What’s The Deal? | 2024 Outlook: Windows of opportunity, bouts of volatility 

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Kathleen Darling: Hello, and welcome to What's the Deal, our investment banking series here on JP Morgan's Making Sense podcast channel. I'm your host today, Kathleen Darling, a member of JP Morgan's debt capital markets team. Today, we're diving into the dynamic world of capital markets with Achintya Mangla, global head of equity capital markets, and Kevin Foley, global head of debt capital markets. Achintya, Kevin, great to have you both on the podcast.

Kevin Foley: Thanks so much for having us, Kathleen.

Achintya Mangla: Kathleen, thank you for having us here.

Kathleen Darling: It's certainly been an interesting and dynamic year for capital markets. Let's first start with a quick year in review. Can you both name one or two major highlights for capital markets in 2023, Achintya, let's start with you.

Achintya Mangla: Sure, Kathleen. I would say the key word is resilience. And I would put it in two buckets. I would start with technology. I think going into and transitioning from a very low rate environment to the current rate environment, there were a lot of question marks on what happens to the tech sector. And I think resilience is the key word when we look at the entire global tech landscape. Away from the performance of the big seven, which is significant and driving a large part of the market gains. I think we have seen companies starting to successfully navigate the journey in profitability while maintaining some element of growth. And I think that balance of growth and profitability is something that we got to give both shareholders and management of these tech companies a lot of credit for achieving in a very credible way. They're reducing cash burns and achieving a business model that can sustain these rates. And at the same time, we continue to see meaningful innovation in the tech space. Clearly, the last 12 months or more have been inspired by AI and large language models, but it is more than just one or two companies. It is the entire ecosystem of innovation. And some of it, the evidence we will only see a few years later, because while the private capital markets in later stage companies have been slow, the reality is we have seen a very meaningful pickup in early-stage venture financing for the tech companies, which really points to greater innovation. So that's on the tech side. I would also say on the secondary markets, and I was wrong once again. When I started the year, I don't think I would have predicted the S&P and NASDAQ to be where they are. But I think the markets have been incredibly resilient, really driven by optimistic data on the inflation side and good earnings data. What's interesting, though, is the primary activity on the equity capital market side hasn't really caught up with the secondary markets, and I think that's unusual to have such a low correlation between a very strong secondary market, but rather muted primary activity. So resilience, Kathleen, is what I would say is the key highlight.

Kathleen Darling: Great. Kevin, can you pick up on that?

Kevin Foley: Sure. I'll play right off the term of resilience, 'cause it's definitely been the factor in the credit markets as well, right? We've had an economy that's been more resilient. We had an employment picture that's been more robust. The conviction around the end of fed hikes has set off a rally here along with the optimistic view of inflation being under control and with the consumer spending remaining robust, all of that has driven a rally here in the last six plus weeks in the credit markets. It's also been helped by the fact that there has just been a lack of supply in terms of primary market, so you have an environment right now where the need to come to the market for refinancing, is limited. You have a muted M&A picture. And you have limited Capex investment or balance sheets that are well-funded already for those investments. And that's keeping new supply limited in an environment where cash is still abundant and there's a lot of liquidity looking to be put to work. And that's creating a very positive technical for our markets, across investment grade, leverage loans, high yield bonds. All of them have had the benefit of having demand outstripping supply, along with a more optimistic view of the economy and where we are in the rate cycle. That has driven a nice rally here at the end of the year. That has definitely been the biggest surprise of the year, and obviously the delay or potentially avoiding of a recession has been one of the biggest surprises of the year.

Kathleen Darling: There's a lot of uncertainty in the year ahead, from geopolitical concerns, the macro backdrop, both in regards to rate movement and a potential recession, as well as an upcoming presidential election in the US. We recently had Jay Horine, head of North American investment banking, on the podcast, and he's approaching 2024 with cautious optimism. Kevin, we've heard you stress the word caution before, so let’s dig into that.

