A shrinking stock market should drive prices up

The combination of firms exiting public markets via private equity deals & consolisation, with few firms of similar standing replacing them, is almost certain to drive share prices higher.

The reasoning is this:
Shareholders in exiting companies are typically receiving cash on the deals. The outlets for them to reinvest the funds is often restricted. Often this is because by various rules set by their policies or regulators eg percentage ceilings on investments in any one company and max percentages on asset classes that are not liquid public markets eg alternative investments. Hence one may have to reinvest funds back in the same but shrinking market.

(Almost peversely, asset diversification frameworks can coral funds into potentially overvalued markets eg equities)

With the same amount of money chasing after fewer companies, the effect will be to drive asset prices up. Moreover, investors are fervently betting on who the next bid target might be in a shrinking list. This is based on the view that private equity firms are awash with cash and need to invest it to maintain returns & justify fees.

The increase in prices also has the effect of increasing the value of pension funds which invest in public markets & reducing some of the pension fund shortfalls that have beset many companies. These shortfalls have, in recent times, detered buyers who were forced to consider making good the deficits eg WH Smiths. The FT reported yesterday that the aggregate pension deficit of listed UK companies has fallen sharply in recent years. This in turn makes companies more attractive bid targets.

So how will this merry go round stop? Probably when the bankers financing many of the Private Equity deals decide that the risks associated are simply getting too hot. With interest rates rising and yields on deals under pressure (because of the higher prices being paid) this day may not be far away.

posted by John Wilson @ 6:48 PM Permanent Link newsvine reddit


At 11:35 PM, Blogger Neil Good said...

John, a minor point but in the sentence "(Almost peversely, asset diversification frameworks can coral funds into potentially overvalued markets eg equities)", I think you meant "corral" rather than the stuff growing a few feet under off the coast of Queensland.....


Also, "perversely" came up as well.....Google Toolbar with the spellcheck picked that one up.......it is really good for spellchecking text comment boxes like this one I am typing now.....worth a look!!

A rare spot in an otherwise prolific high quality output.....thanks once again!

Neil Good.


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