2024 U.S. Election: Focus on the Forest, Not the Trees

For nine out of the last ten elections, the American people have voted for change. We are in a generational era of political disruption which has accelerated since COVID, challenging incumbent parties around the world. President Trump and the GOP’s ability to seize the mantle of change is essential to understanding their historic victory on November 5. Indeed, when responding to exit polls, more than 70% of voters associated incoming President Trump with bringing change, while only 23% did so for outgoing Vice President Harris. What will this change look like for individual investors and institutional allocators of capital, as well as for ordinary citizens in the U.S. and abroad? Without question, now is the time to focus on the forest, not the trees. At KKR, we believe strongly that the next Administration will continue to fuel the drivers of our ‘Regime Change’ thesis from 2021 when the world began to experience a new type of more insular, more fiscally driven asynchronous global recovery. In fact, from our vantage point, last week’s election results merely put an exclamation point on the major secular changes happening globally, including more government spending, more competitive and volatile geopolitics, a messy energy transition, and sticky and more uneven inflationary trends that we as a firm have been emphasizing for years. Consistent with this view, we think President Trump’s vision for America likely involves faster growth and the tackling of big deficits through less regulation and tax cuts. We also think he will continue the transition away from benign globalization, using a more assertive approach to great power competition and security concerns. As such, owning more Equity, Infrastructure, Real Estate, and Credit assets linked to nominal domestic GDP growth will become more important to portfolios. We also expect to see more volatility surrounding a steeper yield curve in reaction to the election, given President Trump’s policy instincts around, for example, tariffs and immigration. That said, KKR’s macro team does not see the long end becoming unglued, as U.S. productivity is surging, and the technical picture remains quite favorable for now. By comparison, Europe and Asia will likely face a combination of both challenges and opportunities, many of which will no doubt be based on what President Donald J. Trump refers to as ‘the art of the deal.’ Deregulation, too, will likely be a tailwind, potentially fueling M&A and other forms of capital markets activity. Against this backdrop, we believe the implications for asset allocation and portfolio construction are profound. Our bottom line: We retain our pro-risk assets stance heading into 2025, leveraging our key global investment themes amidst heightened thoughtfulness around portfolio construction, including a greater focus on pacing, sector concentration, operational expertise, and financial leverage.

At times during one’s career, stepping back and trying to see the forest through the trees is essential. Now, we think, is one of those times. This presidential election cycle is the fourth in which we have partnered to relay what we believe are the most important conclusions. Though each cycle has been different, President Trump’s victory was driven by two ongoing powerful forces that warrant investor attention: an intense dissatisfaction with the status quo, a phenomenon affecting incumbent parties around the world, and the continuation of a political realignment along educational lines that began in the U.S. with the 2016 election and has continued to expand. Also, American voters have demanded change and ‘sent them packing’ in every election since the Global Financial Crisis, except in 2012 when President Obama was reelected. 

EXHIBIT 1: Regime Change: We Have Exited a Low Growth, Low Inflation and Tight Fiscal Environment For Something Quite Different, Including a Higher Resting Heart Rate for Inflation and Rates

Low and High Growth and Inflation Regimes

From a macroeconomic and asset allocation perspective, the ‘Red Sweep’ in the U.S. Presidential election is hugely significant, but it actually does not alter our existing macroeconomic framework that much. Rather, it just adds further fuel to our ‘Regime Change’ hypothesis, which we first laid out to investors when we exited COVID. Our thesis is marked by a ‘higher resting heart rate’ for inflation, nominal GDP, and interest rates. Core drivers of this framework still include: 1) persistent fiscal deficits, 2) supply chain shifts amid heightened geopolitics, 3) an at-times messy energy transition, and 4) structural labor scarcity amidst challenged demographics. What’s different this time is that the potential for deregulation and merger activity (Exhibit 4) in key sectors will likely be an incredibly important trend during the next four years.

We see President Trump’s election greatly emphasizing the significance of these four factors. To be sure, we don’t think we are going back to the June 2022 nine percent inflation environment anytime soon, but we believe a higher neutral rate and volatility around that rate, due to periodic bouts of inflation and other supply shocks, are likely.

EXHIBIT 2: Stronger Labor Productivity Is the ‘Secret Sauce’ to Extending the Business Cycle As Well As Partially Offsetting Higher Deficits

U.S. Annual Labor Productivity Growth, %

EXHIBIT 3: Our Liquidity Indicator Is Still Recovering From Near-Trough Levels. We View This Bullishly

Capital Markets Liquidity (TTM) as a % of GDP (IPO, HY Bond, leveraged Loan Issuance)

EXHIBIT 4: We Think M&A Activity Will Be a Beneficiary of Deregulation

M&A Volume (TTM) as a % Of GDP

See below for details, but we are only making modest changes to our GDP and rates forecasts. Specifically, post the election results, we are nudging up our neutral rate for Fed Funds to 3.375% from 3.125%. Key to our thinking is that the potential drag on GDP growth from tariffs is fairly manageable, on the order of 0.25-0.50 percentage points spread out over a few years, whereas the CPI uplift could be around 0.5-1.0 percentage points on a one-time basis, we believe. Remember that the U.S. is a large consumer economy. Meanwhile, we lower our European GDP growth forecast for 2025 to 0.8% from 1.1% previously, compared to consensus of 1.2%. As in previous years, we will provide a full forecast summary update in our Outlook for 2025 note, which we plan to publish in mid-December 2024. A key area where we intend to spend more time is the currency markets. An America-first presidential policy likely means a stronger dollar, especially relative to countries that have larger trading deficits with the U.S. At a minimum, we expect a material elevation in currency volatility as trade policies are re-negotiated (Exhibit 14). Finally, as we detail below in our scenario analysis work, we think that the implications for China could be material over time, given that country’s ongoing dependence on both fixed investment and exports.

