Global private equity giant KKR has warned the technology sector is becoming outsized with technology driving 100% of global earnings growth, according to its mid-year global macro outlook report.
The firm says it does not expect a major crack in the digital economy, yet at the same time is concerned about tech’s huge influence on other markets such as real estate along with the recent poor performance of several IPOs.
In terms of the lacklustre IPOs, the firm says this shows that private investors may be over-paying for cash flows which may not match consensus expectations.
The report also notes that besides driving 100% of global earnings growth, tech also accounts for nearly 40% of leases in some areas of the real estate market.
It also notes that new issuance on credit markets is heavily skewed to levered transactions related to software companies.
“If the technology sector were to stumble for any reason including increased regulation, the knock-on effect on the global economy could be profound,” it says.
The report adds that the poor performance of several recent IPOs in the growth arena support our view that cash flow matters.
“To be sure, we are not back to 1999, but we do believe that several recent investment rounds in the private growth markets have been at speculative levels. In our humble opinion, investors should avoid where possible business models that are predicated on low marginal revenue economics amidst continued high fixed costs.
“We also believe that estimates around the total addressable market have been exaggerated in certain instances. Importantly, though, we view recent disappointment in performance as a long-term opportunity, and accordingly, we do expect to shift our significant underweight in ‘private growth’ back to an equal weight or overweight, as leading investors in the sector are forced to acknowledge that some of their valuation metrics have gotten too robust.”
The lengthy report also includes detailed views on the global economy and its relationship to public and private market.
A modern day Cold War
It says that effectively relations between China and the US are reaching a Cold War stage.
The report adds: “Investors should make no mistake about where we are headed, given how intertwined the two countries are. Simply stated, we think that a modern day ‘cold war’ of sorts has emerged between China and the United States.
“Consistent with this view, we think that we are at an inflection point for global supply chains, particularly those that rely on proprietary technology.”
It uses Huawei as an important example.
It adds: “Just consider that out of $70bn Huawei spent buying components in 2018, some $11bn in Huawei allocations went to US firms including Qualcomm, Flextronics, and Broadcom. One can see some of this dependence.
“Without question, these relationships are now all in play in a world where it appears US national security concerns have trumped more traditional trade priorities.”
Not weak enough for a recession, not strong enough for inflation
KKR says that the majority of its research team believe the current cycle will be remembered as a series of mini and idiosyncratic economic cycles – neither strong enough to drive up inflation, nor weak enough to induce a traditional recession on a global basis.
It adds, however, that the fundamental interlinkage of supply chains means its research team holds a “growing contingency” view on a more synchronised downturn in 2020.
The firm also says that the economy and markets could be entering a phase where the nominal GDP and global profits are more aligned or where profits could lag GDP.
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