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KKR White Paper 53 1906 PDF
KKR White Paper 53 1906 PDF
INTRODUCTION���������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������� 4
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© 2019 Kohlberg Kravis Roberts & Co. L.P.
2 KKR INSIGHTS: GLOBAL MACRO TRENDS
All Rights Reserved.
Stick to the Plan
With all the geopolitical ‘noise’ swirling around these days, there is
a growing propensity in the investment community to react quickly
to near-term news flows, or even head to the sidelines until there
is greater visibility. Our advice: stick to the plan. No doubt, overall
portfolio risks are higher these days, but our work is telling us that
there is still an attractive path forward for thoughtful investors who
are willing to invest heavily behind big, large tail macro themes.
Specifically, we want to own
more cash-flowing assets “
linked to nominal GDP as part If it ain’t broke, don’t fix it.
of our goal of frontloading
as much yield as possible in
”
THOMAS BERT LANCE
the portfolio. This approach DIRECTOR OF THE OFFICE OF MANAGEMENT AND BUDGET, 1977
should help mitigate both
concerns about late cycle
behavior as well as aggressive central bank policies. We also favor
owning more Opportunistic Credit and Special Situations, both
strategies that have the flexibility to lean into dislocations. Finally, we
feel compelled to embrace Complexity through a variety of investment
disciplines, including Energy, Private Equity, Real Estate, and
Infrastructure. If we are right about our worldview, then our existing
asset allocation framework, which includes an investment process
that we have developed over nearly two decades, should continue to
serve us well amidst the recent spike in uncertainty. Said differently,
if “it ain’t broke, don’t fix it.”
Dec-69
Nov-73
Jan-80
Jul-81
Jul-90
Mar-01
Dec-07
Budget Balance and the U.S. Unemployment Rate
Divergence Between Unemployment and the Budget Deficit Start of Recession
20%
“
96 98 00 02 04 06 08 10 12 14 16 18 20 The trend towards large corporate
Data as at May 31, 2019. Source: BofA Merrill Lynch, Bloomberg. multinationals divesting non-core
subsidiaries remains strongly in
Meanwhile, from a purely tactical perspective, Lance’s phrase also
resonates well with how KKR’s Global Macro, Balance Sheet, and force. The complexity associated
Risk Analytics team (GBR) is feeling about its current asset allocation
framework. Specifically, whereas we had increased risk exposure
with these transactions is
in early January and then dialed some of that very same exposure substantial, but carve-outs often
back in February after a roaring surge in risk assets, we now don’t
feel compelled to dial back up our risks. As we detail below, we are
have the potential to unlock
structurally more cautious on the ‘trade war’ that is unfolding – and significant value, particularly as it
what that means for the traditional global world order – than some
of the investors with whom we speak. Mexican trade issues appear
relates to cash flow generation.
headed in the right direction; however, when it comes to China, our ”
KKR INSIGHTS: GLOBAL MACRO TRENDS 5
United States, robust buybacks, and vigorous cost take-outs. More- So, what is our call to arms for the second half of 2019 and beyond?
over, with U.S. margins now at record levels, we think that the profit See below for full details, but our key messages are as follows:
gap that has existed between the U.S. and the rest of the world could
also converge (Exhibit 6). We remain bullish on deconglomeratization, or carve-outs. In addi-
tion to what we see occurring in the United States, recent trips to To-
EXHIBIT 5 kyo and London lead us to believe that the trend towards large corpo-
U.S. Corporate Profit Growth and Nominal GDP Are rate multinationals divesting non-core subsidiaries remains strongly
Becoming More Aligned… in force. Recent divestiture announcements out of Hitachi, Nestle,
General Electric, Bayer, and Walt Disney only add to our optimism.
Ratio of U.S. Corporate Profits Growth From what we can tell, a combination of sagging returns on capital,
to U.S. Nominal GDP Growth (5-Year CAGRs, Rolling)
increased shareholder activism, and intensifying local competition
5.0 4Q13 all suggest that more activity is in store, which we view positively
4.5 for Private Equity managers. Key to our thinking is that the complex-
4.0 ity associated with these transactions is substantial, but carve-outs
3Q06
often have the potential to unlock significant value, particularly as it
3Q97 3.1 relates to cash flow generation. In addition to the sizeable opportu-
3.0
2.4 nity we are seeing in Private Equity for global corporate carve-outs,
3Q87
2.0
we are also observing similar compelling trends across Energy Real
1.4
Assets and Infrastructure, particularly in the area of optical fiber.
Importantly, we like the opportunity set for this theme not only on the
1.0 4Q18
0.6
equity side but also on the debt side.
0.0
3Q90 4Q01 4Q08 The ‘Yearn for Yield’ underscores the structural reinvestment risk
0.3 -0.2 -0.5 that we think has emerged for income-oriented investors. From our
-1.0
perch at KKR, we see reinvestment risk as one of the greatest chal-
1Q00
1Q15
1Q70
3Q07
2Q11
1Q85
1Q55
4Q03
3Q62
2Q81
3Q77
3Q92
2Q66
4Q73
4Q88
4Q58
2Q96
lenges that CIOs now face. Importantly, this risk is coming during a
period that we have identified as The Uncomfortable Truth, which we
Data as at December 31, 2018. Source: U.S. Bureau of Economic
Analysis, Haver Analytics. define as record low interest rates amidst bulging deficits and soar-
ing debt loads. Our advice is to own more cash-flowing assets linked
to nominal GDP, build more flexibility across mandates, and shorten
EXHIBIT 6 duration where appropriate. Importantly, despite our view that infla-
tion will remain low in the medium term, we respect that the ‘Au-
...As the Profit Gap Between the U.S. and the Rest of the thorities’ are trying to shrink existing debt loads by holding nominal
World Begins to Finally Converge interest rates below nominal GDP. As such, we believe strongly that
Change in Trailing 12-Month EPS Since 2007 Peak
an overweight to modestly leveraged Infrastructure and certain Real
Estate investments with yield is prudent to add some ballast to one’s
MSCI US MSCI Europe portfolio. We are also quite constructive on Asset-Based Finance,
100% MSCI Asia Pacific xJ which continues to provide us with lots of shorter duration opportu-
80% nities with good cash flowing characteristics and sound collateral.
72.7%
60%
Lean into periodic dislocations and growing dispersions. As we
40%
show later in Exhibit 92, our implied default indicator has spiked to
20% 17.6% recessionary levels multiple times in recent years, despite the reality
0% that we have not technically had a recession. We view these false
readings as compelling because it confirms our thesis that the capital
-20%
-28.1% markets are giving investors multiple opportunities to lean into dislo-
-40% cation to buy mispriced assets. Given inadequate dealer inventories,
-60% rising geopolitical tensions, and slowing liquidity growth, we believe
that the frequency of these occurrences is likely to increase, not
-80%
decrease, in the coming quarters. Meanwhile, as we detail below (Ex-
-100% hibits 96 and 97) our research shows that dispersions across many
2011
2010
2015
2008
2019
2009
2013
2017
2007
2012
2014
2016
2018
We are lowering our U.S. Short Duration Government Bond bet to five
percent from seven percent. We still like this investment idea, but two- 11.6
10.2
year U.S. yields have fallen from a high of 2.61% in January to 1.93%
currently1. So, some of the easy money has been made. Overall, 6.3
though, we still retain an outsized position because, when we look
around the world, U.S. two-year Treasuries offer a current coupon
that – apart from China two-year bonds – dwarfs almost any other
sovereign debt that we can find (regardless of duration).
The Illiquidity Premium in Private Credit Has Actually KKR GMAA Target Asset Allocation
Grown in Importance Since 2016 Relative to Publicly
Traded Levered Loans and High Yield KKR GMAA STRATEGY KKR GMAA
JUN-19 BENCHMARK FEB-19
Illiquidity Premium as a Proportion of Yield, %
ASSET CLASS TARGET (%) (%) TARGET (%)
Traded High Yield Traded Leverage Loans Public Equities 53 53 53
U.S. 20 20 20
120%
Europe 15 15 15
101.2%
100% 93.3% 94.1%
Turkey -1 0 -1
86.2%
78.5% 79.9% All Asia ex-Japan 10 7 10
80%
67.2% 68.1% Japan 5 5 5
60.0% 60.1% 58.8% 59.5%
55.3% 58.1% 56.9%
60% 52.9% 53.5% Latin America 4 6 4
46.9% 44.7%
Total Fixed Income 23 30 24
40% 34.9%
Long Duration Gov’t 0 20 0
2013
2010
2014
2016
2018
2015
2008
2017
2009
2007
2012
Levered Loans 0 0 0
Data as at December 31, 2018. Source: Ares Capital, Bloomberg.
High Grade 0 5 0
Growth Capital / VC 0 5 0
Cash 3 2 2
“ Data as at May 31, 2019. Source: KKR Global Macro & Asset Allocation
analysis.
We also want to underscore our
existing macro view that we could Looking at the big picture, our view is that we may be “stuck” in a
be entering a period where the trading range. On the one hand, interest rates remain low, particu-
larly relative to cash flows, and this arbitrage should prevent any long
growth rate of nominal GDP and sustained, 2007-like downturn in risk assets (Exhibit 11).
global profits are more aligned.
