Capital markets are poised to take off in 2024 on a resilient U.S. economy and the expectation that the Federal Reserve will cut interest rates later this year, according to two recent analyst reports.
CFRA analyst Michael Elliott points out that many investment banks went on senior hiring sprees last year, “signaling internal expectations for a recovery sooner rather than later.”
The optimistic indicators come after a drought in M&A activity, which in turn weighs on demand for equity and debt issuances. “2023 was a difficult 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 (“ECM”) and debt capital market (“DCM”) activity eked out modest gains, 7% and 6%, respectively, these returns remain poor when factoring in the already weak 2022 results,” the analyst wrote.
Morgan Stanley also expects a rebound in M&A. “Our Financials sector equity analysts expect global M&A volumes to rise 50% versus 2023, as leading indicators flash green, banks point to deal pipelines building, and headwinds to corporate confidence ease,” wrote the firm’s strategists and analysts led by Andrew Sheets.
By region, the Morgan Stanley team says Europe and North America are expected “with the most positive skew of activity;” however, Australia, India, Korea, and ASEAN will also have favorable conditions. In Japan, M&A should be fueled by a broader shift toward increased corporate efficiency.
By sector, the strategists and analysts expect a resurgence in M&A activity in health care, real estate, staples, and technology.
M&A activity has already started to pick up, CFRA’s Elliott observed. Activity in January 2024, rose 15% Y/Y “and continued strong economic and equity market performance should fuel enthusiasm, deal making, and capital issuances moving forward,” he said. “As we look out in 2024, we believe improvement in the first half of 2024 will be modest before accelerating in the second half.”
That outlook is driven by two factors: (1) Investment banking deals take time, often six to nine months and maybe even more; and (2) interest rate cuts are projected to start in mid-2024.
Elliott expects that firms with higher investment banking concentrations are best positioned for the increase in M&A activity. Evercore (NYSE:EVR), Jefferies (NYSE:JEF), and Lazard (NYSE:LAZ) each had 2023 investment banking revenue mix exceeding 50%, he said. Meanwhile, at Raymond James Financial (NYSE:RJF) and Stifel Financial (NYSE:SF), investment banking revenue accounted for less than 17% or less of their total revenue.
Currently, the average price/earnings multiple of the group of five companies is 13.3x 2024 and 10.7x consensus EPS estimates compared with the investment bank and brokerage sub-industry’s 10-year average forward multiple of 12.6x. On a 2025 basis, that comes to a 15% discount, implying that “investors may not yet fully appreciate the potential for earnings growth to ramp significantly into 2025,” Elliott wrote.
In addition, the five firms have historically traded at multiples above the industry average, “providing an even larger 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.