Against this backdrop, however, there are significant implications for both portfolio positioning and asset allocation that investors should consider. From a portfolio perspective, President Trump’s vision for America is one of faster growth, lower taxes, and less regulation amidst a more competitive world. In this macroeconomic environment, the government – not the consumer or corporate sector – has excess leverage. As such, owning more assets linked to nominal GDP rather than directly to government debt could be one of the biggest shifts for CIOs to consider. Indeed, as we show in Exhibit 1, we have left the lower left quadrant of low growth and low inflation and have entered – likely on a more sustained basis – the top half of the chart, including periods of higher growth and inflation. If we are right, then a fundamental reshaping of asset allocation drivers will unfold, we believe. 

EXHIBIT 5: CIOs Will Need to Increasingly Focus on the Benefits of Diversification Amidst What We Believe Is a Regime Change for Asset Allocation

EXHIBIT 6: Despite Inflation Falling on a Cyclical Basis, the ‘New’ Positive Relationship Between Stocks and Bonds Remains Strong. This Reality Is a Major Development for Global Allocators

U.S. Stock-Bond Correlation and U.S. CPI, %

Given all the uncertainty, why do we not want to take a more conservative positioning stance? In addition to decent fundamentals, there are two reasons:

• First, the U.S. is enjoying a productivity boom that we have not seen since the 1990s. If there were an analogy on which to focus, it would be the 1994-1996 period. In today’s world, 2022 was 1994, a period marked by higher rates and an unsettled fixed income market. 1994/1995 also marked 15 straight months of the ISM Manufacturing being below 50, yet there was no recession. In today’s world, similarly, we have had 23 out of 24 months of ISM Manufacturing prints with no recession. Again, productivity has been key to preventing an economic downturn, reaching 2.2% q/q annualized in 3Q24 and fully 2.8% over the last four quarters.
• Second, we think the technical picture remains extremely favorable. As we show in Exhibit 3, net issuance of IPOs, Levered Loans, and High Yield is still running way below trend, a favorable backdrop for higher prices that is being exacerbated by a record amount of money sitting on the sidelines as well as plump central bank balance sheets that are still serving as an important volatility damper. Meanwhile, on the equity side, the S&P 500 is on track to repurchase $1 trillion in stock in both 2024 and 2025. While European buybacks are not as robust, they should still reach $400 billion or more over the next 12 months. To be sure, more supply will come to market as deal activity picks up, but today’s levels of M&A reflect minimal animal spirits (Exhibit 4).

The biggest risk is clearly higher rates, which dampen valuations, housing activity, and consumer spending. In our view, this risk is asymmetric relative to lower rates because higher rates slow activity and shake suspect capital structures, while lower rates encourage growth and accelerate refinancings. So, for those who can hedge, this area is the one to hedge, if we are right about President Trump’s pro-growth policies.

Where do we go from here? We remain constructive on risk assets, and as such, are most focused on near-term implications for interest rates and FX:

• We are still figuring out all the details from a sector perspective, but Financials, Real Estate, Defense, Oil Services and certain pockets of the Energy complex, should all perform well. We also expect a lot more M&A. On the cautionary side, a higher nominal GDP environment leads to higher financing costs for both buyers of autos and houses. Companies dependent on the full IRA tax credit across EV, wind, and solar may also be challenged though we believe a full repeal is unlikely. We are also watching healthcare closely, but do not anticipate a major overhaul of any retiree benefits or drug prescription programs.
• Movements of the U.S. 10-year yield towards 4.5% are an appropriate reaction to a Trump victory, in our view, given his reflationary policy instincts around growth, tariffs, and immigration. That said, the macro team does not see the long end becoming unglued. Remember that voters handed Trump a significant mandate to control inflation, which we think will ultimately limit appetite for blowout deficit- widening. More likely is that the TCJA is extended for some period of time, but tariffs and partial IRA repeals will substantially offset President Trump’s ambitions around further new tax and spending initiatives.
• Other key macro markets where we expect meaningful election-related differentiation include China, Mexico, and Japan. President Trump’s tariff threats pose further downside FX risks for China, Europe, and Mexico in particular. For Japan, by comparison, there is potential for further JPY weakness if U.S. 10-year yields continue to rise, but − overall − we also see persistent structural tailwinds for investing from ongoing structural reforms.

What is our bottom line? From an investment perspective, we continue to subscribe to our Regime Change thesis, which means that portfolios are likely out of position for the current environment. Overall, the government, not the consumer or the corporate sector, is likely over-levered this cycle. As such, we want to diversify away from these holdings, including owning more private assets that can harness the illiquidity premium in a less correlated fashion. Meanwhile, from an economic perspective, we now argue more intently for an asynchronous global recovery, one that is defined by both rolling recoveries (e.g., services today) and rolling recessions (e.g., the goods economy today).

Within this world, we see several key investment themes on which to focus.

Acknowledgements
Vance Serchuk, Travers Garvin, David McNellis, Aidan Corcoran, Changchun Hua, Emily Spain, Brian Leung, Rebecca Ramsey, Bola Okunade, Emma Sullivan, Ezra Max, Miguel Montoya, Asim Ali, Allen Liu, General (Ret.) David Petraeus