”
-20%
-30%
Apr-00
Apr-07
Apr-14
Jan-95
Jul-98
Jan-02
Jul-05
Jan-09
Jul-12
Jan-16
Oct-96
Oct-03
Oct-10
Oct-17
Data as at May 31, 2019. Source: KKR Global Macro & Asset Allocation
analysis.
• We use a 16.3x multiple for the S&P 500 heading into 2020,
compared to a historical median of 17.0x for today’s low real
rate environment. We think that peaking corporate margins
and heightened trade tensions largely keeps the market “
“stuck” in a trading range through year-end 2020 (with the
S&P 500 returning four to 11% during this period.) The good At a much broader and higher
news for alpha generation is that dispersions are widening, as
the massive tailwind from Quantitative Easing (QE) dissipates
level, we think that a structural
divide between the U.S. and
• We are bullish on our five key macro themes: Deconglomera-
tization, Yearn for Yield, Lean Into Complexity/Dislocation,
China is likely to continue. As
Own Some Cash Flowing Secular Growth, and Experiences part of this new reality, China’s
over Things
government is going to move to
• As we detail below, the underlying dependence on Technol-
ogy for the global economy/capital markets is likely underap-
internalize its economy as fast as
preciated. All told, nearly 100% of global profits this cycle are it possibly can.
– to date - linked to the Technology sector
”
EXHIBIT 12
We Favor Upfront Yield, Collateral and Mandate Flexibility as We Enter a New Phase of This Cycle
KKR GMAA Target Asset Allocation, % Over / Under Weight
10
5
0
-5
-10
-15
-20
-25
Asset-Based Finance
High Yield
High Grade
Long Duration
Gov't Bonds
Opportunistic Credit
US Short-Duration
Fixed Income
Cash
Stabilized Credit
Traditional PE
Real Assets
Growth Capital / VC
Public Equities
Latin America
Gold
Energy / Infrastructure
Data as at May 31, 2019. Source: KKR Global Macro & Asset Allocation analysis.
2.0 EXHIBIT 15
Other Emerging Markets
1.5
make up another 42%
of growth in 2019
Successive Rounds of U.S. Tariffs on China Will
+1.2
Increasingly Hit Goods with Fewer Sourcing Alternatives
1.0
Average % of U.S Imports Sourced from China
China alone makes up 36%
0.5
of growth in 2019
68%
0.0
China Other US Other World
Emerging 51%
Markets
Data as at April 9, 2019. Source: IMFWEO, Haver Analytics.
22%
EXHIBIT 14
The Final $325 Billion Includes Some Very Important Europe Is Likely the Most Exposed to Global Trade
Consumer Products Tensions, Given Its High Percentage of Exports
Gross Exports as a % of GDP
BRIEF DESCRIPTION 2017 U.S. TRADE
IMPORTS FROM 2008 2018
CHINA, US$ BILLION)
12% 12%
Computer monitors 4
Multifunction office machines 2 Data as at April 26, 2019. Source: Eurostat; Bureau of Economic
Analysis; State Administration of Foreign Exchange (China) and China
Knitted cotton apparel 2 National Bureau of Statistics.
National Flags 2
At a much broader and higher level, we think that a structural divide
Data as at July 11, 2018. Source: U.S. International Trade Commission
Dataweb, Haver Analytics. KKR Global Macro & Asset Allocation analysis. between the U.S. and China is likely to continue. As part of this
new reality, China’s government is going to move to internalize its
economy as fast as it possibly can. Already, exports as a percentage
EXHIBIT 17 of GDP have been shrunk to 18% of GDP, compared to 36% in 2007
(Exhibit 19). For perspective, U.S. exports as a percentage of GDP
U.S. Firms Generate a Significant Amount of Revenues are 12% and Europe’s are 46%. Indeed, after 24 years of traveling
by Selling Into China. We Feel Strongly This Reality Has to China, my conclusion after my most recent trip is some structural
Been Underappreciated damage has been done to the U.S.-China relationship. As such, it is
caveat emptor on both sides of the world.
2017: U.S. Surplus (Deficit) with China, US$ Billions
(China Sold to U.S. Less U.S. Sold to China)
There are several layers of disappointment and/or concern amongst
President Trump's only focus both parties to consider. First, many U.S. CEOs in China are disap-
20 pointed that President Xi’s original economic reform plan from 2013
has actually not progressed as much as they might have hoped for. In
59 fact, the percentage of U.S. CEOs in China who were optimistic about
38 business conditions recently dropped to 38% from 45%, accord-
ing to the 2018 U.S. China Business Council Survey we track. Not
-284 surprisingly, this sentiment is adversely affecting their commitment
Key risk if China
goes after U.S. to maintain such a large presence in China, despite the total address-
207
businesses in China able market (TAM) being huge in most areas.
Second, Chinese CEOs view the ZTE and Huawei incidents as game
Goods Goods Services Services US Surplus changers. Somewhat perversely, these two crackdowns in the West
through through imports through With China have created an accelerated rush in China to become less dependent
trade* subsidiaries subsidiaries on foreign manufacturers, particularly those in the U.S., as the Chi-
nese move even more quickly to internalize as much of their supply
*China goods sold to U.S. from China net of goods sold from non- chain as possible. While this internalization may create greater self-
Chinese affiliates operating in China. Likewise, U.S. goods sold to China reliance, this shift could actually lead to higher inflation, less cross-
is net of goods sold to China by other countries’ affiliates operating in the
U.S. Data as at June 11, 2018. Source: Deutsche Bank, China Macro: U.S.
border flows, and potentially lower profits over time, we believe.
Economic Balances With Partners.
Third, as the Chinese government creates more favorable operating
environments for local champions to gain market share, U.S. com-
panies in China are being forced to invest more in capex to remain
competitive. For those U.S. firms operating in China that redeploy
EXHIBIT 22
China, 5% Others, 2%
Ordinary Trade (Higher Value Add)
Reexports (Lower Value Add) Taiwan,
60 6%
May-19
55
57.5
Europe, 9%
50
USA, 45%
45 Japan, 9%
40
Korea, 24%
Re-exports are now less than
35 May-19
a third of exports
31.2
30
Data as at May 21, 2019. Source: 2019 Semiconductor Industry
02 04 06 08 10 12 14 16 18
Association Factbook, WSTS, IHS Global, PwC.
Data as at May 31, 2019. Source: China Customs, Haver Analytics.
“
Against this macroeconomic
backdrop, we generally like our
positioning, and are largely
inclined to stick with many of the
themes we laid out in January.
” KKR INSIGHTS: GLOBAL MACRO TRENDS 13
Our bottom line: Investors should make no mistake about where we Beyond the aforementioned trade issues surrounding technology,
are headed, given how intertwined the two countries are. Simply we would not be surprised to see Taiwan become a tension point
stated, we think that a modern day ‘cold war’ of sorts has emerged again. The U.S. election in 2020 – and all the hype that will lead up
between China and the United States. Consistent with this view, to it – also remains a wild card. Finally, the hope of any accelerated
we think that we are at an inflection point for global supply chains, SOE reform or privatization now appears more challenging, as by
particularly those that rely on proprietary technology. Just consider controlling its SOEs, the government is in charge of the lion’s share
that out of $70 billion Huawei spent buying components in 2018, of employment opportunities across China.
some $11 billion in Huawei allocations went to U.S. firms including
Qualcomm, Flextronics, and Broadcom. One can see some of this de-
pendence in Exhibit 23. Without question, these relationships are now
all in play in a world where it appears U.S. national security concerns
have trumped more traditional trade priorities.
EXHIBIT 23
Huawei’s Supply Chain Is Quite Global, Including a Heavy Dependence on the U.S.
Huawei Top Suppliers
6 4.3 15%
13% 3.9 3.5
3.6 11%
4 11% 3.4 3.4 3.0 2.7 10%
2.8
8%
2 6% 5% 5%
5% 5%
0 0%
Foxconn BYD TSMC Q-Film FIH Mobile Flex SK Hyrix Broadcom Qualcomm Sunny Optical
Industrial (China) (Taiwan) (China) (China) (U.S.) (S. Korea) (U.S.) (U.S.) (China)
Internet
(China)
EXHIBIT 24
China and the U.S. Are Benchmarking Themselves Across Many Key Growth Areas of the Global Economy
Mobile Payments Volume, Orbital Rocket Science & Engineering Patent Applications, 2017,
2018, US$ Trillions Launches, 2018 Graduates, 2014, Thousands Thousands
1447
39
1382
40
31
607
377
0.45
As we indicated in our January outlook piece, we are still forecast- While the consumer impact is not to be underestimated, we actually
ing a deceleration in GDP in 2019, albeit it is likely now more modest are spending more time on what trade headlines mean for CEO con-
in aggregate after the upside surprise to first quarter 2019 GDP. To fidence and ultimately growth. Simply stated, the capex impact from
this end, my colleague David McNellis is raising his U.S. 2019 GDP tariffs is the biggest ‘X-factor’ out there, we believe – something we
estimate to 2.4% from 2.25% previously. Importantly, though, on a think is being notably understated and not fully appreciated in sell-
bottom‐up basis, note that our 2019 GDP upgrade is rather ‘low qual- side forecasts. Specifically, Wall Street estimates generally do not
ity’ in nature, as inventories drive most of the upside. assume any headwind to corporate capex from tariff-related uncer-
tainty (e.g., exectives are now unsure whether to invest incremental
Maybe more importantly, though, than focusing on a point estimate capital into the U.S., Mexico, China, Vietnam, etc., so better to wait
of GDP, is the progression of GDP trends. To this end, we have until we have more clarity). Exhibit 26 underscores our point that the
tried to create an easy to understand ‘roadmap’ that investors can risk to a capex slowdown could be substantial. To date, the evidence
follow. One can see this in Exhibit 25, which we think is a compel- so far is that capex has moderated a bit due to tariffs, but not col-
ling ‘dashboard’ that can be used to outline how we suggest thinking lapsed (Exhibit 27). As such, we will all need to watch that capex
about the potential U.S. economic effects from the tariffs, including momentum does not erode more meaningfully in 2020 than the 2.2%
China Rounds 1-4, as well as the potential auto tariffs. Bottom line year-over- year growth we are forecasting for 2019.
