"Deja Vu": Mergers & Equity Market Tops, & Odds of Economic Recession
March 10, 2020 marks the 20th anniversary of the peak of the tech bubble. There were many factors that contributed to the tech bubble, and there were also numerous signs that equity valuations in 2000 reached unsustainable levels.
One of the most obvious examples of excess in the financial markets in 2000 was the AOL and Time Warner merger, which was announced on January 10, 2000. At the time, anything “Internet” related was viewed as “gold” and many Internet companies like AOL had market valuations that dwarfed traditional “blue-chip” businesses.
In 2000 AOL used its stock value as a currency to buy Time Warner, a company 5 times its size. To be sure, Time Warner’s revenues of nearly $27 billion was more than 5 times greater than the $4.8 billion for AOL, but AOL’s market capitalization of $180-plus billion, more than double Time Warner, enabled AOL to become the acquirer, and not the acquired.
That merger proved to be a “watershed” event. Two months later the tech bubble peaked and two years later, the combined AOL-Time Warner Company, announced a record loss of nearly $99 billion, which still stands for the largest annual loss in corporate history.
There is nothing comparable on the merger front in 2020, but one merger that may in hindsight be considered a signal of a market top is Morgan Stanley purchase of E-trade, announced on February 20, 2020.
The scale of the merger is much smaller ($13 billion vs. the $160 billion AOL-Time Warner) but the strategy behind each is somewhat similar. In 2000, the “Internet” market and its customers was the “gold” and in 2020 the equity market and its customers are viewed as the “gold”. (Note: at the end of 2019 the market value of equity (publicly traded and closely held) stood at record $45 trillion, more than double the 2000s level and a record 2X of Nominal GDP).
To be sure, Morgan Stanley intends to integrate the 5.2 million customer accounts and $360 billion of financial assets (mainly equities and stock-based compensation plans) into its wealth management business just like AOL wanted to integrate its 30 million subscribers into Time Warner’s media empire. Hopefully, the Morgan Stanley-E Trade combination will have more success.
The current equity market correction carries far bigger economic and financial implications than the Morgan Stanley and E-Trade combination. Each of the last two recessions (2001 and 2007/09) was triggered by sharp and protracted financial and real asset markets sell-offs.
In early 2000s household equity position suffered a $6.5 trillion hit (from peak to trough) and in 2007-2009 the loss was nearly $9 trillion.
On Thursday March 12 the Federal Reserve will release the Financial Accounts for Q4 2019 and it is estimated that household holdings of equities (direct and indirectly owned through mutual funds) will stand north of $33 trillion, the largest real or financial asset on household balance sheets.
Based on today’s equity market the current loss of equity wealth is already north of $6 trillion. While its impossible to pinpoint how much of an equity market loss would trigger a substantial spending pullback by the consumer, the combination of a sudden loss of wealth loss and sudden stop in travel and everyday work-life does raise the odds of abrupt drop in consumer spending, and an outright economic recession.
The formal definition of recession is that the drop in economic activity has to be as deep as the shallowest on record (about 0.5%) and as long as the shortest on record (6 months). Whether the requirements of full-blown recession are met or not, the “speed” of the economic and financial adjustments nowadays will make it feel as bad, or even worse.