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Outlook for 2014 January 2014Henry H. McVey. 2 Important Information The views expressed in this presentation are the personal views of Henry McVey of.

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Presentation on theme: "Outlook for 2014 January 2014Henry H. McVey. 2 Important Information The views expressed in this presentation are the personal views of Henry McVey of."— Presentation transcript:

1 Outlook for 2014 January 2014Henry H. McVey

2 2 Important Information The views expressed in this presentation are the personal views of Henry McVey of Kohlberg Kravis Roberts & Co. L.P. (together with its affiliates, "KKR") and do not necessarily reflect the views of KKR itself. This presentation is not research and should not be treated as research. This presentation does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of KKR. This presentation is not intended to, and does not, relate specifically to any investment strategy or product that KKR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own views on the topic discussed herein. The views expressed reflect the current views of Mr. McVey as of the date hereof and neither Mr. McVey nor KKR undertakes to advise you of any changes in the views expressed herein. In addition, the views expressed do not necessarily reflect the opinions of any investment professional at KKR, and may not be reflected in the strategies and products that KKR offers, including strategies and products to which Mr. McVey provides investment advice on behalf of KKR. It should not be assumed that Mr. McVey will make investment recommendations in the future that are consistent with the views expressed herein, or use any or all of the techniques or methods of analysis described herein in managing client accounts. KKR and its affiliates may have positions (long or short) or engage in securities transactions that are not consistent with the information and views expressed in this presentation. This presentation has been prepared solely for informational purposes. The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, neither KKR nor Mr. McVey guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Target allocations contained herein are subject to change. There is no assurance that the target allocations will be achieved, and actual allocations may be significantly different than that shown here. This presentation should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy. The information in this presentation may contain projections or other forward‐looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this presentation, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Performance of all cited indices is calculated on a total return basis with dividends reinvested. The indices do not include any expenses, fees or charges and are unmanaged and should not be considered investments. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Please note that changes in the rate of exchange of a currency may affect the value, price or income of an investment adversely. Neither KKR nor Mr. McVey assumes any duty to, nor undertakes to update forward looking statements. No representation or warranty, express or implied, is made or given by or on behalf of KKR, Mr. McVey or any other person as to the accuracy and completeness or fairness of the information contained in this presentation, and no responsibility or liability is accepted for any such information. By accepting this presentation in its entirety, the recipient acknowledges its understanding and acceptance of the foregoing statement. The MSCI sourced information in this presentation is the exclusive property of MSCI Inc. (MSCI). MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.

3 I. Key Macro Conclusions & Economic Outlook

4 4 Outlook 2014: “Stay the Course” As a Global Recovery Unfolds What Does “Stay the Course” Mean? 1.Retain key overweight positions in global equities and alternatives, including private credit, special situations and real assets. 2.To fund these risk buckets, we continue to target a massive underweight to government bonds and investment grade debt. 3.However, 2014 will not be a repeat of In particular, we believe 1) the “drag” from government austerity should decline in 2014; 2) equity trading multiples for stocks are now ahead of schedule.

5 5 KKR GMAA 2014 Target Asset Allocation Asset ClassKKR GMAA January 2014 Target (%) Strategy Benchmark (%) KKR GMAA September 2013 Target (%) Public Equities U.S. 20 Europe 1615 All Asia Latin America 66 6 Total Fixed Income Global Government Mezzanine 50 5 High Yield 05 5 Bank Loans 00 2 High Grade 05 0 Emerging Market Debt 00 2 Actively Managed Opportunistic Credit 60 ― Fixed Income Hedge Funds 30 ― Direct Lending 30 3 Real Assets Real Estate 52 5 Energy / Infrastructure 52 5 Gold/Corn/Other Other Alternatives Traditional PE 55 5 Distressed / Special Situation 70 5 Growth Capital/EM PE/Other 55 5 Cash 02 0 Source: *KKR Global Macro & Asset Allocation (GMAA) as at December 31, Strategy benchmark is the typical allocation of a large U.S. pension plan. Please visit to review our Outlook for 2013: A Changing Playbook note, which further reviews these ideas.

6 6 Overall, We Believe the Backdrop For the Global Economy Is Favorable in Growth & Inflation Base Case Estimates KKR GMAA Target Real GDP Growth Bloomberg Consensus Real GDP Growth KKR GMAA Target Inflation Bloomberg Consensus Inflation U.S.2.8% 2.6% 1.7% Euro Area1.1% 1.0% 1.2% China7.4% to 7.6% 7.5% 3.0 to 3.5% 3.1% Brazil2.1% 2.3% 6.0% 5.8% Our GDP and Inflation Outlook by Region Seems to Suggest Stronger Growth in 2014, Aided by Less Fiscal Drag Even a Decelerating China Still Makes Up Almost a Third of Global Growth in 2014 GDP = Gross Domestic Product. Bloomberg consensus estimates as at December 31, Source: Bloomberg, FOMC, ECB, Haver Analytics, KKR Global Macro & Asset Allocation analysis. Data as at October 8, Source: IMF, Haver Analytics (bps) 2014 (bps) U.S. Government Drag on Growth Europe Government Drag on Growth -100 to to -75

7 7 …And We Expect Less Fiscal Drag From Austerity Significantly Less U.S. Austerity in 2014 vs European Austerity Is Also Slowing in 2014 Measured as change in general government underlying primary balance, adjusted for cycle and one-offs. Data as at December 31, Source: OECD Economic Outlook 94 Database, with 2014e adjusted by KKR GMAA to account for U.S. Budget Deal announced December 10th. Measured as change in general government underlying primary balance, adjusted for cycle and one-offs. Data as at December 31, Source: OECD Economic Outlook 94 Database.

8 8 We Think the Current Economic Cycle Still Has Room to Run We Are Now in the 54th Month of Economic Expansion If Past Relationships Hold True, This Economic Cycle Has More Room to Run Data as at December 31, Source: National Bureau of Economic Research (NBER), KKR Global Macro & Asset Allocation analysis. Economic expansions from 1919 to Data as at December 31, Source: Federal Reserve Bank of St. Louis, National Bureau of Economic Research, Bureau of Economic Analysis, U.S. Treasury, KKR Global Macro & Asset Allocation analysis.

9 II. Macro Themes

10 10 Multiple Expansion Is Now A Little Ahead of Schedule; We Expect More Bumpiness in 2014 Using Past Cycles as a Guide, Multiple Expansion Now Appears Ahead of Schedule Similar to Past Cycles, Real Rates Are Now Rising Past U.S. economic cycles analyzed: i) 3Q38-1Q45, ii) 2Q61-4Q69, iii) 2Q75-1Q80, iv) 1Q83-3Q90 [excluded here], v) 2Q91-1Q01, vi) 1Q02- 4Q07. Data as at October 31, Source: KKR Global Macro & Asset Allocation analysis of S&P data.

11 11 We Believe DM Likely to Outperform EM Again. Within EM, Look for Differentiation in 2014 Emerging Market Currencies Are No Longer a Tailwind The Cycle Has Turned: Developed Markets Tend to Outperform When Rates are Rising Valuation calculated as the difference between spot and the IMF implied purchasing power parity (PPP) conversion rate. Data as at December 31, 2013.Source: IMFWEO, Haver Analytics, Bloomberg. Data as at December 31, Source: Bloomberg, KKR Global Macro & Asset Allocation analysis.

12 12 We Believe the Illiquidity Premium Is Still Sizeable Enough to Generate Attractive Returns Yield Comparisons – Originated vs. Traded Leveraged Loans Our Analysis Suggests That Both the Illiquidity Premium and the Default Premium Appear Outsized Weighted average yields of senior term debt and senior subordinated debt. Data as at September 30, Source: S&P LSTA, public company filings of Ares Capital Corporation. *KKR Asset Management estimate. Data as at December 18, Source: Barclays US Agg Government Yield to Worst, Bloomberg, KKR Global Macro & Asset Allocation analysis.

