KKR’s Vantage Point – June 24, 2024
When you operate on the scale of KKR, the high-altitude view is, well, higher altitude. In the newly released midyear global macro outlook, titled “Opportunity Knocks,” KKR’s Henry McVey, Head of Global Macro and Asset Allocation, and his team assert that the current economic cycle has further to run, notwithstanding an environment of heightened volatility and political complexity.
“We continue to argue that as investors we are experiencing a Regime Change,” writes McVey. “There remain four pillars to our original thesis: ongoing fiscal stimulus, heightened geopolitics, a messy energy transition, and stickier wages (driven largely by a shortage of skilled workers). If we are right, then global allocators and macro investors need to view their portfolios through a different lens.”
Amid that environment of volatility, McVey and his team see “compelling investment opportunities” across the globe. “Accelerating AI demand for electricity, reorientation of global supply chains, improving labor productivity, and retirement security all represent important macro themes behind which to invest,” according to McVey.
Within those macro themes, and a macro outlook spanning the globe, McVey homes in on opportunities related to real assets. Most specifically, multifamily real estate represents a new “pick” in a section headed “Picks and Pans.”
McVey and his team have advocated an overweight to real estate credit for a while now. “We now see good value on the equity side, too,” he writes. “Key to our thinking: U.S. rental vacancies are at their lowest levels in about 40 years (except for the pandemic), while run-rate household formation will likely run at a higher rate than rental units can be delivered given the pullback in building starts.” The recent surge in U.S. immigration could potentially double the number of households formed over the next three years, adds McVey.
“Finally, we think market technicals are becoming more bullish, too, including signs that cap rates have now started to peak (as more transactions are taking place between buyers and sellers) as well as tighter spreads for RE lending (including the CMBS market),” writes McVey. “So, while we are not yet ready to ‘run’ when it comes to RE allocations, we think owning some existing multifamily in strategic geographies could be quite fortuitous, particularly in cases where replacement costs are near or above asset values.”
More broadly, McVey writes that his team’s research continues to show that many individual and institutional investors are still underweight in real assets, especially infrastructure and energy, “at a time when the need for inflation protection in portfolios remains high. Moreover, if we are right about the AI-electricity demand that we are forecasting, then the opportunity set to own growthier Infrastructure assets, especially around data centers, logistics, etc., is quite compelling.”
He adds that the benefits of using real assets to increase portfolio diversification, especially infrastructure, real estate credit, asset-based finance and certain commodity investments, “dovetail nicely with our current macro view about the need to find more diversifiers in one’s portfolios.”
Although some believe that the Federal Reserve will soon begin reversing course on the benchmark federal funds rate—notably, real estate economist Peter Linneman—McVey and his team aren’t in that number. “We think that Chair [Jerome] Powell will ultimately want to see more credible and consistent evidence that inflation is cooling before cutting rates, which should emerge by this fall,” he writes. “At the same time, though, from the perspective of the Fed’s ‘full employment’ mandate (i.e., its desire not to overtighten), our base case for a slower decline in core CPI suggests that real rates will not reach the two-percent level until the beginning of 2025.”
Put another way, “if we are right that positive U.S. economic momentum means the economy will not slow dramatically heading into the back half of this year (even if we see more signs of normalization), we think the Fed can afford to be patient.” That means that as far as the central bank is concerned, there’s no need to cut the funds rate in the very near term.