After a year of market volatility fueled by bank failures, macroeconomic uncertainty, and inflation, KKR said investors are now “too conservatively positioned” and may miss lucrative investments across public and private markets.
“After multiple trips across Asia, Europe, and the United States to pressure test our macro frameworks in the first half of the year, we think investors are still too conservatively positioned for the path forward we are seeing for the global economy,” according to KKR’s mid-year outlook. The asset manager believes that the S&P 500 has already hit its bottom in this cycle, adding that investors are now experiencing the fastest economic recovery since the end of World War II.
“Our posture this year has been that there is value in the market,” Henry McVey, chief investment officer of KKR’s balance sheet and head of the global macro and asset allocation team, told Institutional Investor. “I think a lot of investors moved to the sidelines after the banking crisis, and I think they [may] miss some of the price increase in risk assets.”
In the public market, KKR has identified small-cap stocks and international equities as attractive investments in the current environment. Small-cap stocks are now trading at the largest discount relative to their large-cap counterparts in more than 20 years, according to the report, which is expected to be released on Wednesday. The valuation gap is so large that KKR believes small-caps may outperform large-caps by about 2 to 3 percent per year. Outside the U.S., KKR is bullish on stocks in Japan and Europe, which are trading at a 25 percent to 30 percent discount to the S&P 500.
“This whole idea of an asynchronous global recovery is really important for investing,” added McVey. “China is having very low inflation. Japan is actually exiting deflation…You have a very different story unfolding around the world, especially in Asia.”
Despite the potential of small-cap stocks, KKR said it’s still too early to abandon large mega-caps as the big technology firms could benefit from the rise of artificial intelligence. “While we do not see mega-cap tech performing well over the long term, these companies’ strong cash balances likely mean that they could be perceived as safe havens this cycle,” according to the report. “They have also emerged as a back-door play into AI in certain instances.”
KKR is also optimistic about real estate investment trusts and private real estate credit. According to the report, REITs and private real estate credit are the most attractively valued asset classes within real assets and private markets, respectively, followed by listed infrastructure, private credit, and private real estate equity.
“Ongoing volatility, as well as bank funding pressures, have caused a pullback in large sources of real estate debt financing,” according to the report. But KKR added that the challenging fundamentals in the real estate market are largely attributable to the office sector, which has been experiencing low occupancy rates since the pandemic began. KKR believes real estate lending overall will “hold up much better” in the current cycle than it did during the 2008 Global Financial Crisis.
Given a higher level of inflation, “you want to invest in things that are more linked to nominal GDP, including real estate credit and collateral-based cashflows, such as asset-based finance and infrastructure,” added McVey.
“As we peer around the corner today or tomorrow, we remain generally constructive on risk assets,” the report concluded. “The end of 2021, not the end of 2023, was the time to reduce risk. In our view, that moment has passed.”
