Despite positive performance through mid-month, U.S. equities dipped lower in August as investors remain cautious regarding inflation and rising rates. The initial strength in equities to begin the month signaled some hope that inflation may have peaked, but concerns over weaker company guidance, an emerging energy crisis and current geopolitical tensions caused stocks to sell off by month-end. While recent economic data signals a looming recession, earnings have been resilient, the labor market remains strong and share buybacks are approaching an all-time record for the year.
The Russia-Ukraine war, which now has lasted over six months, continues to negatively impact the global economy. Since Russia invaded Ukraine in late February, the U.N. Refugee Agency estimates that over 7 million Ukrainians have become refugees and moved to neighboring countries. Currently, Europe’s largest nuclear power station, Zaporizhzhia, is Russian-occupied and has become a fighting ground between both sides. Combat around the nuclear power plant has created fears over the heightened risk of a nuclear disaster.
On August 26, Fed Chairman Jerome Powell indicated during his Jackson Hole speech that he expects the central bank to continue to raise rates in a way that may cause “some pain” to the U.S. economy. The Fed remains committed to attacking inflation which approaches its highest level in more than 40 years. Looking ahead, the next FOMC meeting is September 20-21.
Performance in the Merger Arbitrage space in August was supported by deals that made significant progress towards closing, like Avast, which received clearance from the U.K. CMA following an extended antitrust review; and, Nielsen Holdings plc, in which the acquirers reached an agreement with Nielsen’s largest shareholder to ensure the shareholder approval is successful. There were many noteworthy deals that closed including Vifor Pharma AG, SailPoint Technologies and Turning Point Therapeutics. Deals announced in August are providing a robust pipeline, Vista Equity Partners acquisition of Avalara for $8 billion, Pfizer’s acquisition of Global Blood Therapeutics for $5 billion, and Amgen’s purchase of ChemoCentryx for $3.5 billion.
Looking at the convertible securities space, the primary market has slowed significantly in 2022 but is beginning to pick up with August being the busiest month of issuance year to date. Convertible terms are improving for investors with a weighted average yield of 3.3% and a premium of 30%. Structures such as this should provide a more asymmetrical return profile than we have seen from issuance in some time. We are optimistic that this issuance will continue through the fall. As we have noted, this year we have seen companies test the waters with potential deals only to pull them given the market conditions. At the end of the day these companies will still need capital to operate, and the convertible market remains one of the least expensive ways for them to raise that capital. We see an opportunity for companies to issue new convertibles in exchange for existing issues. This could be an accretive transaction for the company while extending or laddering maturities to be more manageable. For investors, we continue to expect higher yields and lower premiums. In past downturns, the convertible market has been one of the first markets to rebound both from an issuance and performance perspective. This is because convertibles can be issued quickly and less expensively than traditional bonds or equity. The equity optionality allows investors in these issues to participate in the upside as the market recovers.
09/13/2022
Gabelli Funds, LLC
