Decoding Morgan Stanley's M&A Renaissance: The Psychology Behind the Surge

The rebound in mergers and acquisitions is not just a function of better numbers. It is a classic case of "animal spirits" stirring back to life. This concept, coined by John Maynard Keynes in 1936, describes the emotional and instinctive forces-confidence, hope, fear-that drive economic decisions, often overriding pure rational calculation. When these spirits are low, even strong fundamentals can't spark action. When they rise, they can fuel a self-reinforcing surge, as we are seeing now.

The signal for this shift is clear. Morgan Stanley's outlook for 2025 is one of cautious optimism, pointing to a more favorable regulatory environment and stronger capital markets as key drivers. This isn't just a forecast; it's a psychological reset. After years of stress, the narrative is changing from one of constraint to one of opportunity. That shift in collective expectation is the first spark.

This recovery follows a period of extreme caution that created a powerful psychological pull toward action. The market hit a wall, with deal volume troughing at a three-decade low relative to US GDP. For a long time, the fear of regulatory hurdles and volatile markets kept dealmakers frozen. Now, that prolonged period of inaction creates a kind of pent-up energy. The human tendency to follow the herd, once the first few act, can quickly accelerate the trend. The recovery is self-reinforcing, as Morgan Stanley notes, because a strong M&A recovery is also under way, which is self-reinforcing to PE fundamentals.

Viewed through a behavioral lens, the current setup is textbook. After a long drought of deal-making, the mere prospect of a less hostile regulatory climate and easier financing acts as a powerful catalyst. It lowers the perceived risk of taking the first step, triggering a wave of "spontaneous optimism" that Keynes described. The animal spirits are returning, and they are driving the market back toward a more active state.

Sector-Specific Irrationality: Healthcare and Industrials as Case Studies

The rebound in M&A is not uniform. It reveals a market where specific cognitive biases are driving behavior in leading sectors, often in ways that create pockets of mispricing. Look at healthcare, where dealmakers are navigating a clear "triple threat" of tariffs, pricing reforms, and longer drug approvals. Yet, the sector is seeing a surge in platform-building and AI-driven healthtech. This is classic overconfidence in action. The human tendency to underestimate risk and overestimate control leads buyers to pursue ambitious, transformative deals even when the macroeconomic and regulatory fog is thick. The optimism sparked by a single large deal, like Johnson & Johnson's acquisition, can trigger a wave of similar moves, ignoring the underlying headwinds.

At the same time, the absence of mega-deals suggests a different bias at play: anchoring. After years of consolidation, many dealmakers are fixated on past successful models of scale. The strategic recalibration in the first half of 2025 shows this clearly, with a mere 1.0 percent decline in total deal volume but a 56.0 percent increase in deal value. This points to a shift toward operational optimization through smaller, strategic transactions rather than blockbuster combinations. In psychology, anchoring means relying too heavily on initial information. Here, the "anchor" is the proven playbook of building platforms through a series of acquisitions, even when the broader market for such mega-deals remains fragile.

Then there is the resilience of private equity activity, which reflects a powerful form of loss aversion. Despite tighter credit, PE firms are active, motivated to exit assets to lock in gains. The fear of potential future declines-whether from a market correction or a sector-specific downturn-drives a desire to secure profits now. This behavior is not about chasing new opportunities with fresh capital, but about protecting existing value. It's a defensive move, where the pain of a future loss is weighted more heavily than the potential gain of holding on for a bigger exit. This dynamic helps explain why PE remains a key engine for M&A, even as valuations are high and deployment is hindered.

Viewed together, these sector dynamics show how human psychology distorts the market. Overconfidence fuels ambition in the face of known risks, anchoring leads to a reliance on outdated strategies, and loss aversion drives a rush to cash out. The result is a market that is active, but not always efficient. The true test will be whether these behavioral drivers can sustain the recovery when the initial optimism wears off and the real challenges of the healthcare and industrial landscapes come into sharper focus.

