Outlook For 2016: U.S. Equity Market – Adult Swim Only by KKR We approach early 2016 with caution. In our view, valuations are not cheap at a time when central bank policy in the U.S. is changing, global trade is stalling, and corporate margins are peaking. Also, ongoing Chinese yuan depreciation is significant; it literally means that every other country now must think through whether it needs to further devalue to remain competitive. Not surprisingly, we are below consensus in terms of both GDP growth and inflation forecasts for most regions. With these thoughts in mind, we are electing to…
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- Exhibit 1 - With Volatility Increasing and Returns Falling, We Are No Longer Getting Paid to Move Out the Risk Curve
- Exhibit 2 - We Expect Volatility to Head Higher Amidst a Period of Low Absolute Returns Across Many Asset Classes
- Exhibit 3 - KKR GMAA 2016 Target Asset Allocation Update
- Exhibit 4 - With a Strong Dollar, Nominal GDP Growth for 2015 in USD Terms Is Negative
- Exhibit 5 - China Is Maintaining Share by Exporting More High-End Goods. However, It Is Also Importing Less as It Builds Local Competitive Advantages
- Exhibit 6 - Competitive Devaluations Are NOT Working to Drive Increased Export Activity
- Exhibit 7 - Nominal Global GDP in USD Recently Approached Recessionary Levels
- Exhibit 8 - Global Trade Has Actually Declined in Recent Years…
- Exhibit 9 - …Despite a Rash of Quantitative Easing and Currency Devaluations
- Exhibit 10 - There Is an Ongoing Income Recession Occurring in Many Parts of the World…
- Exhibit 11 - …As Global Imports Are Shrinking, Making Currency Depreciation Ineffective
- Exhibit 12 - As China Rebalances Towards Higher Value-Added Exports, It Continues to Grow Its Share of Global Exports at the Expense of Japan, Germany, and the U.S….
- Exhibit 13 - …and Now Dominates in Segments Like Machinery & Transportation, Surpassing Japan, Korea, and Germany
- Exhibit 14 - As Global Trade Slows, Asian Loan Growth Is Expected to Continue to Decelerate Significantly
- Exhibit 15 - Trade Financing Activity Slowed Significantly in 2015, Reflecting Our View That It Is Not Business as Usual
- Exhibit 16 - We Are a Solid 79 Months Into the Current Economic Expansion
- Exhibit 17 - The Dramatic Change in Monetary Base Has Helped to Extend the Economic Cycle
- Exhibit 18 - The Performance Gap Between Manufacturing and Services in the United States Is Now Significant
- Exhibit 19 - The Bottom Line for Job Growth: It’s All About Services
- Exhibit 20 - EM Countries Are Supposed to Account for Nearly Half of Total Global Growth. We Are More Pessimistic
- Exhibit 21 - Europe Is the Only Region Where We Have Boosted GDP Expectations Since January 2015; Overall, We Remain Cautious on Growth in 2016
- Exhibit 22 - Our U.S. GDP Indicator Is Pointing to Another Year of Modest, Low Two Percent GDP Growth. Tighter Credit Conditions and Weak Trade Are the Key Headwinds Being Picked Up by Our Model
- Exhibit 23 - Positive Domestic Components in the United States Are Also Being Offset by Strong International Headwinds
- Exhibit 24 - It Might Not Feel This Way, but Consumers Have Largely Spent Their “Dividend” from Lower Gas Prices
- Exhibit 25 - Why Does Spending Feel More Sluggish Than It Really Is? Probably Because It Is Being Driven by Only a Handful of Categories, Many of Which Are Not Captured in Retail Sales
- Exhibit 26 - Relative to the Prior Cycle, Consumers Are Saving More…
- Exhibit 27 - …And When They Are Spending, They Are Tilting Their Spending Towards Experiences Over More “Stuff”
- Exhibit 28 - The Trends Towards Greater Spending on Experiences Is Accelerating in Europe Too
- Exhibit 29 - A Breakdown of Household Spending in the U.K. Reveals a Heavy Emphasis on Experiences
- Exhibit 30 - As Credit Conditions Tighten, the Illiquidity Premium Is Becoming More Prevalent Across Different Asset Classes
- Exhibit 31 - Lower Inventories in the Broker Dealer Community Have Massively Dented Liquidity
- Exhibit 32 - The Potential to Earn a Sizeable Return in a Negative Real Rate Environment Across Most of Europe Is Compelling, in Our View
- Exhibit 33 - Bank Balance Sheets Are Expected to Continue to Shrink
- Exhibit 34 - Developed Economies Have Begun to Delever, While Emerging Economies Continue to Lever Up
- Exhibit 35 - Increases in Leverage Are Widespread Across All Emerging Regions; However, Asia Stands Out with Private Credit Now at 122% of GDP
- Exhibit 36
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There Has Been a Large Build Up of Debt in the Corporate Sector…
- Exhibit 37 - …Particularly in China and Hong Kong
