NYSE Euronext Guest Writer Series will enable leading thinkers to share their thoughts and ideas with the broader NYSE community.
Guest Writer Paul Donahue is a 23 year veteran at Morgan Stanley and co-head of equity capital markets. He is a glass-is-half-full guy (even when the glass is full).
There are plenty of well-documented challenges to the health of global markets: the uneven economic recovery globally, sovereign duress in Europe and important world elections, to name a few. There are also regulatory developments in U.S. that could allow companies to remain private for longer while still enjoying strong access to capital. Among these: The Private Company and Flexibility Growth Act which makes it easier for companies to remain private. Lastly, some of the malaise with respect to IPOs that we saw at the end of 2011 has carried into the start of 2012.
Yet for all the macro challenges thrown at the markets in 2011 -- the equity capital markets proved resilient: open to both seasoned and new issuers alike. If even modest progress is made to any of these macro challenges, 2012 might be better than many think. And that will definitely contribute to improved equity volumes globally.
Several key trends may lead to a more constructive backdrop:
1. Declining “Volatility of Volatility”: Markets tend to focus on the VIX as a 'fear index' given its role in aggregating implied volatility of the S&P 500. The story of 2011 was less about the VIX and more about how quickly the VIX was moving in either direction. If one were to plot the daily moves in the VIX index like a seismic chart, it would seem like we had an earthquake in 2011. Indeed, in many respects we did -- or at least a huge aftershock to the 2008 volatility earthquake. A low VIX reading is unlikely to stimulate much activity if investors are afraid of it quickly gapping higher. So low volatility of the VIX is important. If the 'volatility of volatility' continues to ease, that will be a good backdrop for the equity new issue markets.
2. Alpha vs. Beta: In real estate, the cliché is 'location, location, location.' Last year in the equity markets, it was 'macro, macro, macro.' Correlations were at all time highs throughout most of the year. Looking into 2012, we may find equity new issues providing a bigger and much needed source of alpha for investors, which would help the new issue environment. IPO’s as a class outperformed the S&P 500 last year until the aforementioned spike in volatility. Initial public offerings remain an alpha opportunity for investors in 2012.
3. Increased Strategic Activity: Additionally, the search for alpha may also be coincident with increasing shareholder activism. Corporate execs are facing increasing pressure from shareholders to return capital to shareholders (through dividends or buybacks) and/or to increase growth (through R&D or strategic combinations). This pressure is in spite of (or because of) the fact that corporate balance sheets are generally strong, businesses are stable or growing modestly and many continue to have healthy cash flows. Issuing new equity isn't a typical response to activism, but looking at creating value through subsidiary IPO's, carve-outs and other vehicles involving the equity capital markets is. And for those companies that see opportunity to grow through acquisition, equity financing activity will likely accompany any increase in corporate M&A.
4. Pension Funding: Many companies have found a very difficult backdrop for their defined benefit pension plans in recent years. The Society of Actuaries estimates that required minimum contributions to pension plans will double in 2012 compared to that of 2011. Some parts of the equity capital markets, including the equity-linked market, may see increased activity as a source for funding corporate pension plans in 2012.
5. New Potential Ways of Raising Equity: Several pieces of legislation are in front of congress that, if approved, will make it easier for companies - particularly small and quickly growing companies - to raise equity capital. For example, The Small Company Capital Formation Act of 2011 will allow small companies to raise more money in unregistered offerings via Regulation A.