INSIGHTS

GLOBAL MACRO TRENDS

VOLUME 7.3 JULY 2017

Mid-year Update: Five

Areas of Focus
 Mid-year Update: Five
Areas of Focus
As we peer around the corner today on what tomorrow
might bring, our work still leads us to forecast lower
overall returns. Against this backdrop, however, we see
five areas that we believe can help drive both absolute
and relative outperformance. First, we believe that we
KKR GLOBAL MACRO & ASSET have entered an important period of change in global
ALLOCATION TEAM corporate structures. Driven by factors such as increased
HENRY H. MCVEY activism amidst declining returns on equity in foreign
Head of Global Macro & Asset Allocation
+1 (212) 519.1628 markets, we see many CEOs now striving to better
henry.mcvey@kkr.com simplify their global footprints. Importantly, this theme is
FRANCES B. LIM not contained to just the corporate sector. In addition, we
+61 (2) 8298.5553
frances.lim@kkr.com see our corporate carve-out theme playing out across
DAVID R. MCNELLIS
both the infrastructure and energy complexes. Second, we
+1 (212) 519.1629 believe that investors can still deploy more capital behind
david.mcnellis@kkr.com
the trend towards consumer experiences over things.
PAULA CAMPBELL ROBERTS
+1 (646) 560.0299
Importantly, this theme appears to be gaining momentum
paula.campbellroberts@kkr.com across both developed and developing economies. Third,
AIDAN T. CORCORAN we now are more inclined to lean in on emerging market
+ (353) 151.1045.1
aidan.corcoran@kkr.com
opportunities, particularly if they are linked to GDP-
per-capita stories at appropriate valuations. Fourth, we
REBECCA J. RAMSEY
+1 (212) 519.1631 still see the illiquidity premium as compelling. Finally,
rebecca.ramsey@kkr.com we continue to embrace complexity, particularly during
BRIAN C. LEUNG periods of market dislocation. Right now we think certain
+1 (212) 763.9079
brian.leung@kkr.com parts of healthcare, MLPs, and low-rated corporate credit
all warrant investor attention.

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2 KKR INSIGHTS: GLOBAL MACRO TRENDS
All Rights Reserved.
September 2017 will mark our six year anniversary at KKR head-
ing up the Global Macro & Asset Allocation (GMAA) analysis effort.
Without question, it has been a wonderful opportunity for the entire
GMAA team to engage with the Firms deal teams across a variety of
assignments, including both entries and exits. All told, during this pe-
riod KKR has deployed in excess of $36 billion across its Private and
Public markets; during the same period KKR has returned in excess
of $53 billion to its investors.
Beyond the day-to-day deal work, having more than 200 portfolio
companies in 19 cities across 16 countries staffed by local profes-
sionals has also created a unique environment for our team to derive
macro insights by leveraging the strengths of our integrated business
model across asset classes and capital structures.
Not surprisingly given the tool kit the platform provides us we
have consistently shied away from using a crystal ball approach to
make bold predictions based on a gut feel. Rather, we have con-
centrated our efforts on building long-term, top-down frameworks,
including both fundamental and quantitative ones that identify key
investment themes behind which we can form capital (or in some
instances avoid forming capital). We have also tried to guide our em-
ployees and investors on where we may be in the cycle, leveraging a
variety of data sets we have built out during the past two decades of
macro analysis and investing.
Today, almost all our work streams suggest that asset prices across
most parts of the global capital markets are somewhere between fair
value and expensive (Exhibit 1). From a cycle perspective, we believe
that we are mid-to-later cycle in some of the more developed mar-
kets, including the United States. Consistent with this view, our base
case remains that we have some form of an economic pullback in
2019. We also think it is worth noting that we are well below consen-
sus in terms of inflation across most parts of the world, including the
United States, Euro Area and Brazil (Exhibit 4).
Against this backdrop, we do feel inspired to narrow our investment
focus towards fewer high conviction themes, relying less and less on
macro tailwinds such as margin and multiple expansion than in the
past. In particular, we are focused on potential macro disconnects,
or financial arbitrages, where we can largely quantify where inves-
tor expectations appear offsides relative to the upside potential we
envision. See below for full details, but our current highest conviction
investment themes are as follows:
De-conglomeratization: Corporate Spin-Offs Are Creating
Rightsizing Opportunities As corporations around the world look
to optimize their global footprints in a world that is increasingly
turning domestically focused, we believe that this transition will
create a significant opportunity for investors to buy, repair, and
improve non-core assets from regional and global multinationals.
We also see increased activism in the global public equity mar-
kets as a play on our thesis. Importantly, as we describe below,
we see this trend towards entities hiving off non-core assets cur-
rently extending beyond traditional corporations to now include
Infrastructure and Energy Assets.
Experiences over Things We see a secular shift towards global
consumers willing to spend more on experiences than on things
these days. Leisure, wellness, and beauty all represent important
growth categories, all of which appear to be taking share from
traditional things. Mobile shopping and online payments are only
accelerating this trend, we believe, and our recent travels lead
us to believe that this shift is occurring in both developed and