Kevin Foley: I think cautious optimism is the right way to term the year. Yes, there is a reason for optimism given what we've seen and the resilience of the economy what looks like a conclusion of fed hikes, because the inflation data has been encouraging. But to declare we're out of the woods, it feels like it's a bit premature. We definitely have the impact of higher rates still working its way through the system. The consumer has been resilient, but that's because the jobs picture has held up. But what is going to be the impact on higher rates on businesses, individuals, as a lot of that still works its way through the system, regardless if inflation is under control or not. Higher for longer feels like it's the mantra. There's a lot of optimism out there about cuts coming from the fed as early as the second quarter of next year. That feels like it might be premature, to be drawing those conclusions. So a lot to be played out. Reasons to be optimistic, but there's also a lot of reasons to be cautious too. So I think we go into it hoping for the best but preparing for the worst. What we're telling our issuers and borrowers right now is there is a good environment. We are coming off the highs that we've seen over the past year. It's a good environment to go out and try to take advantage of the market technicals. When you look at spreads in the high yield market as well as in the high-grade market, neither one is indicating a recession. Or even the possibility of a recession. We're well inside the recessionary averages on a spread basis. We're inside the non-recessionary averages as well. So this is a good backdrop to take advantage of it. You mentioned the geopolitical concerns. Those are still hanging in the balance. We've got a presidential election. We've got the uncertainty around the economy. And there's always the known unknowns that could be a factor. When you look at QE and QT, these are unchartered waters that we're navigating through. And the side effects of that are to be determined.

Kathleen Darling: Achintya, what are your thoughts?

Achintya Mangla: Look, I agree with Kevin, but I would divide the world into I'm cautious on certain elements, and I'm optimistic on some others. And I'm really cautious on the secondary markets. Kind of a reversal of the highlights that we saw in 2023. I think geopolitics, we've talked about it, but an interesting data point that I heard and this might not be entirely accurate to the number, but there are, I think, elections in about 40 plus countries, which represent approximately 40% of the world's population, and 40% of the world's GDP. That is a lot of overhang, and probably unprecedented in recent history. I agree, I think the investors, both [inaudible 00:10:00] equity and credit, are probably being a tad too optimistic on the rate cuts. And I think the other two reasons to be cautious are we are yet to see the impact of lower inflation in corporate earnings. And I think that will drive equity markets to some extent, because the multiples are reflecting the expectation of lower yields, lower inflation, but the earnings are not yet reflecting an impact of lower inflation. So cautious on the secondary markets. I am a little bit more optimistic in terms of primary activity on the equity capital market side. This includes IPOs, follow on offerings, private capital. And it's really driven by various issues, including some companies will need to provide liquidity to shareholders. Others would have made a significant journey towards a business model which combines growth with profitability. And hence, are ready to go public. Yet others would have gone through a phase where they have reduced the cash burn, and haven't needed capital yet to grow further, but the time has now come in 2024 to take advantage and capitalize on the developments that they have needed. And of course, I think we might also see some equitization of balance sheets as corporates around the world start to prepare themselves as they should, for a higher rate environment and a higher rate for longer. So I think cautious optimism is the right way to look at it. Perhaps with a slight reversal of the trend we saw in 2023.

Kathleen Darling: Achintya, in an earlier episode, Lorenzo Soler, head of global equity syndicate, talked about the IPO markets, and he was really focused on quality, that being high quality names, the quality of engagement from the buy side, and the quality of cornerstone investors. How are you thinking about quality as we approach 2024?

Achintya Mangla: Look, I think that's exactly right. IPOs have had a tough time, right? We looked at 2021, 2022, and that class of IPOs has clearly end up [inaudible 00:12:35] as we look at the IPO class of 2023 to 2026 the next cycle of IPOs, I am confident and hopeful that they will give investors the performance expected from the IPO class as well as shareholders and employees the returns they expect as well. That's largely anchored in the quality of the companies going public. There is a lot of liquidity with investors, and investors are absolutely willing and have the risk appetite to invest in IPOs, but the bar has gone high in terms of growth, profitability, quality of management, corporate governance, and scale, to some extent. And yet I do believe that the muted activity of IPOs in 2023 was driven as much by supply as by demand. I think the market is there, the liquidity is there. In fact, we've seen a lot of investors become cornerstones, which is a relatively new trend in North America which shows their keen desire to participate and get a fair allocation in IPOs. But yet, it is also driven by the fact that, as we talked earlier, some of the shareholders and companies are not ready to go public yet. They are on a journey to change their business models, reduce the cash burns, position for a very different market environment than we have seen since 2008. And I think as that journey gets closer to completion, you will start seeing a lot more IPOs in the next couple of years. I don't foresee a first quarter of '24 or the first half to suddenly go back to pre-COVID IPO levels, but I think over the next few quarters, we will gradually go back to an environment where IPOs are a very viable and important aspect of the capital markets. An important tool for private equity venture capitalists and other corporates, and investors start seeing the returns, though I would say that one of the things... And you know, we're working with a lot of investors and corporates, is we go to divert the attention from just the day one performance of an IPO to really the midterm and the long-term performance. And I'm really hopeful that as we keep tracking the delivery of a company versus what it's promised at time of the IPO, three months, six months, 12 months from the IPO, that could align well with shareholder returns. So I think a lot more to happen in the next few years. Interestingly, I think there are a few geographical trends as well. Clearly North America will continue to be the largest and the broadest market for IPOs. And I think we'll continue to attract a host of international companies including European companies.

Kathleen Darling: Can you talk a bit about which specific markets you're keeping an eye on?

Achintya Mangla: The two markets that I think we will see increased activity, particularly relative to pre-COVID is going to be the Middle East and India. I think those are two markets where we're seeing a lot of momentum in terms of domestic liquidity, in terms of local economic growth, private company formation and hence, IPO activity. And the last one is eventually we will see Hong Kong market activity pick up as well. So I think we're really focused on IPO as an asset class, but less so quarter by quarter, more so in making sure that the next class of IPOs over the next two, three years really delivers everything that IPOs are expected to, both from an investor as well as a shareholder perspective, with quality being absolutely the cornerstone and the foundation of a healthy IPO market.

Kathleen Darling: Kevin, switching over to you. Talk to us about your expectations for the debt capital markets in 2024, specifically what are you anticipating across investment grade, high yield, and leverage loan markets? And what do you anticipate the key drivers to be for market activity?

Kevin Foley: So from an investment grade standpoint, we expect issuance volumes in the bond market to be flattish to slightly up in 2024. From a high yield perspective, we're forecasting up around 25%, and from a leveraged loan perspective, up 10%. Probably expect to see similar volumes that we've been seeing in the fourth quarter of 2023 continuing into the first six months of the year and are hopeful that we can see a pickup in activity in the back half of the year, kind of even out to those numbers that I cited. M&A, M&A, and M&A is going to be the three keys in terms of what next year's going to look like. In order to get volumes up or to even hit those levels certainly in the high yield market and leveraged loan market or to exceed them, it is going to be tied M&A. As we were hopeful that if we're getting more clarity on the economic picture, more confidence out there, that we're going to see a pickup in M&A activity. There has been a lot of activity in the fourth quarter in terms of behind the scenes, not necessarily announced in financing commitments being put on the tape, but activity is picking up, and it feels like that is tied to the increased confidence, where we are on the economic cycle, where we are on the rate cycle. And belief that valuations are finding their level, right? We've spent a lot of 2023 of buyers and sellers trying to work through matching up on where are clearing levels? What I often like to say as I'm working through the stages of grief that everyone is past denial that the world has changed and we've gone through a correction, but we've been working our way to that final stages of acceptance. So that is going to be the key for next year in achieving that forecast, particularly in the leveraged finance market. We will benefit from the fact that we start to see the maturities pick up in the back half of '24 into '25 and '26, and a lot of issuers and borrowers are going to choose 2024 as an opportunity to start to address those. There's been a little bit of hesitancy on that because of the fact that everyone has locked in low rates or low spreads. So it's been a very good environment. We've gone through the greatest refinancing wave, no one's been in a rush to go out and take that paper out, but they're gonna have to start to address that as time marches on. So we expect as the year progresses, we're gonna see it pickup in the refinancing activity, but again, the key is going to come back to that M&A picture, what the volume's going to be like and what's that going to drive demand for new financings.