13 13 We Believe There May Be a Chance to Unlock “Trapped” Liquidity Pools in Europe Spread Between SME Loans In Spain and Germany Remain at an All-Time High European Bank Leverage Is Double That of the U.S. Data as at October 31, Source: European Central Bank, Haver Analytics. Data as at 3Q2013. Bottom up aggregates for Banks and Diversified Financials within the MSCI Europe and S&P 500 respectively. Source: MSCI, S&P, Factset, Bloomberg.

14 III. Equities

15 15 Unlike Last Year, We Look for EPS Growth to Be Biased Upward Our Quantitative Earnings Model Suggests Faster Growth in 2014 A Key Input to 2014e Growth Is Recovering Home Prices The Earnings Growth Leading Indicator (EGLI) is a statistical synthesis of seven important leading indicators to S&P 500 Earnings Per Share. Henry McVey and team developed the model in early A = Actual; E = Estimated. Data as at December 31, Source: KKR Global Macro & Asset Allocation analysis, Bloomberg. EGLI Suggests Strong Growth in 2014

16 16 Investors Tend To Place A Significantly Higher Multiple On Stocks When Real Rates Turn Positive Multiples Tend to Expand in a Positive Real Rate Environment Similarly, Real GDP Growth of 2-3% Implies a Higher P/E Multiple Data as at December 31, Source: Thomson Financial, S&P, Federal Reserve Board, Factset.. Normalized Price-to-Earnings valuation ratio = Price divided by average of past 5 years EPS. Study from 1900 to 3Q13. Source: BEA, Historical Statistics of the United States, Factset, S&P, Bloomberg, stock market data Used in "Irrational Exuberance" by Robert J. Shiller.

17 17 We Expect Market Momentum to Be Choppy But Exceed 2013 Levels Pulling All the Pieces Together: 2014 S&P 500 Price Target Suggests a 2000 Trading Range Data as at December 31, Source: KKR Global Macro & Asset Allocation analysis. &P S&P 500 Trailing P/E ,6201,6741,7281,7821,8361,8901, ,6351,6901,7441,7991,8531,9081,962 Approximate YE 2013 Range 1101,6501,7051,7601,8151,8701,9251, ,6651,7211,7761,8321,8871,9431, ,6801,7361,7921,8481,9041,9602, ,6951,7521,8081,8651,9211,9782, ,7101,7671,8241,8811,9381,9952, ,7251,7831,8401,8981,9552,0132, ,7401,7981,8561,9141,9722,0302, ,7551,8141,8721,9311,9892,0482, ,7701,8291,8881,9472,0062,0652,124 YE 2014, Assuming 9% EPS 1191,7851,8451,9041,9642,0232,0832,142 Growth and No P/E Expansion 1201,8001,8601,9201,9802,0402,1002, ,8151,8761,9361,9972,0572,1182, ,8301,8911,9522,0132,0742,1352, ,8451,9071,9682,0302,0912,1532, ,8601,9221,9842,0462,1082,1702,232 S&P 500 Earnings Per Share ($)

18 18 We Believe Aggressive Capital Management By Corporate America Is Now Acting As A Major Driver Of Growth And Returns Dividends and Buybacks Are Still AcceleratingS&P 500 Dividend and Buyback Yield Combined Now Offers Much More Yield Than 10-Year Treasury Data as at December 31, Source: Factset, ISI, Barclays. Data as at September 30, Source: Goldman Sachs Research.

