Increased M&A Activity Could Support More Stock Market Gains

One of the many results of the U.S. 2024 election that made the forty-fifth President the forty-seventh will be fewer business regulations. After a period of slow merger and acquisition activity, it could pick up over the coming months and years.

Goldman Sachs recently forecast that M&A activity would increase in 2025:

For over a year, capital markets have sought clarity on two common bottlenecks for M&A: monetary policy and regulation. With these dynamics normalizing, a generational technology disrupting industries, sponsors seeking liquidity, and a growing desire from corporates to transform their portfolios through M&A, we expect significant upside potential for dealmaking next year — but with a healthy dose of volatility as capital markets navigate “known unknowns” in the form of tariffs, geopolitics, and more.

Increased M&A activity could support certain stock market sectors, creating significant profitable opportunities for investors and traders.

Creating economies of scale

• Small-cap stocks have market caps between $300 million and $2 billion.
• Medium-cap stocks have valuations between $2 billion and $10 billion.
• Large-cap stocks have market caps over the $10 billion level.
• M&A activity can create economies of scale and provide capital from large-cap companies that acquire companies with lower valuations.

Dilutive versus accretive acquisitions

• Acquisitions tend to provide premiums to current valuations for the acquired company.
• The acquirer’s shares will decline if the market perceives the acquisition as dilutive or subtracting value from the larger company.
• The acquiring company’s shares can rise if the market perceives the deal as accretive or adding value to the larger company.
• Therefore, cash-rich companies searching for acquisitions are very selective.
• Acquisition prospects could create significant competition, boosting valuations and share prices for the target companies.

The sectors that stand to gain the most

• Small and medium-cap companies are the most fertile ground for acquisitions.
• Emerging technologies requiring significant capital to achieve goals could be hot M&A prospects.
• According to Goldman Sachs, cross-border M&A could increase to enhance multinational reach.
• Fewer U.S. regulations could turbocharge M&A activity across all sectors. 

The trading products that could benefit

• The Russell 2000 ETF, IWM, could benefit from increased M&A activity as it reflects small-cap companies.
• The iShares Core S&P Mid-Cap ETF (IJH) reflects the mid-cap companies in the S&P 500 index. While the SPY ETF has a 17.86 P/E, the IJH is less expensive from a valuation perspective with a 12.82 P/E, making it fertile ground for M&A activity.
• Select stocks within these indices can offer substantial upside potential if they become takeover prospects that will command significant premiums to current share prices.

Turbocharging those products with leverage

• The TNA, UWM, and URTY are 2X and 3X ETFs on the small-cap Russell 2000 stocks.
• MIDU provides 3X leverage for the mid-cap stocks.
• Leverage comes with significant risks as the ETFs employ swaps and options that suffer from time decay when the indices move lower or remain stable.
• Leveraged products require time and price stocks.
• Optimizing leveraged ETF trading requires accepting small losses in the quest for oversized gains.

If fewer U.S. regulations significantly increase M&A activity in 2025, it could bolster the stock market. Small and medium-cap companies could command significant valuation premiums as cash-rich large caps compete for acquisitions. Increased M&A deals would likely push the leading stock market indices to higher highs over the coming months and years.