KKR, a leading global investment firm, today released KKR’s 2022 mid-year outlook by Henry McVey, CIO of KKR’s Balance Sheet and Head of Global Macro and Asset Allocation (GMAA). In “Walk, Don’t Run,” McVey outlines his team’s perspective on how the macroeconomic narrative is shifting from a singular focus on surging inflation expectations and central bank policy efforts to one where inflation and tightening financial conditions are adversely impacting corporate profits.
In the piece, McVey and his team make a number of out-of-consensus calls, which include:
- Broad-based margin degradation not yet priced in: McVey forecasts that S&P 500 earnings per share will contract five percent in 2023 versus a consensus expectation of nine percent growth.
- Oil prices higher for longer: At $115 and $100 per barrel for 2023 and 2024, the team is materially above consensus on oil ($24 and $19 per barrel, respectively).
- Inflation headwinds shifting from goods to services: The team forecasts goods deflation in the U.S. in 2023, but expects services, food, and energy inflation to remain elevated.
- Materially higher yields for the German bund in 2023: the team’s forecast for the German bund in 2023 is much higher than the market expects (2.0% versus 1.15%).
- Divergence between the economic and market recovery in China: China is in contraction according to the team’s proprietary cyclical indicator, with no ‘V-shaped’ recovery like in 2020. However, the market now seems to have largely discounted the tough economic environment that the team is forecasting.
McVey and his team continue to believe that a combination of excess stimulus, heightened geopolitical risks, sticky supply side constraints and a changing relationship between stocks and bonds, have created a new investing regime. As such, they urge investors to pay close attention to the following mega themes as they navigate this new environment:
- Pricing Power: Higher input costs and supply chain pressures have created an environment that strongly favors companies with pricing power and unit volume growth.
- Collateral-Based Cash Flows: Given the unusual backdrop of stickier-than-expected inflation, excess stimulus, and higher commodity prices, demand for collateral-based cash flows, including Infrastructure and Real Estate, is likely to accelerate more than many investors now think.
- The Security of Everything: Fragmentation of global trade and supply chains will likely add a new dimension to geopolitical rivalries as more industries and sectors, including healthcare, energy, communications, and data, become “strategic” from a national security perspective.
- Energy Transition: Energy transition is an approximately $1.5-2.0 trillion per year growth opportunity. It is a broad-based theme that is likely to impact every industry and require many companies to rethink and retool parts of their business models.
- Revenge of Services: U.S. goods-buying is still running above trend while services is running four percent below trend. In light of this, now may be the time to flip exposures to the underdog category, services.
- Efficiency: Automation/Digitalization/Testing: We expect to see a boom in key areas of innovation as well as a continued shift to decentralization across many sectors.
In light of these themes, McVey and his team highlight the following conclusions for asset allocation:
- In the liquid markets, favor Credit over Equities and particularly the short-end of the curve, including municipal bonds, mortgages and CLO liabilities.
- Stay overweight almost all investments linked to pricing power and collateral-based cash flows, including Infrastructure and select parts of Real Estate.
- Stay overweight flexible, opportunistic pools of capital that can provide thoughtful solutions to good companies with levered capital structures.
- Own select commodities, such as oil and those linked to the energy transition theme, including aluminum, copper and lithium.
- Reduce exposure to price takers, particularly in the consumer sectors.
- Avoid big cap technology stocks.
- Stay cautious on Turkey and Mexico.