19 IV. Fixed Income

20 20 Market Rates Are Now Much Closer To Our Estimates Across Most Maturities Interest Rates: Current Market Expectations Are Now Closer to Our Forecasted Outlook Market forecasts as per U.S. Treasury actives curve for nominal yields and U.S. TIPS curve for real yields. Data as at December 18, Source: Bloomberg, KKR Global Macro & Asset Allocation (“GMAA”) analysis. Current Market GMAADec ’14e Market DeltaGMAADec’16e Market Delta 10yr Yield2.9%3.1%3.3%-0.2%3.8%3.9%-0.1% Memo: Prior Forecast3.2% 3.7% 5yr Yield1.7%2.2%2.4%-0.3%3.4%3.8%-0.3% Memo: Prior Forecast2.7% 3.5% Real 10yr Yield 0.7%1.0% 0.0%1.7%1.4%0.3% Memo: Prior Forecast0.8% -1.3% Real 5yr Yield -0.4%-0.1%0.1%-0.2%1.3%1.0%0.3% Memo: Prior Forecast0.0% 1.1% KKR GMAA Fed Forecast vs. Market Expectations Old GMAA forecast as at September 18, New as at December 20, Source: Federal Reserve, Bloomberg, KKR Global Macro & Asset Allocation Forecast.

21 21 We Expect Rate Hikes To Be At An Unusually Slow Rate Relative to the Historical Average We Believe Next Interest Rate Hike Cycle Will Be Historically Mild Relative to History Data as of December 20, Source: Federal Reserve, Bloomberg, KKR Global Macro & Asset Allocation Forecast. Trough MonthPeak MonthMonths Trough Rate Peak Rate Change (bps) Rate of Change (bps/yr) CPI y/y at Peak Real Fed Rate at Peak Feb-83Aug %11.50% %7.2% Dec-86May %9.81% %4.4% Jan-94Feb %6.00% %3.1% May-99May %6.50% %3.3% May-04Jun %5.25% %1.0% Average 194.6%7.8% %3.8% KKR GMAA '15-'17 Est.~ %3.00% %0.5%

22 22 We Think We Are at an Important Inflection Point in the Fixed Income Cycle. As Such, We Suggest Retaining Ultimate Flexibility If We Are Right Rates Are Rising, This Has Implications for All Asset Allocation Decisions, Particularly in Fixed Income Asset Class Selection Matters More Today, So the Flexibility to Again Toggle Between Fixed Income Asset Classes Is Important Data as at November 30, Source: Bloomberg. Data as at December 31, Source: JPMorgan Research, Bloomberg.

23 23 Rising Rate Environments Have Historically Been Opportunity Rich Periods For Fixed Income Hedge Funds In 2014 We Again Expect Leveraged Loans and High Yield to Outperform Versus Many Other Parts of Fixed Income Fixed Income Hedge Funds Have Shown Strongest Absolute and Relative Performance in Rising Rate Environments Data as at December 18, Source: JP Morgan, Barclays, Bloomberg. * Equal-weighted average of HFRI RV Corporate, Convertible Arbitrage, and Asset Backed Indexes. TD = to date, as of November 30. Source: Bloomberg, KKR Global Macro & Asset Allocation analysis.

24 V. Real Assets

25 25 We Continue To Eschew Traditional Real Assets With No Yield, Including Standard Commodity Swaps/Notes GSCI Total Return Swap Has Not Created Much Value for Investors Since 2004 Gold Faces Significant Challenges in a Rising Real Rate Environment The GSCI total return index measures the returns accrued from investing in fully collateralized nearby commodity futures, while the GSCI spot index measures the level of nearby commodity prices. Data as at December 31, Source: Goldman Sachs, Bloomberg. Data as at November 30, Source: Bloomberg, Global Macro & Asset Allocation analysis.

26 26 Our Strong View Is That Central Bank Policy Is Directed Towards Lifting Long-term Inflation Expectations History Shows That Pinning Fed Funds Below GDP Growth Leads to Rising Inflation Rates We Believe Inflation Is Running Too Low Today and Will Increase As the Economy Accelerates e = KKR Global Macro & Asset Allocation estimate. Our estimate assumes the Fed does not tighten until mid-2015 and that nominal GDP growth averages 4.5% annually between 2012 and Data as at May 31, Source: KKR Global Macro & Asset Allocation Forecast as of December 31, 2013.

