As we peer around the corner towards tomorrow, our macro viewpoint remains that this cycle will be different. The ongoing uncertainty linked to COVID-19 has meant looser fiscal and monetary policies for longer relative to history. Moreover, the global energy transition, coupled with excess consumer savings, is impacting the economic recovery in ways that are dramatically different than recent recoveries. Our base view is that, after almost four decades, disinflation is giving way to reflation. Therefore, to be successful in the environment we envision will require preparation, including both a deep study of the past as well as a vision towards the future. As one of the world’s greatest novelists, Miguel de Cervantes, once noted: To be prepared is half the victory. Overall, our posture at KKR is that the current environment remains generally constructive for risk assets. Key to our thinking is that the total ‘stock’ of global monetary support, including the $12.8 trillion of increased central bank liquidity injected from the G4 economies since the start of the pandemic, will overpower the global interest rate tightening cycle that already has started. In addition, real rates, except in China, are still extremely low, which elevates the value of the illiquidity premium. However, as we detail in this piece, the road ahead will be a bumpy one, particularly as the ‘flow’ of liquidity into the system slows. Finally, this cycle – more than ever – will favor thematic investors who are able to incorporate a top-down approach that champions both innovation and complexity amidst periodic dislocations to take advantage of the robust opportunity set we see unfolding.
One of the key attributes of the investment management business, and one that we have always found appealing, is it is a learning business. Without question, both investing successes and failures – and probably more so the failures than the successes – help to build muscle memory and pattern recognition that can alert us to what might unfold next. These past learning experiences taken together can often serve as a differentiating feature for predicting the direction of future returns, especially during periods of heightened uncertainty. And, if there is one thing we have had in abundance over the past 18 months, it has been heightened uncertainty.
The good news is that we at KKR have plenty of experience on which to draw. Henry Kravis and George Roberts, who founded KKR over 45 years ago, have ensured through the appointment of their successors Joe Bae and Scott Nuttall that we remain a learning institution. At our core, we draw upon our past, including both what worked and what did not. In fact, post-mortems conducted by the Firm led to the creation of the KKR Global Institute to ensure that macro, geopolitics, and government and public policy became important considerations for every investment. However, we are also cognizant that even learning institutions must continue to evolve. Indeed, both our founders often quoted General Erik Shinseki at our KKR town halls, reminding us that “If you don’t like change, you are going to like irrelevance even less.”
So, where does this leave us today as we use our existing resources and past experiences to peer around the corner on what tomorrow might look like? Not surprisingly, given the substantial amount of liquidity that is in the system, our quantitative models, our fundamental research, and our intuition lead us to believe that economic growth continues at a solid clip on a nominal basis for the next few years. If we had to say the current period ‘rhymed’ with a past period, it would be the 2001-2007 economic recovery. During those years, China’s fixed investment build-out created inflationary pressures and a strong capex cycle; this time, by comparison, it is both record levels of stimulus and the global energy transition that are acting as important catalysts for upward pressure on input costs.
Importantly, as we show in Exhibit 1, our research suggests that, despite several macroeconomic headwinds, now is not the time to hit the panic button. In fact, based on 2021’s strong returns, the probability of positive forward returns over the next 12 months is approximately 75% or greater. On a 3-year basis, it is actually 90% plus or higher.
|How Our Thinking Has Evolved
|Inflationary pressures, labor and housing in particular, remain key areas of focus. All told, 24 of 26 headline CPI inputs are now above the Fed's two percent long-run inflation goal.
|We boost our CPI forecast in the U.S. to 5.0% in 2022, compared to a consensus of 3.6%. We remain positive on pricing power stories and collateral-based cash flows across Private Equity and Real Assets
|Despite tightening measures in 2022, we look for real rates outside of China to lag this cycle
|We forecast real rates of -0.5% in the U.S. and -0.1% in Europe, respectively, in 2022. Housing should remain a major beneficiary
|Equities remain the asset class of choice. Both innovation and complexity should work this cycle
|We remain overweight Global Equities again in 2022. Our new projected path has the S&P 500 ending 2022 at about 4,900 with 15% EPS growth.
|We are now in a global tightening cycle, but the sheer stock of liquidity will keep financial conditions from getting too tight
|Unlike the onset of the taper tantrum in 2013 (when the short-end of the curve was mispriced), we would now hedge the long-end of the interest rate curve
|We still see both strong demand and uneven supply, albeit better than in 2021, for commodities again in 2022
|We still favor select commodities linked to the global energy transition. We still like longer-dated Oil
Strong Returns in 2021 Actually Bode Well for 2022
Yet at the same time, both structural and cyclical risks are mounting. On the structural front, for example, we think that the risk of ‘irrelevance’ from disintermediation is spiking. Innovation is rampant across multiple industries, and it is leading to disruptors displacing incumbents. Just consider that the average company in the S&P 500, one of the most blue chip of equity indexes, now lasts just 12 years as an index member; in 1958, by comparison, the average company lasted 61 years. All of our thematic work at KKR suggests that the pace of innovation will continue to accelerate. At the heart of this increase, we believe, is the proliferation of global data that can be shared, analyzed, and interpreted. All told, global data is likely to double every two to three years, we believe.