Thoughts from the Road: Keeping Perspectives
When I last visited Aidan Corcoran and Bola Okunade in London back in May, we left the various meetings we organized there with a decidedly more cautious outlook for the global economy, Europe in particular (see our note Thoughts From the Road, May 2022). While we are again trimming our growth forecasts and raising our inflation outlook, our changes are now more modest than in the past. More importantly, though, to us is that the sentiment of investors, companies and markets has – without question – ‘caught down’ to the realities that Europe is now facing heading into the fall, leaving us in a much more balanced position to consider the trade-offs between weak fundamentals relative to cheaper prices.
EXHIBIT 1
For the Eurozone, We Further Cut Our Real GDP Expectation for 2023
No doubt, Europe faces a long list of headwinds (e.g., Mario Draghi’s resignation, record U.K. inflation, the ‘weaponization’ of Nord Stream I, ECB hikes, etc.). Inflation is raging across both the U.K. and the Continent, driven by an energy crisis that likely exceeds that of the 1970s. However, the universal bearishness we encountered discounts a lot of these headwinds, which gives us confidence to now lean into dislocated opportunities. Indeed, if investing success is capitalizing on a variant perception relative to the consensus, as we believe it is, the surprise might be that Europe does not fully sink into the abyss by 2023. To be sure, we fully agree it is premature to ‘call the bottom’ before ISMs reach their floor (Exhibit 4), but I do know that sentiment today in Europe feels about as bad as it did in 2011 when I joined KKR. This is especially noteworthy, as my introduction to the firm coincided with the Greek debt crisis, when there were real questions about whether the Eurozone could hold itself together amidst material spread widening across most sovereign bonds and bank debt in Europe. Ultimately, that time period proved to be a good investing period for many investors, including KKR. Our deal teams avoided the noise and focused on long-term investment themes whose growth rates and business models ultimately overpowered a macro environment that proved to be extremely choppy for a prolonged period.
EXHIBIT 2
The Russian Invasion of Ukraine Has Destabilized European Gas Prices
EXHIBIT 3
Surging Natural Gas Prices Are Further Confirming Our Recession Models’ Cautious Tone
Importantly, we also know that markets bottom before earnings. One can see this in Exhibit 5. So, where should one look for opportunity? Credit fixed income issuance in Europe is now essentially shut down (Exhibit 11), a backdrop that will soon drive increased demand for private capital. Meanwhile, many stocks are down 20-30% in the public markets (and private market sellers are beginning to appreciate that the world has indeed changed). At the same time, mega themes like automation/digitalization, the security of everything, and the energy transition are all gaining, not losing, momentum. So, our call remains that now is not the time to run, but it is the time to walk (see Walk, Don’t Run, June 2022).
DISCLAIMER
