Same As It Ever Was?

Whereas Reaganomics and Thatcherism were terms for economic policies that defined the 1980s, we similarly believe that we have now entered a new period. The acceptance of big government with a more ‘visible hand’ in tackling thorny challenges such as inequality, data security, cross border investing, monopolistic pricing, and climate change, is becoming mainstream. In particular, we have entered a new era for policy, one that relies on more government support/intervention/regulation on the fiscal side as well as more reflationary strategies on the monetary side. This part of the future macroeconomic landscape we envision is not ‘transitory’, we believe. So, against this backdrop, we think that pricing power and collateral-based cash flows become truly distinguishing features. There is also the unique cross-current of disinflationary technological change occurring at the same time that there has been a dearth of capital expenditures in old economy sectors required to fund a massive transition towards new energy sources. And all this is occurring at a time of rising geopolitical tensions. Not surprisingly, our asset allocation suggestions for the future are distinctly different from what worked during the past decade.

I was recently reviewing my Outlook calendar, and it inadvertently flipped back to the week of February 10th, 2020. If memory serves, one night that week my wife Laura and I sat in a crowded New York City theater and saw David Byrne’s American Utopia, our last pre-COVID Broadway show, which included a rousing rendition of one of my favorite songs, Once in a Lifetime. As I think back on that experience now, several lyrics in the song — although originally released nearly 30 years ago — were eerily on point for the environment we soon would all experience.

For starters and with true compassion for all of the lives that have been so adversely affected in so many ways, all of us at KKR hope that this pandemic is truly a ‘once in a lifetime’ event. Yet, even after all the incredible scientific breakthroughs that have taken place, the virus continues mutating in its quest for survival.  Moreover, we are all still struggling with understanding the true health, economic and social impacts of the disease, particularly on marginalized communities and those without sufficient social safety nets. So, we still don’t yet know, even as the ‘days go by’, exactly what tomorrow will look like. Will it be the ‘same as it ever was’? We don’t think so.

From KKR’s perspective, we are actually cautiously optimistic about the future, though we are also of the mindset that many aspects of pre-pandemic everyday life may never quite go back to normal. Beyond some notable changes to our day-to-day protocols at home, at the office, and at school that we must all embrace, follow-on aftershocks from the pandemic must also be integrated into our approach as allocators of capital on behalf of the retirees, teachers, first responders, and other investors we serve.

With these considerations in mind, we enter the second half of 2021 increasingly confident that the portfolio that drives excess returns in the next decade will likely look a lot different than the one that garnered outsized returns during the 2009-2019 period. Key to our thinking is that we have entered a new era for policy, one that relies on more government support/intervention/regulation on the fiscal side as well as more reflationary strategies on the monetary side. Indeed, whereas Reaganomics and Thatcherism were terms for economic policies that defined the 1980s, we similarly believe that we have now entered a new period where acceptance of the ‘visible hand’ of big government in tackling thorny challenges such as inequality, data security, cross border investing, monopolistic pricing, and climate change, is becoming mainstream. If we are right, then we could enter more periods where nominal GDP growth increases faster than nominal profits.

Meanwhile, unlike the most recent economic recovery, the Western Hemisphere — not the Eastern one — is leading the charge to resuscitate growth via larger debts and deficits. By comparison, it was China that spent aggressively using a variety of fiscal and monetary measures funded by large increases in its overall debt load to steady global growth in the aftermath of the Global Financial Crisis (GFC). 

Importantly, though, we think that our structural reflationary call is going to be tested over the next few months, as the rate of change on economic growth and money supply growth both moderate. The rapid spread of the Delta variant too could pose significant challenges in the near-term If we are right, then PMIs too will likely come down from near record levels. Goods inflation also could fall somewhat precipitously, albeit from record levels, according to our estimates.

However, do not be fooled by this perceived growth slowdown. It is a rate of change transition, not a growth bust, as spending shifts more from the public sector to the private sector. Nominal GDP should remain higher this cycle, as we have strong conviction that something structural on the reflation front has changed. Simply stated, the macroeconomic outlook is not the same as it ever was. We do not make this statement lightly, but we are convinced that there are six structural inputs that will make this recovery much different than those experienced during the last four decades — and certainly wildly different from the one that defined the brittle, long-tailed recovery that started in 2009/2010. See below for full details (Section II in particular), but they are as follows:

Six Structural Inputs to Recovery Which Will Be Unlike the Last Four Decades:

1. There is a more accommodative approach to monetary policy, including Average Inflation Targeting (AIT) in the United States
2. Austerity is out; sustained global fiscal stimulus is in, with more of it going directly to consumers
3. We see more input cost pressures in already fragile supply chains, particularly as the PPI rises above the CPI; labor shortages too are part of this emerging conundrum
4. Lower real rates mean easier financial conditions for longer
5. The current global energy transition towards a cleaner environment is actually inflationary
6. There is now a record amount of savings to be spent earlier in the cycle

If we are right in our assessment, then chief investment officers will need a dramatically different top down framework to deploy capital effectively. In particular, we strongly believe that a theme-based approach is warranted to navigate what is becoming an ever more complex global economy.

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