27 VI. Alternatives

28 28 There Have Been Benefits To Adding Alternatives, Private Equity In Particular, To An Overall Portfolio, A Trend We Expect To Continue Our Work Shows Most Pensions Are Still Not Efficiently Positioned in Terms of Allocations Pension Funds With Higher Non-Liquid Alternative Asset Classes Have Delivered Higher Returns Constraints: Minimum allocation to equities 20%, minimum bonds 20%, maximum real estate 20%, maximum private equity 20%. Data as at December 31, Source: Cambridge Associates, MSCI, S&P, Barclays, BAML, HFRI, NCREIF, Bloomberg, and Antolin, P. (2008), "Pension Fund Performance", OECD Working Papers on Insurance and Private Pensions, No. 20, OECD publishing, © OECD. doi: / Source: Pensions and Investments Research Center, as of November 21, Reflects asset allocation for defined benefit assets as of 9/30/2012 and Cliffwater 2013 Report on State Pension Performance and Trends, July 22, Data as at June 30, 2012; based on 97 state pension systems, including those whose fiscal 2012 end is not June 30.

29 29 Alternatives Remain An Elegant Way To Gain Cyclical Exposure To Beneficiaries Of Ongoing Deleveraging in Europe European Banks Are Finally Beginning to De-leverage… …But There Is Still Much Work to Be Done Data as at 3Q2013. Bottom up aggregates for Banks and Diversified Financials within the MSCI Europe and S&P 500 respectively. Source: MSCI, S&P, Factset, Bloomberg. Data as at December 31, Source: Statistical Office of the European Communities, European Central Bank, Bureau of Economic Analysis, Federal Reserve Board, Cabinet Office of Japan, Bank of Japan.

30 VI. Currencies

31 31 In The Currency Arena, We Believe Pressure On Fiscal And Current Deficits Makes Currencies A Logical “Release Valve” We Think a Dollar Bull Market Has BegunWithin Latin America, We Think Mexico is More Attractive than Brazil Data as at December 4, Source: Bloomberg. Data as at December 31, Source: Bloomberg.

32 VII. Asset Allocation Summary/Q&A

33 33 Outlook 2014: “Stay the Course” As a Global Recovery Unfolds What Does “Stay the Course” Mean? 1.Retain key overweight positions in global equities and alternatives, including private credit, special situations and real assets. 2.To fund these risk buckets, we continue to target a massive underweight to government bonds and investment grade debt. 3.However, 2014 will not be a repeat of In particular, we believe 1) the “drag” from government austerity should decline in 2014; 2) equity trading multiples for stocks are now ahead of schedule.

34 34 KKR GMAA 2014 Target Asset Allocation Asset ClassKKR GMAA January 2014 Target (%) Strategy Benchmark (%) KKR GMAA September 2013 Target (%) Public Equities U.S. 20 Europe 1615 All Asia Latin America 66 6 Total Fixed Income Global Government Mezzanine 50 5 High Yield 05 5 Bank Loans 00 2 High Grade 05 0 Emerging Market Debt 00 2 Actively Managed Opportunistic Credit 60 ― Fixed Income Hedge Funds 30 ― Direct Lending 30 3 Real Assets Real Estate 52 5 Energy / Infrastructure 52 5 Gold/Corn/Other Other Alternatives Traditional PE 55 5 Distressed / Special Situation 70 5 Growth Capital/EM PE/Other 55 5 Cash 02 0 Source: *KKR Global Macro & Asset Allocation (GMAA) as at December 31, Strategy benchmark is the typical allocation of a large U.S. pension plan. Please visit to review our Outlook for 2013: A Changing Playbook note, which further reviews these ideas.


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