Emerging Market Growth Concerns Dull Global Outlook
While some of the emerging economies continue to face slow growth from lower commodity exports, the outlook for most developed economies has brightened in recent months. The U.S. slowdown during the first half of this year was not as bad as thought earlier, while economic trends from the Eurozone remain stable. Helped by sustained labor market gains, U.S. consumer sentiment is picking up again and should help aggregate growth during the second half of the year. Though Eurozone consumer confidence and retail sales were weaker than expected in July, the region’s unemployment rate remained steady in June. Consumers and businesses in Europe are likely to become more optimistic as the tentative deal to provide financial support to Greece reduces risks. The Japanese economy is likely to expand at a moderate pace this year, helped by the central bank’s bond purchases.
In contrast, some of the large emerging economies remain constrained as energy and commodity prices declined again after the second quarter’s moderate recovery. The Russian economy remains in a recession while the Brazilian economy is expected to remain stagnant this year as well as in 2016. In China, the government and the central bank are continuing their efforts to sustain economic growth at the current pace of 7 percent. However, there are concerns that the recent equity market volatility in China could limit growth by slowing investments and consumer spending. Nevertheless, lower oil prices should help consumers in China as well as in other large emerging countries such as India and Indonesia.
Global equity prices saw moderate gains in July as gains in the U.S. and Europe helped offset losses in Asia and select other markets such as Canada. Manufacturing activity growth was largely unchanged from the previous month, as the U.S. and most European countries saw further gains. Global services activity growth accelerated in July, again helped by gains in the U.S. as well as China, the U.K. and Spain.
GLOBAL INDUSTRY SPOTLIGHT FOR THE MONTH: HEALTHCARE
The pharmaceuticals segment of the global healthcare industry continues to see significant merger and acquisition activity. Several of last year’s transactions were aimed at moving the tax domiciles to more favorable locations, also known as tax inversions, but that has slowed following government opposition. Most of the recent transactions involve generic drug makers trying to streamline their product portfolios and achieve cost advantages through economies of scale. However, the major proprietary drug companies have stayed away from large acquisitions and have instead focused on buying out smaller companies with research capabilities or promising drug pipelines.
Over the last two years, no other industrial sector has seen as many mergers and acquisitions as healthcare. Within the healthcare sector, the pharmaceuticals segment has dominated as the total value of transactions continue to set new records. The primary driver in several of last year’s transactions involving U.S. based companies was the potential savings by shifting the tax domicile of merged entities to Canada or select European countries. Such deals, called tax inversions, were popular until the U.S. government publicly stated that it would try and prevent mergers designed only for saving taxes.
More recently, the focus has shifted to generic drug makers broadening their product portfolios or trying to extract cost advantages through economies of scale. Generic manufacturers have seen strong revenue growth and market share gains over the last decade, helped by the large number of patent expiries for proprietary drugs. However, more intense competition has reduced generic manufacturer margins even for drugs that have been blockbusters for the original patent holders. This has forced the generic companies to tighten their cost structures and broaden their product offerings through acquisitions. Many of the recent transactions were driven by this strategic need. A few transactions were to streamline the product portfolios, by divesting lower margin products acquired as part of earlier mergers.
At the same time, the world’s largest pharma manufacturers have so far stayed away from larger acquisitions. They have instead focused on buying out smaller companies with highly developed research capabilities, or promising new drug discoveries that are under clinical trials. This is again a continuation of their strategy of dedicating capital and management resources on research and development. Though these proprietary drug makers have seen slower revenue growth when compared to generic companies, their attractive margins and product pipelines continue to support equity valuations. Aggregate global pharmaceutical sales crossed $1 trillion last year and, according to Thomson Reuters, are projected to rise to $1.3 trillion by 2018. This revenue expansion should offer enough growth opportunities for the proprietary drug makers as well as the generic companies.
Another factor driving the heightened merger and acquisition activity is the low cost of capital, as interest rates remain exceptionally low in most major economies. It has probably never been easier for large companies with healthy balance sheets to raise debt in order to finance their acquisitions. In addition, low borrowing costs make return on invested capital more attractive for potential acquirers. Borrowing costs are expected to remain low, and help sustain increased mergers and acquisitions activity, as the U.S. Federal Reserve is unlikely to increase interest rates meaningfully in the medium term. Meanwhile, the European Central Bank and Bank of Japan are expected to continue their quantitative easing through most of 2016 while the Bank of England has further delayed its anticipated rate increase.
This article is for informational purposes only. This article is not intended to provide tax, legal, insurance or other investment advice. Unless otherwise specified, you are solely responsible for determining whether any investment, security or other product or service is appropriate for you based on your personal investment objectives and financial situation. You should consult an attorney or tax professional regarding your specific legal or tax situation. The information contained in this article does not, in any way, constitute investment advice and should not be considered a recommendation to buy or sell any security discussed herein. It should not be assumed that any investment will be profitable or will equal the performance of any security mentioned herein. Thomas White International, Ltd, may, from time to time, have a position or interest in, or may buy, sell or otherwise transact in, or with respect to, a particular security, issuer or market on our own behalf or on behalf of a client account.
FORWARD LOOKING STATEMENTS
Certain statements made in this article may be forward looking. Actual future results or occurrences may differ significantly from those anticipated in any forward looking statements due to numerous factors. Thomas White International, Ltd. undertakes no responsibility to update publicly or revise any forward looking statements.
