since June to demonstrate a return to demand dominance. 

The Nasdaq-100 Index has been a relative leader and has paused in the region of the September peak as it unwinds the short-term overbought condition. A sustained move below 4000 would question the support building hypothesis.