Unlike other recoveries over the past 20 years, we at KKR see the present recovery as one that is highly asynchronous. There is a specific set of macroeconomic factors that is preventing this recovery from creating the traditional virtuous circle of improving demand in developed markets that leads to better growth conditions in emerging markets.
There are five major factors that are slowing global economic growth. They are as follows:
1. The countries driving incremental growth in the global economy this cycle have largely nascent consumer economies. In the past the U.S. was happy to play the role of consumer as countries looked to grow through their export businesses. Our global growth forecast, however, suggests a global economy in which almost 70 percent of total incremental global growth comes from the emerging economies, many of which lack the absolute consumption capacity — as well as the access to credit — required to play the role of the world’s most important shoppers.
2. There is still no real wage growth in the developed economies at a time of increased focus on export-driven growth. The lack of real wage growth has been consistently slowing the trajectory of the recovery from the 2008–’09 economic crisis. True, jobs are being added in the U.S. But real wages have actually contracted since the start of the recovery in the second quarter of 2009. As a result, personal consumption expenditures are running at just 55 percent of the U.S. historical average.
Moreover, stagnation in real wage growth is occurring in markets at a time when many key inputs — including food, health care and rent — are now outpacing inflation. A similar story holds true in both Europe and Japan.
3. Developed-markets governments are acting as drags, not catalysts, on GDP growth. After years of excessive borrowing and spending, governments are now being forced to tighten their belts. But we underestimated just how big a deal government deleveraging would be. In the U.S., for example, government spending has actually been contracting at a 1.6 percent annualized rate since the recovery started, compared with an average positive 1.5 percent contribution to annual growth since 1950. Europe is experiencing similar headwinds in this area, though compared with the U.S. the negative multiplier effect from government contraction there is even more significant.
4. Productivity is actually declining in many developed and emerging markets. Many high-profile emerging-markets countries have seen notable declines in productivity in recent years. For example, in Brazil real wages rose by a full 27 percent in local currency terms from 2003 to 2013, but over the same period labor productivity contracted by 8 percent. A major issue is that these countries did not invest enough in fixed investment, infrastructure in particular, as was the case during China’s economic growth miracle at the turn of the century. Within the developed economies, productivity has also sagged. All told, real GDP per employee in the developed markets increased just 0.7 percent on average during 2012 and 2013, compared with developed-market GDP growth per employee of closer to 2 percent, on average, before the 2008–’09 global financial crisis.
5. Less favorable demographics pose a challenge to many key economies. If demographics are indeed destiny, then investors need to start paying closer attention to them. In the U.S. the outlook for working-age population growth has fallen to 0.3 percent over the next five years, versus 1.1 percent in the prior recovery. Without question, this decline presents a headwind to growth. Demographic trends in Europe, which accounts for 24 percent of total global GDP, are even more concerning. Even China, which has accounted for one third of incremental global growth so far this recovery, is now seeing an annual decline of 5 million people in its working-age population.
Given the structural inability for the global economy to deliver a synchronous recovery, we feel there is a potentially seismic shift in the way that top-down macro investors think about traditional asset allocation decisions. The investment playbook used in past recoveries cannot be used this time. In particular, we recommend the following:
• Investors must increasingly focus on investment opportunities in a country and/or sector in which a clear competitive advantage can be built to drive above-average growth and profits.
• At the moment, we favor reform-focused countries, particularly those in which there is already sizable internal demand, such as India, Indonesia and Mexico. In addition to the pro-growth policies of these nations’ new governments, we also think that the central banks in these countries are doing a better job of managing inflation than in the past.
• Investors with patient capital should consider increasing their allocation in countries with attractive demographic profiles — and, hence, faster potential growth. Possible challenges in these economies include illiquidity, corruption and other hindrances to doing business.
• This slowdown, particularly on the emerging-markets side, is going to create ample restructuring opportunities for investment managers that can help corporations navigate a slower and bumpier economic growth environment. Already, many banks in emerging markets are now overweight with bad corporate credit, creating a growing role for private lenders and restructuring professionals to step in and provide value-added capital to struggling corporations.
• If the global economy is recovering in an asynchronous manner, then interest rates have the potential to stay lower than normal for longer, particularly in developed economies. Interest rate curves therefore should flatten, and central bank policy could rest at a much lower equilibrium than has been the historical average.
Our bottom line: We now see a global economic recovery that is highly asynchronous, with the traditional features of past periods of global growth not present in the same fashion as before. There is a unique set of macroeconomic factors coalescing around this recovery that is preventing it from creating the traditional cycle of improving developed-markets demand in the developed markets spurring emerging-markets growth.
Henry McVey is the head of global macro and asset allocation at KKR in New York.
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