KKR Sees A 100% Probability Of Recession In 24 Months

When predicting the future, there are two types on Wall Street: the majority, who see nothing but blue skies, like Bank of America which forecasts no recession  until 2027 (when the S&P will supposedly be 3,500) resulting in the longest economic expansion in history, and a minority who admit they have no idea what will happen.

And then there is KKR, which not only breaks the cardinal rule of established financial institutions and reveals a bearish forecast in its 2018 outlook, but - in breaking the second rule - it also puts a timeframe on it.

In short: KKR says there is a 100% probability the next recession will hit in the next 2 years.

The Private Equity firm unveils this gloomy forecast when it explains "Where Are We in the Cycle/Expected Returns." Over the next 12 months, KKR is not especially gloomy, noting that the Trump tax cuts will likely offset the risk of an imminent slowdown...

As many of our readers will know, our base case for some time has been that a modest economic slowdown will occur in 2019. However, with tax cuts taking effect in 2018, the chance of a near-term recession appears quite remote. Consistent with this viewpoint, our proprietary recession model, which we show in Exhibit 64, suggests a limited chance of recession during the next 12 months. According to the model, high interest coverage, tight High Yield spreads, low delinquencies, and a modest consumer obligations ratio all appear to be favorable tailwinds that should sustain economic growth through 2018.

However, when KKR extends the projection horizon to 24 months, things get ugly.

Interestingly though, when we extend the model from 0-12 months to 24 months, the risk of recession increases materially. One can see this in Exhibit 65. We link the uptick in the model’s cautionary outlook in late 2019 and beyond to a structurally peaking U.S. dollar, a flattening yield curve, higher unit labor costs, and some reversion to the mean in both consumer confidence and home building expectations.

The above should not come as a surprise: the current expansion is already third longest in history:

Finally, KKR pulls no punches when making another warning: about the stock market.

Importantly, irrespective of where we are in the cycle, we believe that – compliments of central bank intervention – the current prices of many financial assets appear more cyclically elevated than current economic conditions might otherwise support. Indeed, as we show in Exhibit 67, the S&P 500 has been up for nine consecutive years, despite a U.S. economic recovery that has been lackluster by most standards. This performance feat by the U.S. equity market is quite extraordinary, as it has occurred only one other time on record – the 1991-1999 period.

 

And at the risk of pointing out the obvious, all of this is expected to hit in 2019/2020, just in time to make the next presidential election especially interesting.