M&A outlook bright but economy still in doldrums

MERGERS and acquisitions activity is set to intensify as the weak pound makes UK firms more attractive to overseas suitors in search of bargains, it has been predicted.

But the recovery in western economies may run out of steam later this year, according to investment house Threadneedle, with growth estimates for next year pared back as a result. And its caution was echoed yesterday by Barclays Wealth, which forecast a sluggish economic recovery over the rest of 2010.

In its latest investment outlook, Threadneedle said a combination of high free cash-flows, low returns on cash and attractive valuations would drive more M&A activity in the coming months.

Sarah Arkle, chief investment officer at Threadneedle, said: "Currency effects have made UK companies particularly attractive to overseas suitors and this market, with its constructive takeover laws, may be a focus of corporate activity," said Arkle.

M&A activity may also be boosted by strong equity performance, itself supported by a benign global inflation outlook that means any interest rate hikes in developed economies will be gradual, claimed Arkle.

"In this environment, risk assets can continue to perform well and we remain overweight in equities. Markets are increasingly being driven by upward earnings revisions as proof emerges that the strong will get stronger in a period of prolonged sub-trend growth," she said.

However, Arkle said she expected the strong western economic growth of the first half of 2010 to peter out in the second six months. "The rate of activity around the year-end has a significant effect on the full-year numbers, resulting in relatively muted estimates for 2011 growth in the US, eurozone and UK," said Arkle.

Barclays Wealth also warned yesterday that the recovery would be sluggish over the rest of the year. Michael Dicks, chief economist at Barclays Wealth, said the western economic recovery was being hindered by poor performance in Europe, which he described as "still the weakest link in the global economy".

"In the euro area, for example, fourth-quarter GDP turned out below our December prediction," he said.

Both Threadneedle and Barclays Wealth warned that while the outlook remained more positive elsewhere in the global economy, there were potential constraints on emerging markets performance.

Arkle said: "Although we remain positive on the economic fundamentals in emerging market equities, interest rates are now on an upward trend in many emerging markets and this may make it harder for them to outperform in the short term."

Dicks added that while emerging markets were well positioned for economic growth, Asian inflation risks were increasing.

"Fiscal stimulus is being reined in, particularly by the bigger emerging markets, but the sheer strength of the recovery means that monetary tightening will proceed at a faster pace than we had been thinking formerly."