The Valuation Gap: Where Psychology Meets Financial Reality

The current M&A surge is a classic example of market psychology running ahead of financial reality. While deal volume is climbing from a three-decade low, the broader market signals a more cautious, even skeptical, environment. This disconnect is the first red flag. Despite the uptrend, IPO activity has slowed. That's a critical data point. When new public companies are scarce, it suggests the underlying capital markets aren't yet fully confident. The recovery is therefore not broad-based; it's being driven by a specific subset of players-primarily private equity-fueled by internal momentum and a desire to exit, not by a wave of fresh, risk-tolerant capital from the public markets. This creates a potential bubble in the M&A market itself, where deal volume is rising but the quality and sustainability of the financing are questionable.

The risk of poor outcomes from large deals is well-documented, yet the herd mentality persists. Evidence shows the risks and poor outcomes associated with many M&A projects have been well documented, with bad strategy and overpaying being common causes. Yet, the decision-making process often becomes distorted by powerful psychological forces. CEOs can become blinkered by a "deal focus," ignoring cautionary data and viewing internal dissent as a "blocker." This groupthink, combined with the deal heat from months of intense effort, makes it incredibly difficult to walk away even when evidence mounts that a deal will destroy value. The human desire to leave a legacy or simply to see a complex, costly process through to completion overrides rational financial analysis. The market is betting on a wave of successful integrations, but history shows that most large deals fail to deliver promised benefits.

Viewed another way, the prospect of a more benign operating environment in 2026 provides a rational backdrop, but the market's reaction appears ahead of the actual economic data. The evidence notes that a more benign operating environment has commenced, with trade wars paused and financing costs falling. This is a positive shift that should support M&A. However, the market is already pricing in a multi-year recovery cycle, with PE firms doubling down on cost efficiency now to set the stage for 2026 growth. The psychology here is one of recency bias and overreaction. The market is extrapolating the recent pause in headwinds into a long-term trend, while overlooking the high valuations that are already hindering deployment. The rational expectation is for a gradual improvement, but the behavioral response is a full-throated embrace of a new golden age. This gap between measured economic reality and emotional market response is where the true risk lies.

Catalysts and Risks: What Could Break the Sentiment

The current M&A cycle is built on fragile psychological foundations. Its sustainability hinges on a few key forward-looking factors that could either validate the recovery or abruptly reverse it.

The primary catalyst for a broader, more durable rebound is a revival in the capital markets beyond M&A itself. Specifically, a sustained increase in IPO activity would be a critical signal. It would demonstrate that fresh, risk-tolerant public capital is returning, reducing the market's reliance on a narrow base of private equity monetizations and strategic buyers. This validation would lower the perceived risk of taking a public company private or merging with one, as the exit path becomes clearer and more liquid. Without this broader market support, the recovery risks becoming a self-contained bubble, driven by internal momentum rather than a healthy, expanding pool of capital.

The most immediate threat to this fragile optimism is a resurgence of external pressures. The evidence points to a "triple threat" for healthcare, but the principle applies more broadly: tariffs, pricing reforms, and longer approval times are just one set of macroeconomic and regulatory headwinds. A broader return of geopolitical tensions or, more critically, a resurgence of regulatory scrutiny could quickly extinguish the current favorable environment. The market's optimism is predicated on a "more favorable regulatory environment" and relaxed antitrust guidelines. Any reversal of that trend would trigger a powerful fear response, causing dealmakers to freeze again. The psychological pull toward action is strong, but it can be overridden by a credible threat of new friction.

Finally, the market's ability to sustain its positive narrative depends on its capacity to ignore or rationalize early failures. The evidence is clear: the risks and poor outcomes associated with many M&A projects have been well documented. As more deals close and integration begins, signs of botched integrations or disappointing returns will emerge. The danger is cognitive dissonance. Dealmakers, having invested immense time and capital, may rationalize these outcomes as temporary setbacks rather than evidence of flawed strategy. This is the "deal focus" mindset in action, where leaders become blinkered and view dissent as a "blocker." If integration failures become widespread and visible, it will force a painful reassessment. The market's current animal spirits could then snap back to a state of caution, as the reality of execution challenges collides with the earlier wave of optimism.