Kathleen Darling: Across each of your businesses, are there certain trends you're closely watching? And Kevin, let's start with the debt capital markets.

Kevin Foley: I think what everyone is watching, what's happening with the treasury market. We're running deficits with no end in sight. You've had an environment where banks, foreign governments have been big buyers. The fed has been a big buyer of the treasury market. The regional banks. All of those have pulled back their appetite for treasure issuance at a time when the need for issuance is going to pick up because of funding of deficits. You have treasuries that have been sitting on fed balance sheet that are gonna start to come out without a natural buyer. We watch each auction. We're trying to assess demand and the pickup in supply and how that's going to play itself out. That is going to have an impact on rates, regardless of what the fed is doing. So even in an environment where the fed may be done cutting rates, the fact that you have a anticipated pickup in treasury supply at a time where demand may be pulling back from entities that have been making up the lion's share of the buyer base over the past five years, shifting, that can have a significant impact on rates. So we'll be watching each auction closely starting today.

Kathleen Darling: Achintya, what are you closely watching in regards to the equity capital markets?

Achintya Mangla: I think first, all the points Kevin mentioned are actually gonna impact the broader markets with current equity, so I think treasury markets and the rate trajectory is absolutely critical like it has been in '23. The two additional things I would say are corporate earnings, going back to my earlier point, if inflation does come down, how do corporate earnings fare? And consumer spending. I think we have all benefited from pretty robust consumer spending post-COVID, and I think it'll be interesting to see how consumer spending, business confidence approaches and what the trends are in that direction in 2024. That combined with the treasury aspects Kevin mentioned I think will define, to a large extent, the broader market sentiments.

Kathleen Darling: As we close out the year and this podcast, what is the one take away you want to leave clients with today?

Achintya Mangla: I think the one take away we would leave our clients with, and we'll continue to work with our clients with is really prepare for a higher rate environment, and we alluded to earlier in this podcast, hope for the best, but prepare for what might be less than ideal market conditions, especially when it comes to rates. And I think the thing that we're going to start working with a lot of companies and our clients is the conversation on what the right capital structure is how a capital structure should look like in a higher for longer rate environment is the one that we want all our companies and clients to focus on. And the conversation will go beyond absolute leverage levels. The conversation will include modeling in what could be the higher cost of financings as the debt maturity wall comes closer. The impact on interest costs, debt servicing costs, and therefore, the implied strategy for capital structure. And I think that'll be an interesting conversation and we will work with our clients to anticipate those changes, anticipate the refinancing as they come along and ensure that they're ready for all environments, including rate cuts. Or if indeed the market has or sees less rate cuts, then anticipate it. That would be our best advice, and as always, be nimble as the markets present different opportunities.

Kathleen Darling: And with that, Kevin, we'll round it out with your takeaway for clients.

Kevin Foley: So being a credit person versus the equity person, I'll stick with the hope for the best prepare for the worst, glass half empty folks. But it is don't be complacent. It is take advantage of the environment while it's there. There are reasons to be optimistic. There are reasons to be cautious. Our expectation is at the very least we will see some volatility in these markets, so try to take advantage of the backdrop while it's there and take the money while it's available. We're going to anticipate volatility. At what point, what's the trigger? Hard to say. But there will be plenty of windows of opportunity. There'll be bouts of volatility and that's going to be 2024 in a nutshell.

Kathleen Darling: Achintya, Kevin, it has been a pleasure having you both with us on What's the Deal to provide your insights on both the equity and debt capital markets. We'll definitely stay tuned for the new year to see how markets unfold, so thank you again for joining us.

Achintya Mangla: Kathleen, Kevin, great to speak to you both. And for all our listeners, thank you for listening and have a great holiday season.

Kevin Foley: Kathleen, thank you for having us, and to all our clients out there, thank you for all the trust you've placed in us in 2023, and we look forward to working together in the future, and happy holidays, happy New Year to everyone.

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