is that all the measures in total are a GDP drag of approximately 80
basis points in 2020 (hence why we are not pushing out our poten-
EXHIBIT 25
To Date, Proposed Tariff Measures Represent an Aggregate Potential U.S. GDP Headwind of 1.25%, of Which We Think
Approximately 0.4% Could Manifest in 2019. In 2020, However, the Drag From Tariffs Could Reach 80 Basis Points
IMPLEMENTED,
ANNOUNCED, OR TOTAL DIRECT
THREATENED AS OF POTENTIAL GDP 2019E POTENTIAL 2020E POTENTIAL
MAY 2019? EFFECT IMPACT IMPACT COMMENT
Data as at June 7, 2019. Source: KKR Global Macro & Asset Allocation estimates, Bureau of Economic Analysis, Census Bureau, Office of the U.S. Trade
Representative, Haver Analytics.
Capex Deferrals Due to Tariff Uncertainty Remain the Most Important ‘X-Factor’ in Our Outlook
Approximate Cumulative Potential Tariff Impacts as a % of U.S. GDP
+0.5% 1.0%
+0.2%
+0.1%
+0.1%
Round 1: $50bn Round 2: Additional Round 3: Prior Round 4: Additional Ttl China Tariff, Potential Tariff on Ttl Potential 10% Deferral of
China Tariffs @ $200bn @ 10% $200bn raised to $325bn @ 25% Potential Auto & Parts from China+Auto Tariff U.S. Business
25% Rate Rate 25% Rate Rate Consumption Europe and Japan Consumption Investment
Impact @ 25% Rate Impact Spending
Data as at May 16, 2019. Source: KKR Global Macro & Allocation estimates, Bureau of Economic Analysis, Census Bureau, Office of the U.S. Trade
Representative, Haver Analytics.
EXHIBIT 27
Looking at the bigger picture (and again consistent with our view
that President Trump will implement the next $325 billion in tar- To Date, the Evidence Suggests Tariff Uncertainty Has
iffs), we remain on the hawkish side of the trade debate. To be sure, Slowed – But Not Collapsed – U.S. Investment Trends
there may ultimately be some opening up of Chinese markets to buy
more goods such as soybeans, but rule of law issues are likely to Growth in U.S. Real Fixed Investment Spending, %
remain problematic between the two countries. Moreover, Trump has
6.3%
allowed national security issues to bleed into the current trade nego-
tiations, a political move that we think has longer-term implications 5.3%
than many investors currently appreciate. Said differently, even if the 4.8%
current impasse on trade is resolved, there will not be an easy fix on
the race for global technological dominance.
3.4%
Hence, we view this latest salvo in the U.S.-China trade war as one
2.2%
that has – over time – serious implications for global supply chains
1.7%
and capital allocation. Our view is that China will escalate the already
rapid pace of development and acquisition of high value added indus-
tries, particularly as the latest moves by President Trump could likely
foster distrust in regard to global supply chains, especially around
the reliance of foreign markets for needed technology. Businesses, 2014 2015 2016 2017 2018 2019e
particularly those in technology related industries, will be looking to
develop supply chains in other locales such as Vietnam, the Philip- Data as at June 7, 2019. Source: Bureau of Economic Analysis, Haver
pines and Thailand to circumvent U.S.-China trade concerns. If we Analytics, KKR Global Macro & Asset Allocation estimates.
are right, then we should expect lower global growth than in the past
and likely a structural peak in corporate profitability.
“
Simply stated, the capex impact
from tariffs is the biggest
‘X-factor’ out there, we believe.
”
16 KKR INSIGHTS: GLOBAL MACRO TRENDS
EXHIBIT 28 EXHIBIT 30
Growth in Personal Consumption Expenditures Remains, Easy Central Bank Policy in Europe Is Only Partially
to Date, Quite Steady Being Offset by Tight Credit Conditions
Growth in U.S. Real PCE, % Elements of 2019 Eurozone GDP, ppt
3.7% 0.1 -0.1
0.3 -0.2 1.2
0.1
2.9% 0.8
2.7%
2.5% 2.6%
2.3%
0.1
EXHIBIT 29 EXHIBIT 31
We Are Maintaining Our 2019 Eurozone Real GDP Our Forecast Is for Eurozone Inflation to Reach 1.5% in
Growth Forecast of 1.2% the 2019-2020 Period
6% Eurozone Real GDP, Y/y % Change Eurozone CPI, Y.y % Change
4% Actual
4% Actual Forecast
Forecast
Adjusted R-Square:
2% 3%
91.7%
0%
2%
-2%
Adjusted R-squared = 90.4% 1%
-4%
-6% 0%
2010
2018
2006
2008
2012
2014
2002
2020
2004
2016
2011
2013
2010
2003
2014
2004
2016
2018
2015
2006
2008
2019
2005
2017
2009
2007
2012
2002
Data as at May 31, 2019. Source: Bloomberg, Eurostat, European Central Data as at May 31, 2019. Source: Bloomberg, Eurostat, European Central
Bank, European Commission and KKR Global Macro & Asset Allocation Bank, European Commission and KKR Global Macro & Asset Allocation
analysis. analysis.
As one might guess, further escalation in the trade arena will likely
EXHIBIT 33 be met with fiscal and monetary stimulus including more reserve
required ratio cuts, liquidity injections, pledged supplementary lend-
Exports Now Represent a Sizable 50% of Gross GDP in ing, and other short-term liquidity tools. Moreover, as the Fed begins
Germany to lower rates, we expect China to follow with interest rate cuts to
Real German GDP, % and Exports as a % of Real GDP manage the rate differential, while maintaining tight capital controls,
to limit currency depreciation. On the fiscal side, we expect even
55%
German Exports, % of German GDP more targeted stimulus focused on infrastructure, the consumer, and
German GDP, % of EZ GDP the auto sector.
45%
35%
“
This shift in the structural outlook
25%
for trade influences our thinking
2001
2003
2011
2000
2010
2006
2008
2018
2005
2015
2009
1999
2007
2013
2017
2002
2004
2012
2014
2016
China Continues to Add More Stimulus to Support Growth as the Trade War Escalates. Despite This Impressive Effort
by the Government, We Wonder If Slowing Growth in Capital Expenditures Will Require Even More Stimulus
Approximate Cumulative Potential Tariff Impacts as a % of China GDP Approximate Recent Stimulus
as a % of China GDP
0.3%
+0.8%
2.0%
1.9% -1.8%
+0.6%
+0.2% +1.0%
+0.1%
+0.1%
Round 1: Round 2: Round 3: Round 4: Total Tariff, 5-10% Total Fiscal May 2019 Recent
$50bn China Additional Prior $200bn Additional Potential Deferral of Impact Stimulus Targeted Stimulus
Tariffs @ $200bn @ Raised to $325bn @ Consumption Business Reserve
25% Rate 10% Rate 25% Rate 25% Rate Impact Investment Required
Spending Ratio Cut
Fiscal stimulus includes value added tax cuts, personal income tax cuts, personal income special deductions, social insurance reduction, infrastructure
spending, and other various tax cuts implemented since May 2018. The targeted reserve required ratio cut refers to the May 2019 policy response to the
latest escalation in tariffs. Data as at May 31, 2019. Source: KKR Global Macro & Asset Allocation analysis.
Year-to-date, core inflation has been soft falling to 1.6% year-over- EXHIBIT 35
year on weak domestic demand. At the same time, however, head-
line inflation actually increased to 2.7% in May 2019 from just 1.5% Real GDP Growth in China Is Expected to Continue to
year-over-year in February 2019 on the back of higher commodity Decline Meaningfully in the Years Ahead
prices (Exhibit 37). A key driver has been bad weather, which has led China: Real GDP Growth Y/y, %
to a 13-18% year-over-year increase in vegetable prices. In addition,
the outbreak of swine flu has brought the supply of pigs to the lowest Real GDP Y/y
level in over a decade. As a result, pork prices are already up 18% OECD Long Term Projections
year-over-year, and will remain elevated for a few more months, as it 16
takes at least six months for piglets to reach full size. As such, given 2007
14
that pork has an estimated 2.5% weighting for the country’s CPI bas- 14.2
12 China has already
ket, pork prices could add up to 50 basis points to headline inflation, 2010 had a hard landing
we believe. If there is good news on the headline inflation front, we 10 10.6
believe that the recent VAT tax cut, which became effective April 1, 2020
8
2016 5.5
2019, should help offset the 10 basis point price increase from tariffs 6 2030
6.7
that we had been previously forecasting. All told, we believe average 3.2 2040 2050 2060
4
CPI for 2019 will be around 2.3% year-over-year, which is below 1.9 1.4 1.4
the three percent threshold and leaves the PBoC with ample room to 2
ease monetary policy. 0
80 85 90 95 00 05 10 15 20 25 30 35 40 45 50 55 60
Data as at March 31, 2019. Source: China National Bureau of Statistics,
OECD, Haver Analytics.
