KKR has just published their 2017 mid-year economic outlook and it includes some rather dire predictions for the U.S. economy. Among other things, KKR predicts a U.S. recession by 2019 and a massive cycle of millennial deleveraging after a huge expansion of consumer credit in the form of student and auto loans.
Before getting into the details, here's a chart depicting how KKR sums up the macro picture. In short, pretty much every major economic growth and asset valuation metric in the U.S. is flashing red warning signs relative to historical norms.
Today, almost all our work streams suggest that asset prices across most parts of the global capital markets are somewhere between fair value and expensive. From a cycle perspective, we believe that we are mid-to-later cycle in some of the more developed markets, including the United States.
So, exactly where are we in the economic cycle? Oh, just about 96 months into the typical 37 month expansion phase...which, for those who like to keep score, is the 3rd longest expansionary period in U.S. history. Meanwhile, in terms equity returns, the S&P's cumulative returns over the past 8 years have only been exceeded by returns that previously preceded the great depression, the 1987 crash and the tech crash...but it's probably nothing.
Since we arrived at KKR in 2011, we have been arguing for a longer cycle. Several factors have influenced our thinking over the years. First, given how bad the environment was for jobs and growth in 2008/2009, it would only make sense that it would take longer than normal to create a sustainable economic recovery. Second, as the world transitions away from manufacturing towards more of a services-based economy, our research leads us to believe that the cycles have – on average – gotten more extended. Third, the level of monetary stimulus this cycle has been unprecedented, and as such, it will likely take much more time for central banks to unwind what is now a $14.5 trillion global QE experiment.
Though it may not feel this way to some, we are actually now 96 months into an economic expansion in the United States (Exhibit 40). Our base view is that the expansion continues through 2018, and then we run into a soft patch of economic growth thereafter. While economic expansions do not die of old age, they are affected by issues like peaking margins, heightened leverage, and deteriorating credit. For our nickel, we see all three as potential concerns being issues by 2019.
All of which, we would guess, has something to do with the following chart depicting the massive $1.8 trillion rotation out of actively managed accounts into passively managed ETFs and other index-tracking vehicles. It's not that difficult to see why individual company valuation metrics have become so meaningless in the age of ETF investing as investors have been lured into the false hope that the natural "diversification" of these products provides some level of downside support. Meanwhile, the only 'valuation' metric that is tracked by these 'investors' is returns, so as long as money keeps flowing in, then valuations keep going up...and just like that you have a perfect feedback loop to fuel an epic bubble.
That said, we suspect it's only a matter of time before these same investors realize that buying a basket of stocks doesn't really provide any of the benefits of 'diversification' if all the names in the basket are perfectly correlated.
At some point, as we like to say, math and facts win over simplistic BTFD narratives.
Of course, while equity markets are screaming 'everything is awesome', KKR notes that some troubling signs are starting to emerge in the actual underlying economic data. Take for example auto sales and multifamily housing starts...
And then, of course, there is one of our favorite topics: consumer credit.
As KKR notes, as have we on numerous occasions, this latest expansionary period has been fueled in large part by a massive, bubbly expansion in consumer credit, particularly for autos and student loans. Moreover, the biggest beneficiary of that massive expansion has been the generation that is perhaps one of the least financially secure in history....which probably helps explain why auto delinquencies are suddenly rising despite improving employment levels.
While aggregate statistics by the government for the U.S. consumer are reporting record low unemployment amidst surging household net worth, we have come to an increasingly more conservative outlook for the U.S. consumer, particularly at the low end of the market. Key to our thinking is that, as we show in Exhibit 76, basic household expenses continue to increase faster than overall wages, which is a growing issue for the large segment of the U.S. market that has not built net worth in recent years. Moreover, debt loads in areas such as student lending and autos has crept up to what we view as concerning levels. Sub-prime credit cards too should be an area of investor focus, in our view. How else can one explain rising auto defaults that now approximate 2007 levels with unemployment below the natural rate of employment?
All of which culminates with KRR's prediction that a recession in the U.S. is imminent.
But, at least the recession isn't coming for another 1.5 years...takeaway: Buy Moar Stocks Now.
The full report can be reviewed here: