The merger and acquisition market has been red-hot this year, but things are expected to cool down in 2016. Although the first quarter is expected to bring a slight year over year increase in M&A deal volume because of how many deals were entering the due diligence phase this past summer, it’s simply going to be difficult for 2016 to be able to match the sheer number and size of this year’s deal activities. Looking on a quarter over quarter basis, the M&A market is expected to drop off meaningfully:

M&A Fed Rate Hike

M&A deceleration already underway

During the third quarter, early stage deal activity increased 5.6%, a deceleration from the 9% increase recorded in the previous quarter and the slowest rate in two and a half years. North America particularly contributed to the slowdown with a 3% decline.

In his quarterly Deal Flow Predictor, Intralinks Strategy and Product Marketing Vice President Matt Porzio explained that the first quarter’s slight increase will be driven by corporations seeking growth in an environment in which inflation is slow and private equity buyers exiting the companies they bought. Also during the first quarter, acquisition financing should remain “cheap,” he said, potentially rising by 7% year over year.

The downside risks to M&A volume in the first quarter include continued problems in China and other emerging markets, which threaten to trigger a slowdown across the world’s economies. Also another correction in the world’s stock markets and high M&A valuations could weigh on the number and value of deals that are done, as could an escalation of regional conflicts due to rising tensions between NATO or the U.S. and Russia over policy in Syria.

Fed rate hike on tap

The M&A market is also expected to be impacted by the interest rate hike, which is just around the corner. Some corporations and private equity may be holding back on fears that the U.S. Federal Reserve potentially mishandling the interest rate hike, which is expected to come at the next meeting on Dec. 16.

Although the rate hike is expected to start slowly with a gradual increase through the first half of 2016, analysts from Deutsche Bank warned this week that the Fed may raise rates more quickly than the market currently expects. If this happens, the M&A market will likely see broad-based impacts possibly leading to a steeper slowdown than currently projected.

“It’ll be interesting to see how the markets absorb a US rate hike, although nominal with a predicted 25 basis point jump,” Porzio told ValueWalk. “The equity/debt markets reacted pretty strongly to the European Central Bank’s weaker than expected stimulus. Along with a stronger U.S. dollar, in general, we’re interested in seeing how M&A financing will be impacted.

“This is a record year for deals valued at over $1 billion – we’re already at 530 deals through November 2015 vs. 499 in all of 2014, so the larger strategic deals are still getting, and will still get done,” he added. “The middle market is where we really may see the impact from rate movements, especially where deals are highly leveraged based on the valuation environment.”

Smaller M&A players may be “squeezed out”

Porzio noted that this year they’ve been seeing declines in early-stage M&A activities in the Industrials and Telecommunications, with Industrials peaking during the second quarter with 1,517 announced deals. As of Dec. 7, however, Intralinks has observed only 719 deals being announced during the fourth quarter. On a macro-level, Porzio expects the Energy and Power sector to ramp M&A volumes next year.

“As downward pressure on oil prices continues and no indication that the cartel will slow crude oil output, we think that many in the sector will also view low valuations as the new reality, and without access to long-term capital, many of the smaller players will be squeezed out,” he told ValueWalk.

For the first quarter anyway, despite the expected slowdown as next year progresses, Porzio expects this year’s momentum in M&As in most sectors to continue. Here’s a look at their expectations for M&As by sector and geography:

M&A Fed Rate Hike

M&A Fed Rate Hike

“As larger deals come to market, we’ll probably see ancillary dispositions picking up in order to overcome any antitrust regulatory scrutiny,” he added. “M&A will always be an active part of corporate strategy, so consolidations will always happen across sectors. Our Q1 2016 Deal Flow Predictor indicated highest early-stage activity in Healthcare, High Tech, Materials, Consumer, Real Estate and Retails sectors so anticipate some degree of momentum to be sustained in these sectors through 2016, barring any major market shifts.”

And here are the values Intralinks saw in its Dealnexus Public Deal Marketplace as of the end of the third quarter:

M&A Fed Rate Hike

M&A Fed Rate Hike

All images in this article are courtesy Intralinks.