“
We think the potential for a
second half slowdown in China
is now more likely than the
consensus forecast embeds.
”
KKR INSIGHTS: GLOBAL MACRO TRENDS 19
EXHIBIT 36 EXHIBIT 38
Despite the Slowdown in Its GDP, China Continues to …While PPI Is Softer on Weak Profitability/Pricing Power,
Innovate in Key Strategic Areas, Including Robotics Slower Overcapacity Reduction, and Softening Global
Annual Supply of Industrial Robots, Thousands
Demand
China: Headline PPI Y/y (L)
350
Asia / Australia China: Industrial Capacity Utilization (R)
300 Of which: China
12 79
Europe 10
250 America 78
8
6 77
200 4
2 76
150 0 75
-2
-4 74
100
-6
73
-8
50
-10 72
05 07 09 11 13 15 17 19
0
94 96 98 00 02 04 06 08 10 12 14 16 18 Data as at March 31, 2019. Source: China National Bureau of Statistics,
Haver Analytics.
Data as at 2018. Source: IFR World Robotics 2018.
Mexico
EXHIBIT 37
We are using this mid-year update to downgrade our 2019 GDP
China Headline Inflation Is Currently Higher on Food growth estimate for Mexico to 1.2%, which is below both consensus
Prices… expectations of 1.4% and our prior forecast of 1.6%. Even though the
China: CPI, Y/y , % threat of U.S. tariffs is averted for now, significant growth headwinds
remain and we believe there is a non-trivial chance that the U.S.
Ex Food & Energy Food Energy Headline CPI
could again threaten Mexico with protectionist measures leading up
3.5 to the 2020 elections.
Food inflation causing CPI to rise
3.0 May-19
2.5 2.7 What’s ailing the Mexican economy? Well, a recent trip to the nation’s
2.0
capital confirmed that the combination of rising U.S.-China trade ten-
1.5
1.0 sions, roadblocks in USMCA2 approval, construction delays in Mexico
0.5 City, recent credit rating downgrades, and Pemex’s long-term fiscal
0.0 sustainability concerns will all likely keep a lid on private investment
-0.5
(Exhibit 40). Meanwhile, on the public expenditure front, Andrés Man-
-1.0
-1.5 uel López Obrador (AMLO) has actually shown himself to be fiscally
prudent thus far. Somewhat ironically, though, this discipline is re-
Apr-16
Oct-16
Apr-17
Oct-17
Apr-18
Oct-18
Apr-19
Jan-16
Jul-16
Jan-17
Jul-17
Jan-18
Jul-18
Jan-19
“
While consumer confidence in
Mexico is actually hovering near
record highs, it has not led to a
boom in consumer spending.
”
2 United States, Mexico, Canada Agreement.
We Expect Mexico Real GDP to Grow Just 1.2% in 2019, MXN Is Already Trading More Than One Standard
Dragged Down by Both Tight Monetary Conditions and Deviation Below Its Long Term Average in Real Effective
Lackluster Investment Appetite Exchange Rate Terms
Components of Mexico Real GDP Growth Model Mexico: Real Effective Exchange Rate (CPI-based)
% Deviation from Long Term Average
2.5% 1.1%
35% MXN
2.0% strength
-0.3% 25%
+1stdev
1.5% 15%
1.2% 1.2%
-0.7% 5%
1.0% -0.1%
-5% Bull
0.5% -15%
-1stdev Base
0.0% -25%
Baseline US GDP Credit Manu. Mex 2019e
MXN
-35% weakness Bear
Growth Condition Confid. Equities growth
130 4.0%
4% 3.7%
3.5%
3.3% 3.2%
120 3%
2.2%
2.0%
2% 1.8% 1.8%
110 1.5%
1.0%
1%
100
Investment is Low
0%
90
2018a 2019e 2020e 2021e 2022e 2023e
'13 '14 '15 '16 '17 '18 '19
Data as at June 7, 2019. Source: Bloomberg, Banxico, Haver Analytics,
Data as at May 31, 2019. Source: Bloomberg, Banxico, Haver Analytics,
KKR Global Macro & Asset Allocation analysis.
KKR Global Macro & Asset Allocation analysis.
Overall
Info Tech
Prof Svs
Manufacture
Finance
Healthcare
Retail Trade
Agriculture
derpinnings to our thesis. First, we think that technology is creating
structural downward pressure on inflation. One can see this in Ex-
hibits 43 and 44, respectively, which show the consistent downward
pressure that technological transparency/advancement are having on Note: Healthcare is proxied by hospitals, retail trade by general
both consumer and producer prices. merchandise trade, finance by securities/investment. Data as at 2005
through 2018. Source: Haver Analytics, BEA input-output tables,
EXHIBIT 43 Vanguard, KKR Global Macro & Asset Allocation analysis.
Moore’s Law Is a Drag on Inflation, Particularly in the
Early Years of Innovation
Second, our research shows that the direction of interest rates
Moore's Law Is a Drag on Inflation generally correlates with growth in nominal GDP. One can see this in
Technology drag on inflation (RHS)
Exhibit 45. This viewpoint is significant because nominal GDP in both
Production cost including technology (LHS) the United States and China, two of the major drivers of global GDP,
Production cost excluding technology (LHS) has slowed materially in recent years. Third, we think that demo-
Indexes for Product ion Cost s
150 4% graphic forces are increasingly driving more demand for income-
Annual Inflation Rate Diff
140 related products. In fact, by 2030, all baby boomers will be older than
3%
130
age 65. As a result of this new demographic reality, one in every five
2% U.S. residents will be above retirement age.
120
110 1%
100
0%
90
Avg = 0.4pp -1%
80
70 -2%
“
As we noted in our most
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
6% EXHIBIT 47
Forecasts
Data as at May 19, 2018. Source: Bloomberg, Haver Analytics, MSCI, 5000 TLTRO-III eases the liquidity
glide path in the EZ
IBES, KKR Global Macro & Asset Allocation analysis. 4500
4000
3500
3000
EXHIBIT 46 2500
2000
With China Slowing, Global Nominal GDP Growth 1500
1000
Continues to Trend Downward 500
Global and China Nominal GDP (USD), 3yr Rolling CAGR 0
2022
2024
2023
2021
2018
2019
2020
2017
14% 30% TLTRO is Targeted Long Term Refinancing Operation. Data as at May 31,
2019. Source: KKR Global Macro & Asset Allocation analysis, European
12% Central Bank.
25%
10%
20%
8%
6% 15% “
4% Pulling all the pieces together,
10%
2% we come away expecting the Fed
0%
5% to cut rates by 50 basis points in
-2% 0%
the second half of 2019, starting
in July or September. If our ‘mild
2001
2010
1989
1998
2019
1995
2013
2007
1986
1992
2004
2016
We Believe That U.S. Rates Can’t Break Out to the Upside As China’s Current Account Surplus Shrinks, Its Desire to
as Long as the Yield on German Bunds Remains So Low Own as Many U.S. Treasuries Will Wane Too, We Believe
U.S.-Germany 10-Year Rate Spread, % China: Current Account % GDP (L)
May-19 China: Holdings of US Treasury Securities US$T (R)
3.0 2.33
12 18
2.5
10 16
Apr-89
2.0 2.16 May-99 Sep-05 8 14
1.5 1.51 1.18
6 12
1.0
4 10
0.5
2 8
0.0
0 6
-0.5
-2 4
-1.0
-4 Regime 2
-1.5 Change
89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19 -6 0
00 02 04 06 08 10 12 14 16 18 20
Data as at May 31, 2019. Source: Bloomberg.
Data as at December 31, 2018. Source: U.S. Department of Treasury,
State Administration of Foreign Exchange, Haver Analytics.
EXHIBIT 49
U.S. Savers Have Stepped in to Account for a Larger In every one of those occasions, the Fed ended up cutting over the next
Percentage of U.S. Treasury Ownership 12 months, by a median of fully 100 basis points. In three out of those
four occasions, the economy ended up falling into recession within
U.S. Treasury Security Ownership, %
1.5 years, with 1998 being the only exception. What’s really interest-
U.S. Federal Reserve ing, though, is that equity market performance was generally quite
Foreign Central Banks & Savers strong following these short-end curve inversions. Specifically,
U.S. Savers equity markets rose over the next 12 months in three out of the four
past instances – and by a median of fully 13%. It seems that while
2014 2Q'2018
short-end curve inversions do signal coming economic trouble, the
equity market’s first reaction is usually to rally in celebration of lower
14.1%
19.5% rates.
