By Henry H. McVey Apr 20, 2023
I recently traveled in Japan and China with Frances Lim, who heads up our macro effort across all of Asia. During the trip, we spent time with our KKR colleagues across Private Equity, Growth Equity, Real Estate, Credit, and infrastructure, and our own Global Macro team, including Changchun Hua and Allen Liu in Beijing. We also met with government officials, CEOs, external macro experts, and investors.
Without question, it was time well spent, especially given that this was my first trip back to China since just before COVID. It was also great to be able to compare and contrast the two largest Asian economies. See below for specific read-outs from our visits to Japan and China, but our larger macro conclusions from our latest Thoughts From the Road are as follows:
- There is no ‘one’ Asia, so a more nuanced approach is required. Our visit to Japan felt more akin to visiting Europe or the United States. Labor shortages, sticky services inflation, and tightening monetary policy were the key areas on which our discussions focused. In China, by comparison, inflation is low (PPI is actually negative), international travel is much more muted (six customs officials with no lines or waiting versus 25+ entry points in Japan but with an hour or more waiting time), and export growth is strong (up 15% in China versus no growth in Japan). When I compare this trip to my visit to South East Asia last fall (See TFTR Asia: Beating to a Different Drum from October 2022), it is an important reminder that both a local and differentiated approach is now needed in a region with the world’s largest consumption economy (Exhibit 12).
- However, consistent themes emerged that are applicable globally. In our view, there are four ‘big’ themes to consider. First, we left Asia more confident that our work (see Eye of the Tiger, February 2023) around global shifts in the labor market will lead to important investment opportunities. Wages are up in both Japan and China as demographic headwinds shrink labor supply. This reality, we believe, is why more automation, especially in the corporate sector, is inevitable. Second, our 'security of everything' thesis is certainly alive and kicking in Asia. Without question, every CEO with whom we spoke expressed concern about ’security’, including energy, data, transportation, food, and water. Indeed, there was a greater recognition that we have moved, as my colleague Vance Serchuk likes to say, from a period of benign globalization to one of great power competition. Third, the energy transition is front and center with politicians, business executives, and citizens, though we do acknowledge that the pace of change still differs mightily by country and sector. Importantly, though, even in emerging markets like China, as one example, government mandates for a cleaner environment are being superseded by consumer preferences, including the rise of environmentally friendly brands. Finally, untapped, under-earning savings is a mega theme, in our view. Globally, there is too much money sitting in deposit accounts, earning too little return, to support the hundreds of millions of 65+ individuals in Japan, China, Europe, and the U.S.
- Better Asian growth will provide some ballast to the tightening financial conditions that we are seeing from the fallout of Silicon Valley Bank. Specifically, while our colleague Changchun is already ahead of consensus at 5.8% GDP growth in China this year versus three percent in 2022, there may actually be some additional upside to this forecast. Importantly, the 1Q23 GDP ‘beat’ of 4.5% versus consensus expectations of four percent and a year ago results of 2.9% growth, support our positive tilt, especially our view that consumption has bottomed. Our bottom line for global investors: While positive economic momentum out of Asia may not be enough to help the small domestic businesses in the United States that rely on regional banks for capital, it is definitely going to help the big multinationals that are represented in the large equity indexes in the U.S., Europe, and Japan.
- We remain bullish on our ‘Keep It Simple’ thesis in 2023. The current macro environment is full of significant and complicated headwinds, and our trip did not alleviate any of our concerns. However, there are some substantial dislocations in the capital markets, and as we have written about extensively, dislocations create opportunities. Without question, it is a great time to be a lender, corporate carve-outs are accelerating as return on equity declines against rising shareholder activism, and there are some high quality public companies trading at cheap multiples. Said differently, we believe it could be possible to make a very good return in this market without having to stretch for risk. However, we continue to believe that we are in a new investing regime, a regime that requires a different skill set and approach than simply repeating what worked from 2010 to 2020. Finally, the technical picture is incredibly compelling at a time when the fundamentals are not. Buybacks are booming, there is very little supply, and only eight percent of the top 25 central banks will be tightening by year-end compared to 84% at the end of 2022. Hence, our view is that investors should be transitioning from a ‘Walk to a Jog’ when it comes to deployment. Both 2023 and 2024 are likely to be very good vintages in the alternatives space, we believe, despite the higher cost of debt capital.
In the following section we provide greater detail and key insights from our trip to Japan and China.