Capital markets are poised to take off in 2024 thanks to the resilience of the U.S. economy and expectations that the Federal Reserve will cut interest rates later this year, according to two recent analyst reports.
CFRA analyst Michael Elliott underlines this that many investment banks went on a senior hiring spree last year, “signaling internal expectations for a recovery sooner rather than later.”
The upbeat indicators come after a drought in M&A activity, which in turn weighs on demand for equity and debt issuance. “2023 was a tough year for investment banks as global M&A activity fell 17%, the lowest level in 10 years, according to Refinitiv. While both equity capital market activity ( “ECM”) and debt capital markets (“DCM”) declined modest gains of 7% and 6% respectively, these returns remain poor when taking into account the already weak 2022 results,” wrote l ‘analyst.
Morgan Stanley also expects a recovery in the M&A sector. “Our financial sector equity analysts expect global M&A volumes to rise 50% over 2023 as leading indicators flash green, banks target pipeline construction and corporate confidence headwinds ease,” they written by the company’s strategists and analysts led by Andrew Sheets.
By region, the Morgan Stanley team says Europe and North America are expected to “have the most positive tilt in activity”; however, Australia, India, Korea and ASEAN will also have favorable conditions. In Japan, mergers and acquisitions are expected to be fueled by a broader shift towards greater business efficiency.
By sector, strategists and analysts expect a pickup in M&A activity in healthcare, real estate, consumer staples and technology.
M&A activity has already started to pick up, CFRA’s Elliott noted. Activity in January 2024 increased 15% y/y “and continued strong economic and equity market performance should fuel enthusiasm, deal-making and capital issuances going forward,” he said. “Looking ahead to 2024, we believe improvement in the first half of 2024 will be modest before accelerating in the second half.”
This outlook is driven by two factors: (1) investment banking takes time, often six to nine months and perhaps longer; and (2) interest rate cuts are expected to begin in mid-2024.
Elliott expects firms with higher investment banking concentrations to be best positioned for increased M&A activity. Evercore (NYSE:EVR), Jefferies (NYSE:JEF) and Lazard (NYSE: LAZ) each had 2023 investment banking revenue mix above 50%, it said. Meanwhile, at Raymond James Financial (NYSE: RJF) and Stifel Financial (NYSE:SF), investment banking revenues represented less than 17% or less of their total revenue.
Currently, the five-company group’s average P/E multiple is 13.3x through 2024 and 10.7x consensus EPS estimates versus the investment banking and brokerage subsector’s 10-year average forward multiple. 12.6x. On a 2025 basis, that equates to a 15% discount, implying that “investors may not yet fully appreciate the potential for meaningful earnings growth in 2025,” Elliott wrote.
Additionally, the five companies have historically traded at multiples higher than the industry average, “providing an even greater discount,” he noted.
For example, Evercore’s (EVR) 10-year average P/E is 14.4x, Jefferies’ (JEF) is 14.2x, and Lazard’s (LAZ) is 14.6x.