32.2%
48.8%
37.2%
48.3%
“
Data as at June 30, 2018. Russell Napier, CBO, Treasury, TIC Data,
Maybe even more important,
Federal Reserve. interest rate markets embed
a strong expectation of cuts,
Turning to the short end of the yield curve, we now expect the Fed
to start cutting rates later this year. Economic momentum is slow- which means that the Fed would
ing amidst trade-related uncertainty, and Core PCE inflation is again implicitly tighten financial
below the Fed’s two percent target (Exhibit 51). Maybe even more
important, interest rates markets embed a strong expectation of cuts, conditions if it failed to act—
which means that the Fed would implicitly tighten financial conditions
if it failed to act—something we do not think it wants to do. History
something we do not think it
offers a useful guide to the current environment: U.S. two-year yields wants to do.
have fallen to more than 50 basis points below the fed funds rate,
reflecting a market expectation for cuts. This backdrop is something
”
that has happened only four other times since the 1980s (Exhibit 52).
May-14
Jul-15
Jul-08
Nov-17
Mar-06
Mar-13
Jan-19
Jan-05
Sep-09
Jan-12
Sep-16
Data as at June 7, 2019. Source: BEA, Haver Analytics, KKR Global As we turn towards the back half of 2019, we thought it might make
Macro & Asset Allocation analysis. sense to review what has changed in our thinking since January. As
a refresher, in January we made the following assumptions in our
forecast:
EXHIBIT 52
• In terms of forward P/E, we thought SPX would trade in the
Prior Times U.S. 2-Year Yields Dipped 50 or More Basis 15.5x to 16.5x range. Throughout the year, the multiple has
Points Below the Fed Funds Target ranged from a low of 14.2x on January 3rd to a high of 17.2x on
April 30th (Exhibit 56).
12-Month
Forward
2-Year 12-Month Change • In terms of 2019e EPS, we thought it would come in at $167-
Yield - Fed Forward in U.S. Months $168 per share (2.5% growth), now essentially in line with cur-
Funds Change in 10-Year 12-Month Until Offi- rent expectations of $168-169 (which have fallen from north of
Target Fed Funds Yield (Basis Forward cial Onset $175 at the beginning of the year).
(Basis Target (Ba- Points) S&P 500 of Next
Points) sis Points) 10-Year Total Return Recession
• We estimated 6-14% upside in U.S. Equities (inclusive of divi-
Apr-89 -53 -150 2 11% 16 dends). As of May 31, the S&P 500 had returned roughly 11%.
30% EXHIBIT 55
2003
2000
1988
1994
2018
1985
2006
2015
2009
1982
2012
1997
6%
5%
Data as at May 31, 2019. Source: Bloomberg, Haver Analytics, S&P, IBES. 4% 2.7%
3% GMAA forecast
2% 2.5%
EXHIBIT 54 1% 1.9%
Feb-18 Jul-18 Dec-18 May-19
Importantly, This Improved Outlook Is Contingent on
Credit Conditions and PMIs Remaining Steady Around Data as May 31, 2019 Source: Bloomberg, Haver Analytics, S&P, IBES,
KKR Global Macro & Asset Allocation analysis.
Current Levels
2019 CON- 2020 CON- DELTA
EXHIBIT: 56
TRIBUTION TRIBUTION
We Are Using a 16.3x Multiple for 2020, Compared to a
Credit Spreads -1.7% 1.3% 3.1%
Median of 17.0x, to Reflect a More Conservative Outlook
ISM PMI -0.9% 0.9% 1.7%
Distribution of Fwd P/E When Real 10y UST Yield is in
0.2-0.6% Range (1990 - Present)
Oil Prices -3.1% -2.6% 0.5%
Max
Apr-19 Peak
Trade-Weighted USD -0.4% -0.1% 0.3% 20x Today Median 18.7x
Dec-18 17.2x
16.1x 17.0x
G7 ex US Monetary Policy -0.3% 0.0% 0.3% 18x 14.9x
Min
Baseline Growth 5.3% 5.3% 0.0% 16x 11.5x
Stronger USD
Home Price
Confidence
Oil Headwind
Forecast
Baseline
• Total return: So, when we pull it all together, our base case,
including a two percent dividend yield, calls for a four to 11%
percent return through year-end 2020, assuming the S&P 500
Our Earnings Growth Leading Indicator is a combination of seven macro trades at approximately 15.8x to 16.8x our 2020 EPS estimate of
inputs that in combination we think have significant explanatory power $178.20 per share next year. One can see this in Exhibits 59 and
regarding the S&P 500 EPS growth outlook. Data as at May 31, 2019. 60.
Source: Bloomberg, Haver Analytics, S&P, IBES, KKR Global Macro &
Asset Allocation analysis. EXHIBIT 59
P/E
S&P 500 Quarterly Earnings Growth, Y/y % Change
EPS 14.8X 15.3X 15.8X 16.3X 16.8X 17.3X 17.8X
27%
28% 26% $166 2,451 2,534 2,617 2,700 2,784 2,867 2,950
25%
Our Global Cycle Dashboard Suggests That U.S. Equities Are Moderately Overvalued on the Whole. However, the
Rates-Adjusted Equity Valuation Metric Suggests There May Be Further Room to Run
Equity Valuation Metrics Economic and Credit-Related Metrics
Avg.
Embedded Across
Avg. EPS Grwth Credit and
Across Avg. (Rate-Adj. Cycle- Unemp. Credit Trailing 5yr
All Across Eq- EV/ Market Cap Equity Related Rate (in- Spreads Equity Mkt
Metrics uity Metrics EBITDA Fwd P/E % of GDP Valuation) Shiller P/E Metrics verse) (inverse) Return
U.S. 0.7 0.7 1.5 0.5 1.4 -0.7 0.8 0.8 1.5 0.7 0.1
Europe 0.2 -0.1 0.1 0.0 0.6 -1.4 0.1 0.8 2.0 0.7 -0.3
EM 0.1 -0.1 0.9 -0.1 0.0 -0.5 -0.6 0.3 0.6 0.6 -0.4
Japan -0.3 -0.7 -1.2 -1.0 1.0 -1.3 -1.0 0.4 1.2 -0.8 0.9
Data as at May 22, 2019. Note: Readings show number of standard deviations Rich/(Cheap) vs. History. Source: MSCI, IBES, Bloomberg, KKR Global Macro
& Asset Allocation analysis.
“
Meanwhile, we also do not believe that Japan is poised to outper- Global equities generally look
form meaningfully, given its heavy dependence on global trade. And
beyond the issues that Japan may face from a slowdown in global somewhere between fairly valued
trade, we also expect domestic headline noise around the upcoming
consumption tax increase. If we had to speculate today on tomorrow,
to downright expensive on a
our base case now is that there is greater than a 50% chance it is market capitalization-to-GDP
pushed to 2020 as part of a potentially larger reform package. In the
interim, however, there could be significant bouts of uncertainty and
perspective. However, when we
volatility, we believe. adjust for interest rates, they
In terms of Emerging Markets as an Equity asset class, we think that appear to be at attractive levels.
the long-held bear market is in the process of bottoming. As a result,
we continue to support our January 2019 call to lean into areas of
”
of 2020. For our nickel, we believe December 1900 - September 1902 21 Median = 37
that that there is a lot of of late Data as at June 15, 2019. Source: NBER, KKR Global Macro & Asset
Allocation analysis.
cycle behavior occurring that
will likely be corrected amidst
heightened geopolitical tensions
during the next few quarters.
”
30 KKR INSIGHTS: GLOBAL MACRO TRENDS
EXHIBIT 67 EXHIBIT 69
Market Performances Following Long Stretches of S&P 500 Margins Have Approached Peak Levels at a
Consecutive Performance Are Usually Choppy Time When Wages and Input Costs Are Rising. By Sector,
Technology Is at the High End, While Healthcare Is at
# OF CONSEC- the Low End
UTIVE YEARS
OF POSITIVE CUMULATIVE S&P 500 Sector Operating Margins Relative to History
RETURNS START END RETURN CAGR
25y Max/Min Range Latest
3 1954 1956 113% 28.7% 30
15
3 1978 1980 67% 18.7%
10
4 1942 1945 146% 25.2%
5
4 1958 1961 104% 19.5%
0
Industrials
Utilities
Materials
Cons Disc
Healthcare
S&P 500
Telcos
Energy
Tech
5 2003 2007 83% 12.8%
Analytics.
Data as at May 31, 2019. Source: Bloomberg, Haver Analytics, KKR Global
Macro & Asset Allocation analysis.