- Exhibit 38 - Nominal GDP Growth Has Fallen Faster Than Credit Growth in China
- Exhibit 39 - China Stands Out with Excessive Credit Growth Relative to Nominal GDP When Compared with Other Asian Countries
- Exhibit 40 - Private Sector Credit Is Running at Very High Levels Relative to GDP in Several EM Countries
- Exhibit 41 - Growth in Corporate Debt Is Becoming an Issue in the U.S. Too, Not Just in Emerging Markets
- Exhibit 42 - Even After Adjusting for Energy, Equities Definitely Appear Expensive Relative to Debt
- Exhibit 43 - The Current Trailing P/E for the S&P 500 Is Now Essentially In-Line With the Long-Term Average of 16.6x
- Exhibit 44 - Market Capitalization-to-GDP of the U.S. Stock Market Would Suggest That We Are Not as Early Cycle as Some Investors Would Suggest
- Exhibit 45 - Four Key Sectors Are Expected Drive the Majority of the S&P 500’s EPS Growth in 2016
- Exhibit 46 - Public Equity Valuations Have Moved Up Substantially Around the World in Recent Years
- Exhibit 47 - S&P Margins Appear to Have Peaked
- Exhibit 48 - S&P 500 Sector Margins Are Now Past Peak Levels
- Exhibit 49 - We Now See the S&P 500 As Fairly Valued
- Exhibit 50 - We See Limited Upside to U.S. Equities, Unless Earnings Growth Surprises on the Upside
- Exhibit 51 - A Record Number of European Companies Now Have Dividend Yields Above Corporate Bond Yields
- Exhibit 52 - Japan Midcaps Have Been On an Upswing; We See More Running Room Ahead
- Exhibit 53 - Our Rules of the Road Suggest EM Valuation Now Looks Attractive Relative to DM, But Lacks a Catalyst
- Exhibit 54 - We Remain Cautious on EM, Even Though Its Valuation Discount Is Now Similar to What It Was at the 2009 Valuation Trough
- Exhibit 55 - We Are Still Only Two-thirds of the Way Through the EM Bear Market on Both Time and Price
- Exhibit 56 - We Expect U.S. Rates to Move Higher in 2016, With Most of the Upside Being at the Short End of the Curve
- Exhibit 57 - While the Market Seems Too Dovish on the Fed Rates Outlook, We Think the FOMC’s Own Forecasts Appear Too Hawkish
- Exhibit 58 - We Believe The Unemployment Rate Is Headed Firmly Below the Fed’s Long-Term Target of 4.9%
- Exhibit 59 - We Think Wage Growth Will Continue Heading Higher in 2016
- Exhibit 60 - We Think Demographics Are Serving as a Long-Term Fundamental Anchor on Inflation
- Exhibit 61 - Europe’s Low Rate Environment Is Serving as a Further Technical Constraint on the U.S. 10yr Yield
- Exhibit 62 - The Underperformance of the High Yield Sector Has Not Just Been Concentrated In Energy
- Exhibit 63 - The Recent Adjustment in Liquid Credit Spreads Has Pushed Valuations to More Attractive Levels
- Exhibit 64 - We Are Increasingly Concerned That Higher Quality Debt Will Trade Down Towards its Lower Quality Brethren
- Exhibit 65 - We Also Think That European High Yield Looks Too Expensive Relative to Its Global Counterparts
- Exhibit 66 - For a Similar Spread, BB Loans Offer Much Less Volatility
- Exhibit 67
- Increased Leverage Throughout EM Has Softened the Blow that Declining Margins Had Upon Return on Equity
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As Banks Retreat, There is a Wall of Commercial Real Estate Debt Maturing
- Exhibit 69 - The MLP Arena Has Seen Its Cost of Capital Rise; Not Surprisingly, Deal Activity Has Waned
- Exhibit 70 - We Think That the Dollar Could Have Another Compelling Year as the Bull Market Still Has Room to Run
- Exhibit 71 - Growth in Many Countries Is Levered to the Exports and Global Trade Story
- Exhibit 72 - Market Concentration Now Appears to be an Issue
- Exhibit 73 - Many of the Market’s High Flyers Now Seem Fully Valued
- Exhibit 74 - China Is Rebalancing to Higher Value Add Exports; the Risk to Multi-Nationals Is That It Becomes Price Competitive in High Value Added Goods the Way It Did In Low Value Added
- Exhibit 75 - China’s Currency Could Still Be Too High for Its Level of Competitiveness
- Exhibit 76 - One Could Consider Buying USD/CNH Call Spreads to Hedge a Further China Devaluation
- Exhibit 77 - The Forward Is Discounting That China’s Currency Will Continue to Move
- Exhibit 78 - M&A as a Percentage of GDP Suggests We Are Now Approaching Peak Levels
- Exhibit 79 - Several Macro Indicators Support Our View That It Is Adult Swim Only in 2016
- Exhibit 80 - Buybacks Were Greater Than the Total Free Cash Flow of the S&P 500 in 2Q15. This Aggressive Approach Seems Inconsistent With Where We Are in the Cycle
- Exhibit 81 - Seven Years of Positive Consecutive Performance for the S&P 500 Is Highly Unusual
- Exhibit 82 - One-Year GBP Implied Volatility Is Not Pricing In Enough “Brexit” Risk, in Our Opinion
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