While We Expect Services to Outperform Goods, We Do Housing-Related Expenditures Are Not Yet in Full
Expect Payrolls in the Services Sector to Keep Moderating Recovery Mode
As Well
Housing-Related % of GDP
U.S. Payroll Employment: Services, 3-Month Moving Average 23%
250 Current
Cycle 22%
200
150
21%
100
50
20%
0
-50 Average of
past 7 cycles 19%
-100
-150 18%
Cyclical trough Recession
-200
0% 12% 25% 37% 50% 62% 75% 87% 100% 17%
Mar-80
Dec-82
Sep-85
Jun-88
Mar-91
Dec-93
Sep-96
Jun-99
Mar-02
Dec-04
Sep-07
Jun-10
Mar-13
Dec-15
Sep-18
Where We Are in Business Cycle (% Cycle Completed)
Data as at June 7, 2019. Source: Bureau of Labor Statistics, Haver
Analytics. Housing Related includes New Construction and Improvements, Rent and
Owners’ Equivalent Rent, and Household Utility Spending Furnishings,
Household Equipment, and Routine Household Maintenance. Data as at
Yet, in areas such as housing, we still think that we are only mid- March 31, 2019. Source: Bureau of Economic Analysis.
cycle at best. Supporting our constructive view is the reality that
residential construction as a percentage of GDP is now just 18.9%,
compared to 22.5% as of the end of 2005. In addition, housing stock EXHIBIT 73
has grown old, which fuels our bullish stance on areas such as home
improvement. One can see this in Exhibit 73. We continue also to Average Age of the Housing Stock Has Moved Up
forecast solid household formation statistics. All told, we expect U.S. Considerably Since the GFC. We View This Bullishly
net new household formation of around 1.3-1.4 million annually over Average Age of Housing Stock, Years
the next five years, which would represent a 30-40% acceleration
from the 1.0 million average that prevailed over the past five years. 35
Generational trends are also suportive: Millennials are starting to age 34
into the key household-enlarging demographic of 35-44 year-olds. 33
Meanwhile, the senior population is living at home longer into old 32
age, which is another demographic support for housing demand. 31
30
29
28
27
“ 26
2000
1996
2008
1976
2012
1984
1968
1992
2004
2016
1988
1972
still think that we are only mid- Data as at December 31, 2017. Source: Bureau of Economic Analysis,
cycle at best. Supporting our Haver Analytics.
The Key to Any Potential Recession in 2019/2020 Is How the Consumer Performs
90% 24 Month U.S. Recession Probability Breakdown
ConsCreditCards, 14%
ConsCreditCards, 14%
70% Factor , 19%
HomeBuilds, 11% CI Loans, 26%
Factor G, 7% HYSpreads, 13%
Factor G, 13% Factor H, 10%
50% LEI, 7% S&P 500, 9%
Factor F, 5% Factor F, 4% CoreCPI, 8% Factor H, 11%
Factor E, 4% Factor , 5%
Inventory, 5% ConsSpending, 6%
Factor E, 5% ConsSpending, 7% Factor C, 11% Factor , 11%
30% ConsSpending, 5% Factor D, 5% Factor C, 13%
Factor D, 5% NewOrders, 4% Factor B, 7%
Factor C, 5% Factor A, 5% Factor C, 18%
Factor B, 10%
Factor B, 5% CorpIntCov, 10% CorpIntCov, 17%
10% NewOrders, 5%
Other, 8% Factor A, 11% Factor B, 11%
Other, 7% Other, 5%
Other, -2%
CorpIntCov, -10%
-10%
Factor A, -7%
ConsDelinquencies, -36%
ConsDelinquencies, -38%
-30%
-50%
Asia Crisis (Dec 1997) Tech Bubble (Dec 1999) Financial Crisis (Dec 2006) Dec 2017 May 2019
Data as at May 31, 2019. Source: KKR Global Macro & Asset Allocation analysis.
So, what are the key variables that we are watching to see whether a SECTION II: Themes
recession could occur earlier or later than 2020? On the earlier side,
a spike in trade tensions surrounding Huawei and/or a more rapid #1: Corporate Carve-Outs Recent trips to Europe and Japan give us
deterioration in corporate margins are the key areas on which we are increased confidence that our ‘deconglomeratization’ thesis still has
focused. Not surprisingly, banks are growing apprehensive, and as a legs to run much further into this cycle. Several factors influence
result, they are tightening lending standards, which is creating minor our thinking. First, many big conglomerates are underperforming in
shock waves in our recession model. One can see this in Exhibit 74. certain regions of the world. General Electric certainly has raised
awareness about the pitfalls of trying to be all things to all people in
In terms of what could go right and extend the cycle, global central the United States. However, our research suggests this problem runs
banks could turn even more dovish and the cloud of uncertainty that much deeper and broader. Said differently, we think that the uptick in
has defined the trade talks could lift. Already, in Asia we see that ‘deconglomeratization’ is a global phenomenon. Indeed, just consider
Australia, New Zealand, India, and Malaysia have cut rates, while in the significant decline in return profiles that we are seeing in Asia,
the United States the Federal Reserve has done a total about face as illustrated in Exhibit 76, which shows how dramatically the returns
since Chairman Powell muttered that the bank’s balance sheet was of conglomerates have fallen to below average from above average
on “autopilot” in late December 2018. Moreover, if President Trump since the Global Financial Crisis.
shifts his focus towards more domestic issues ahead of the Novem-
ber 2020 election, he could not only back away from trade but also
focus on domestic catalysts such as a highway spending reauthoriza-
tion and/or improved drug pricing.
10 EXHIBIT 77
2 US UK Germany Netherlands
16%
0
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 14%
Note: 2018 data is annualized. Data as at February 22, 2019. Source: 12%
Morgan Stanley.
10%
8%
EXHIBIT 76 6%
Conglomerates Are Losing Their Advantage In Emerging 4%
Asia, and As Such, More Corporate Repositioning Stories 2%
Are Likely
0%
10-Year Shareholder Returns of Conglomerates (India and SEA) 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15
Minus Total Shareholder Returns of Pure Plays, Basis Points
Data as at December 31, 2016 or latest available year. Source: National
Statistics, OECD.
360
“
Against a bumpy backdrop,
there is a greater probability this
cycle of ongoing rolling regional
-110
and/or sectoral recessions (e.g.,
2003-2012 2007-2016
Europe in 2011, U.S. Retail in
Data as at September 14, 2019. Source: Dealogic, Bain & Company, Asia 2013, U.S. Energy in 2016, etc.)
Conglomerates: End of the Road.
versus a 2007-like broad-based,
global catastrophe. Maybe more
Consistent with this trend, the pace of carve-outs has been surging,
particularly in Europe. One can see this in Exhibit 75. A recent report
importantly, though, is our strong
by Ernst & Young on corporate behavior highlighted that this trend is belief that corporate profits are no
gaining momentum, as fully 75% of European respondents indicated
a carve-out was their preferred method of divestment, up sharply longer likely to grow faster than
from 48% last year. Seventy-nine percent of these same individuals
reported that streamlining their operating model will factor into their
nominal GDP.
divestment plans over the next 12 months. ”
Local and Regional Competitors Are Increasingly The Gap Between Target Returns and Traditional Fixed
Challenging the Returns of Multinational Firms Income Instruments Likely Means a Greater Move into
Top 500 Global Companies Return on Equity, LTM as at 2016, %
Alternative Products...
Multinational Firms Local Firms Median Pension Plan Assumed Return
vs. 30-Year Treasury Rates
Technology
9% Assumed Rate of Return UST 30-Year Yield
Other Consumer
8%
Industrial
Cyclical Consumer 7%
Utilities 6%
All Sectors 5%
Financial
4%
Diversified
3%
Basic Materials
2%
Media & Communciations
Energy 1%
-5% 0% 5% 10% 15% 20% 25% 0%
2000
2010
2014
2002
1992
2004
2016
1994
2018
2006
1996
2008
1998
2012
Data as at January 31, 2017. Source: National Statistics, OECD, The
Economist.
Data as at December 31, 2018. Source: The Pew Charitable Trust.
“ 4
EXHIBIT 81
Mar-09
Jun-07
Jun-14
Dec-10
Mar-02
Dec-03
Mar-16
Mar-95
Dec-17
Sep-05
Dec-96
Sep-12
Sep-98
India 6.4
13.8
Mexico 4.8
14.3
Data as at April 1, 2019. Source: Bureau of Economic Analysis, NBER, 6.2
Turkey
KKR Global Macro & Asset Allocation analysis. 9.6
Indonesia 6.8
10.9
U.S. Households Are Not Spending Relative to Their Net The Government Has Focused on Stimulating Nominal
Worth This Cycle GDP Through Monetary Policy
US Household Net Worth as % of Disposable Income U.S. Fed Funds Rate, % Points Above/(Below)
U.S.Nominal GDP Growth
Personal Savings Rate (%, RHS)
3yr Moving Avg.
700% 14%
10% 2009
2%
600% 0.8%
8% 0%
550%
500% -4%
4% 2005 2012
1978 -3.7%
-4.1%
-6% -5.6%
450% 2%
2002
2008
2005
2014
1960
1990
2017
1984
1966
1969
1996
1999
1963
1993
1972
1978
1987
1975
2011
1981
'81 '84 '87 '90 '93 '96 '99 '02 '05 '08 '11 '14 '17 '20
Data as at May 20, 2019. Source: Bloomberg. Data as at May 18, 2018. Source: Bloomberg, KKR Global Macro & Asset
Allocation analysis.
-50%
Commodity
S&P 500
European HY
US HY
MSCI World
SXXP
MSCI EM
Topix
US IG
Germ. Bond
European IG
Gold
US Bond
Japan Bond
US Nominal GDP
EU Nominal GDP
US House Price
US wages
European wages
US CPI
European CPI
EA House Price
“
We note a strong ‘Yearn for Yield’ Data as at December 31, 2017. Source: Goldman Sachs.
evident among U.S. consumers,
who continue to sock away
savings at a heady rate relative to
the current advanced state of the
economic cycle.
”
“
Against this backdrop of a slowing
40%
China and increasing disruption,
we have seen the percentage of
companies with top line growth
30%
of eight percent or more decline
to 23% of the MSCI All Country
23%
World, compared to 45% in
20%
98 00 02 04 06 08 10 12 14 16 18 2000/2001. In our humble opinion,
Data as at December 31, 2018. Source Bloomberg, S&P. many of these structural growers
now enjoy not only a cheaper cost
of capital but are increasingly
benefiting from a network effect
that allows them to gain greater
operating leverage than their
peers.
”
38 KKR INSIGHTS: GLOBAL MACRO TRENDS
EXHIBIT 89 EXHIBIT 90
Private Investments in Six of the 10 Best-Funded U.S. Demand for European Logistics Has Exceeded Supply
Tech Startups to Go Public Since 2015 Have Fallen from Every Year Since 2009
the Peak Levels They Hit in Funding Rounds Before the European Logistics Thousands of Square Meters, %
Companies’ Stock Debuts
30 10.0%
The Top 10 Best Funded U.S. Tech Companies to Go Public Since 2015 Completions 9.0%
25 Take Up
8.0%
Vacancy
7.0%
20
6.0%
15 5.0%
4.0%
10
3.0%
2.0%
5
1.0%
0 0.0%
2010
2011
2017
2009
2013
2012
2014
2016
2018
2015
Data as at 2018. Source: CBRE, Euromonitor.
EXHIBIT 91
Data as at May 25, 2019. Sources: Pitchbook (Total raised), company
SEC filings (private share prices, amount raised at peak price), Wall Street
We Are Bullish on Data and Analytics Across a
Journal. Variety of Sectors
Industry Datasphere CAGR, 2018-2025, %
Ultimately, we believe that the poor performance of several recent Healthcare is poised to grow given the advancements in healthcare
analytics, increasing frequency and resolution of MRIs, and other image
IPOs in the Growth arena support our view that cash flow matters.
and video-related data being captured in today’s advanced modes of
One can see this in Exhibit 89. To be sure, we are not back to 1999, medical care
but we do believe that several recent investment rounds in the Pri- 36%
vate Growth markets have been at speculative levels. In our humble 30%
opinion, investors should avoid where possible business models that
27% 26%
are predicated on low marginal revenue economics amidst contin- 25%
ued high fixed costs. We also believe that estimates around the total
addressable market have been exaggerated in certain instances. Im-
portantly, though, we view recent disappointment in performance as
a long-term opportunity, and accordingly, we do expect to shift our
significant underweight in Private Growth back to an equal weight or
overweight as leading investors in the sector are forced to acknowl-
edge that some of their valuation metrics have gotten too robust.
Global Healthcare Manufacturing Financial Media and
Services Entertainment
“
Data as at November 2018. Source: IDC. https://www.seagate.com/files/
In an odd time characterized www-content/our-story/trends/files/idc-seagate-dataage-whitepaper.pdf
60%
EXHIBIT 92
50%
Our Implied Default Rate Has Hit Recessionary Levels
Several Times, Despite the Reality That We Have Not Yet 40%
Had a Technical Recession in the United States 30%
0%
14% Oct -02
Apr-19
Jun-18
Oct-18
Dec-18
Feb-19
Dec-17
Apr-18
Aug-18
Feb-18
14.7% Oct-11 Feb -16
12% 11.2% 11.0%
Data as May 31, 2019. Source: LSTA.
10%
“ 3
2015
2005
2019
1995
2009
2017
2007
1997
revenue economics amidst Data as at May 31, 2019. Source: MSCI, Factset.
…While in Europe, Growth Stocks Are Still Expensive As the Tailwind from Quantitative Easing Slows,
Eurostoxx 600 High vs. Low Sales Growth PE
the Macro Environment for Security Selection
Premium Should Improve
100%
Average Pair-wise Correlations of All S&P 500 Stock Combinations
90% (Daily Returns 2Q86-April 30, 2019)
80%
80%
Clustered / macro market
70% 70%
60% 60%
50%
50%
40%
40%
30%
30%
20%
10%
20%
0% 10% Differentiated /
96 98 00 02 04 06 08 10 12 14 16 18 stock picker's market
0%
Note: High sales growth is greater than eight percent while low sales
2010
2000
2014
1990
2002
1986
1992
2004
2016
1988
1994
2018
2006
1996
2008
1998
2012
growth is less than four percent. Data as at May 31, 2019. Source: IBES,
Datastream, Goldman Sachs Global Investment Research.
Data as at April 30, 2019. Source: BofA Merrill Lynch U.S. Equity &
Quantitative Strategy.
“ 1.6
2010
2000
2008
1998
2005
2011
2009
2013
2017
1999
2003
2007
2012
1997
2014
2002
2004
2016
2018
2015
2006
1967
2017
1987
2007
2012
1982
1997
1977
2002
1992
1972
Wallet Share: Goods vs. Services
20% 23%
Retail Goods (RA) Data as at April 29, 2019. Source: KKR Global Macro & Asset Allocation
Healthcare (LA) analysis, Haver Analytics, BLS, IDC.
Consumer Services,
Recreation &Travel (LA) 22%
19% Meanwhile, in the Emerging Markets, as countries move up the GDP-
per-capita curve, we continue to see demand for basic healthcare
offerings, including private insurance and specialized surgery care,
21%
especially in fast-growing consumer markets such as Brazil, China,
18% Indonesia, and India. Importantly, the trend towards services extends
well beyond just the Healthcare sector. Recreation, travel, and leisure
20% all appear to be market share gainers versus basic ‘things’ that con-
sumers traditionally bought with their disposable income. Moreover,
17% consumers are more willing to use the Internet to price shop, making
19% them more fickle in some instances.
As one might guess, there are times when our team does macro
16% 18% analysis on a particular topic while working with a deal team on
an investment. An on-the-ground visit to a certain country and/or
Mar-10
Mar-11
Mar-09
Mar-19
Mar-13
Sep-09
Mar-04
Mar-12
Sep-13
Mar-14
Mar-06
Mar-08
Mar-16
Mar-18
Mar-05
Mar-15
Sep-04
Sep-10
Sep-11
Sep-14
Mar-07
Mar-17
Sep-06
Sep-08
Sep-16
Sep-18
Sep-05
Sep-15
Sep-07
Sep-17
Sep-12
company can help to confirm that the micro and the macro are totally
Data as at March 31, 2019. Source: Evercore ISI. in sync, which is what we are usually searching for when we deploy
capital on behalf of our limited partners. Our recent trip to China was
one of those times, as Frances Lim and I had several corporate meet-
“ ings that confirmed her bullish thesis about the massive opportunity
set linked to the burgeoning Chinese millennial population. By way
We are finally seeing dispersions of background, of the total 828 million millennials in Asia, Frances
widen out. This shift in the estimates that fully 40%, or 330 million, are today in China. To put
the 330 million in perspective, we would note that there are ‘just’ 66
macroeconomic backdrop as million millennials in the U.S. One can see this in Exhibit 100. Said
differently, China’s millennial population alone is now roughly the
liquidity exits the system likely same size as the entire population of the United States. Also, as we
means that stock picking and show below, millennials are now a sizeable proportion of the overall
Chinese population. Given this heft and growth, they will unequivo-
security selection are going to cally dominate the labor force and consumer markets over the next
become more important again. two decades.
”
42 KKR INSIGHTS: GLOBAL MACRO TRENDS
Against this current backdrop, we have come to appreciate that Chi- EXHIBIT 101
nese millennials have developed distinct consumption preferences in
Chinese Millennials Save Less and Allocate Three Times
recent years. As we show in Exhibit 101, they spend about one-third
more on leisure. They value fresher and healthier food and product
More of Their Income to Leisure
alternatives than their parents, and they price comparison shop much Spending Breakdown China Overall vs. Chinese Millennials
more than their elders and many of their global peers. We link many
of these traits to their tech-savvy ways – and it is not just goods Housing, Transport, Utilities Shopping, Food
purchased. Just consider that it only took Didi, China’s ride hailing Shopping, Non-Food Leisure
leader, three years to reach 50% penetration, while Uber has yet to
reach 50% penetration after seven years in the U.S. Meanwhile, Ali- 100%
Pay has only taken four years to hit a penetration rate of 50%, while 9%
90%
ApplePay has yet to reach the 50% milestone in the United States. To 80%
14% 30%
be sure, some of this accelerated migration in China is linked to the 70%
country’s desire to use technology to accommodate its population of 28% 16%
60%
1.4 billion as well as to create national champions, but it also speaks
50%
to the rapid adoption of technology throughout the country. Favorable 16%
40%
logistics also help greatly in a country where courier costs are low
30%
and population density is high. 49%
20% 37%
EXHIBIT 100 10%
0%
With More than 6x as Many Millennials in Asia than in China Overall Chinese Millennials
the U.S. and Europe Combined, the Asian Millennial Will
Data as at December 31, 2016. Source: Goldman Sachs Global Investment
Reshape the Global Consumer Market Research.
2017: Number of Millennials
Born 1980-1994 (Millions)
EXHIBIT 102
828
We Believe That Potential Spending of High Earners
5.0x the number of millennials in China
Will Be Oriented Towards Upgrades and Experiential
and 12.5x the total number in Asia Spending
relative to the U.S
Millions of Chinese Living in High Income Households
330 222
328
60 66
130
47
Asia includes China, India, Japan, Hong Kong, Korea, and ASEAN
(Indonesia, Malaysia, Philippines, Thailand, Singapore, Vietnam). Data as
at June 24, 2017. Source: United Nations World Population Prospects,
Haver Analytics.
2018 2028 2038
Data as at 2018. Source: Global Demographics estimates, HSBC.
“
Against this current backdrop,
we have come to appreciate
that Chinese millennials have
developed distinct consumption
preferences in recent years.
”
KKR INSIGHTS: GLOBAL MACRO TRENDS 43
EXHIBIT 103 EXHIBIT 104
Millennials Have Different Attitudes and Buying Habits Technology Has Been the Key to EPS Growth This Cycle
Than Older Generations LTM Earnings, January 2009 = 100
300
Millennials Attitudes, Buying Habits and Attitudes
According to a 2018 Harris Poll
83% World Technology
78% 250
72%
World ex Tech
69%
Europe
200
150
100
View Live Plan to Increase Prefer Have Participat-
Experiences as Spending on SpendingMoney ed in a Live
Helping Experiences in on an Experience Event in the Last
Connection With the Coming Year or Event Over 12 Months 50
Friends, Buying
Community or Something
People Around Desirable
the World
0
Data as at 2018. Source: Harris Poll of Millennials. 85 88 91 94 97 00 03 06 09 12 15 18
Data as at June 6, 2019. Source: Worldscope, Datastream, and Goldman
Sachs Global Investment Research.
SECTION III: Investment Considerations/Risks
#1: Reliance on Technology While maybe not as extreme as 2000, EXHIBIT 105
this cycle has clearly been heavily technology dependent. How
dependent? As Exhibit 104 shows, essentially all the earnings growth
Technology Remains an Area of Outsized Growth in the
this cycle has come from the Technology sector. However, it is not Credit Markets These Days
just corporate profits that are being driven by technology. Indeed, we Growth in Par Outstanding by Sector, 2009-2018
recently heard one major CEO in the real estate sector acknowledge
that fully 35% of commercial lease ups during the past 12 months
Leveraged Loans High Yield
were directly linked to the Technology sector.
Industrials
Basics
Utilities
Consumer
Financials
TMT
Energy
Importantly, there is political instability across all regions these days. Failure of governance Adverse consequenc-
Failure of urban plan-
For example, in Europe the recent elections for the European Parlia- (global, national,
ning
es of technological
ment confirmed that the balance of power is shifting away from the regional) advances
traditional center parties (Christian-Democrat and Social-Democrat),
Breakdown of critical
which – for the first time since 1979 (first European Parliament elec- Interstate conflict Food crises infrastructure and
tions) – have lost their combined majority. The old, post-World War II networks
political parties, built around class and economic structures and party
loyalty have eroded with the increased prominence of identity, migra- Large-scale terrorist Large-scale involun- Large-scale cyberat-
attacks tary migration tacks
tion and climate change as core voting issues. At the same time,
radical populist parties, while gaining seats, remain below the 25% Profound societal
State collapse or crisis Data fraud/thefts
threshold and are strongly internally divided on core issues, such as instability
migration and Russia. In this context, Liberals (economically to the
Weapons of mass
right and socially on the left) and Greens (who have now become an Infectious diseases
destruction
established political force in Northwestern Europe) will have a strong
voice in the upcoming appointments of key personnel (presidency of Water crises
EU Commission, EU Council, EU parliament and European Central
Bank) and legislative initiatives over next five years. Both parties Source: The Global Risks Report, World Economic Forum.
have a strong pro EU agenda.
Other 6%
5%
4Q19e “
0%
1.0%
Coming into 2019, we had more
-5% conservative operating margins
-10%
assumptions than the consensus,
-15%
expecting margins to compress by
-20%
20 basis points or so rather than
'96 '99 '02 '05 '08 '11 '14 '17 '20 expand for a third straight year.
Data as at April 30, 2019. Source: Bloomberg, Haver Analytics, KKR
Global Macro & Asset Allocation analysis.
Consensus has since converged
towards our view.
”
35 Vietnam +37%
There are clearly risks to consider. Tariffs are undoubtedly overhangs
30 Taiwan +22% to both growth and confidence, and as we indicated earlier, we view
25 the U.S.-China tensions as much more concerning than the U.S.-
Korea +16%
20 Mexico ones (and we do not mean to belittle them either). Beyond
15 heightened geopolitical tensions, we think both corporate margins
10 and excesses in the Technology sector warrant investor attention.
5
0 Overall, though, we think the most likely outcome is more of a muddle
-5 through one – one that is defined by isolated downturns that create
-10 short-term dislocations. Ultimately, though, low rates, de-levered
China -14% financial institutions, and accommodative central banks should help
-15
-20 to prevent a 2007 repeat. So, stick to the plan. If we are right, then
we think our existing asset allocation framework should continue to
Jan-14
Jun-14
Nov-14
Apr-15
Sep-15
Feb-16
Jul-16
Dec-16
May-17
Oct-17
Mar-18
Aug-18
Jan-19
serve us well. Said differently, if ‘it ain’t broke, don’t fix it.”
References to “we”, “us,” and “our” refer to Mr. McVey not intended to, and does not, relate specifically to any events or targets will be achieved, and may be signifi-
and/or KKR’s Global Macro and Asset Allocation team, as investment strategy or product that KKR offers. It is be- cantly different from that shown here. The information in
context requires, and not of KKR. The views expressed ing provided merely to provide a framework to assist in this document, including statements concerning financial
reflect the current views of Mr. McVey as of the date the implementation of an investor’s own analysis and an market trends, is based on current market conditions,
hereof and neither Mr. McVey nor KKR undertakes investor’s own views on the topic discussed herein. which will fluctuate and may be superseded by subse-
to advise you of any changes in the views expressed quent market events or for other reasons. Performance
herein. Opinions or statements regarding financial This publication has been prepared solely for informa- of all cited indices is calculated on a total return basis
market trends are based on current market conditions tional purposes. The information contained herein is with dividends reinvested. The indices do not include
and are subject to change without notice. References to only as current as of the date indicated, and may be
any expenses, fees or charges and are unmanaged and
a target portfolio and allocations of such a portfolio refer superseded by subsequent market events or for other
should not be considered investments.
to a hypothetical allocation of assets and not an actual reasons. Charts and graphs provided herein are for
portfolio. The views expressed herein and discussion of illustrative purposes only. The information in this docu- The investment strategy and themes discussed herein
any target portfolio or allocations may not be reflected ment has been developed internally and/or obtained may be unsuitable for investors depending on their spe-
from sources believed to be reliable; however, neither cific investment objectives and financial situation. Please
in the strategies and products that KKR offers or invests,
KKR nor Mr. McVey guarantees the accuracy, adequacy note that changes in the rate of exchange of a currency
including strategies and products to which Mr. McVey
or completeness of such information. Nothing contained
provides investment advice to or on behalf of KKR. It may affect the value, price or income of an investment
herein constitutes investment, legal, tax or other advice
should not be assumed that Mr. McVey has made or will adversely.
nor is it to be relied on in making an investment or other
make investment recommendations in the future that are
decision. Neither KKR nor Mr. McVey assumes any duty to, nor
consistent with the views expressed herein, or use any
or all of the techniques or methods of analysis described undertakes to update forward looking statements. No
There can be no assurance that an investment strategy
herein in managing client or proprietary accounts. Fur- representation or warranty, express or implied, is made
will be successful. Historic market trends are not reliable
ther, Mr. McVey may make investment recommendations or given by or on behalf of KKR, Mr. McVey or any other
indicators of actual future market behavior or future per-
and KKR and its affiliates may have positions (long or formance of any particular investment which may differ person as to the accuracy and completeness or fairness
short) or engage in securities transactions that are not materially, and should not be relied upon as such. Target of the information contained in this publication and
consistent with the information and views expressed in allocations contained herein are subject to change. no responsibility or liability is accepted for any such
this document. There is no assurance that the target allocations will information. By accepting this document, the recipient
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The views expressed in this publication are the personal different than that shown here. This publication should foregoing statement.
views of Henry McVey of Kohlberg Kravis Roberts & Co. not be viewed as a current or past recommendation or a
L.P. (together with its affiliates, “KKR”) and do not nec- solicitation of an offer to buy or sell any securities or to The MSCI sourced information in this document is the
essarily reflect the views of KKR itself or any investment adopt any investment strategy. exclusive property of MSCI Inc. (MSCI). MSCI makes no
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not represent valuation judgments with respect to any tions or other forward‐looking statements regarding MSCI data contained herein. The MSCI data may not be
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