EXHIBIT 1

Our Cycle Dashboard Suggests That Many Assets Classes at the Aggregate Level Are Now Fairly to Fully Valued; As
Such, More Creativity Will Be Required
CYCLE METRICS: NUMBER OF STANDARD DEVIATIONS RICH/(CHEAP)

EQUITY VALUATION METRICS ECONOMIC AND CREDIT-RELATED METRICS

Embed- Avg.
ded EPS Across
Avg. Growth Credit and Trail-
Avg. Across Market (Rate-Adj. Cycle- Unemp. Credit ing 5yr
Across All Equity EV/ Cap % of Equity Related Rate Spreads Equity Mkt
Metrics Metrics EBITDA Fwd P/E GDP Valuation) Shiller P/E Metrics (inverse) (inverse) Return

U.S. 0.7 0.6 1.4 0.7 1.2 -0.8 0.8 0.8 1.1 0.7 0.5

EUROPE 0.3 0.0 0.1 0.3 1.1 -1.2 -0.2 0.8 0.9 1.0 0.4

EM 0.1 0.0 1.5 -0.2 0.3 -0.6 -0.8 0.2 0.4 0.7 -0.5

JAPAN 0.0 -0.5 -0.4 -0.9 1.1 -1.2 -1.0 0.9 0.7 -0.1 2.1

Data as at June 30, 2017. Source: Bloomberg.

KKR INSIGHTS: GLOBAL MACRO TRENDS 3

 developing countries. On the other hand, the work we lay out
below shows that true core goods inflation has actually been
negative on a year-over-year basis for the past 16 consecutive
quarters and negative for 50 of the last 69 quarters since 2000.
Not surprisingly, we view this deflationary pressure as a secular,
not cyclical, issue for corporate profitability in several important
parts of the global economy.
Emerging Markets over Developed Markets As we indicated in
our 2017 Outlook Piece (see Outlook for 2017: Paradigm Shift), our
five factor model has begun to inflect upwards for EM. The direc-
tion of these signals is important, because when they do collec-
tively turn upward, EM outperformance can often last for years.
Also, we are now more constructive on EM currencies, which is
an important part of the EM total return equation for both equity
and debt investors. If we are to be right, then commodity prices
must stabilize near current levels. Details below.
Fixed Income Illiquidity Premium Despite the prospect of dereg-
ulation in financial services in the U.S., we still view the illiquidity
premium as compelling, particularly in todays low interest rate
environment. Importantly, though, at the moment we think that
there is likely more potential upside in Asset-Based Lending than
in Direct Lending, which represents a shift in our previous view.
Continue to Embrace Dislocation While the S&P 500 Volatility In-
dex (VIX) has been low in recent months, ongoing periodic spikes
in uncertainty often linked to geopolitical tensions have created
attractive investment opportunities since 2011. All told, the VIX has
jumped 50% or more on a year-over-year basis one out of every 11
days since April 2009. That compares to similar volatility spikes on
just one out of every 20 days during the prior 2003-2007 market
cycle. In our view, these types of unforeseen shocks represent a
secular, not a cyclical, pattern. See below for details, but cer-
tain Master Limited Partnerships (MLPs), CCC-rated credits, and
healthcare companies currently appear interesting to us.
Based on these macroeconomic views, we are making the following
changes to our target asset allocation:
We are reducing our Global Direct Lending allocation to five
percent from eight percent at the start of the year and 10% a
year ago. We are still structurally bullish on this market (hence,
why we retain significant exposure), but we do believe that pric-
ing in the small end of the market has gotten competitive. Also,
on the large end of the market, we think that High Yield is becom-
ing on the margin more of a competitive option relative to
Private Credit. So, we think right now could be a good time to al-
locate capital to Direct Lending at a more measured pace versus
the all in call we have been making in recent years.
and using the proceeds to increase our allocation to Asset-
Based Lending/Mezzanine. Meanwhile, our recent trip to Europe
leads us to believe that the private credit opportunity in Asset-
Based Lending/Mezzanine is actually growing quite nicely. Bank
stock prices are rising, enabling financial institutions to dispose
of performing assets that are priced to move. As such, we are
increasing our allocation to Asset-Based Lending/Mezzanine to
eight percent from five percent.
4 KKR INSIGHTS: GLOBAL MACRO TRENDS
Within Liquid Credit, we still favor Opportunistic Credit and
Levered Loans. See below for details, but we retain our four
hundred basis point, non-benchmark position in Bank Loans,
including certain spicy parts of the CCC-credit market. We also
retain our 500 basis point position in Opportunistic Credit, which
has served us well, particularly during periods of notable disloca-
tion. By comparison, the implied default rate for High Yield is now
less than one percent, which inspires us to underweight the asset
class. Investment Grade Debt, we believe, also looks richly priced
to us, and as such, we hold a five percent underweight versus the
benchmark (zero versus a five benchmark allocation).
We continue with a notable underweight to government bonds;
within government bonds, we now favor EM exposure to DM
exposure. Since our arrival at KKR in 2011, our base call has
been that risk assets would generally outperform risk-free assets.
We based this view on 1) the relative spread of risk assets using
earnings yields in equities and credit spreads in fixed income
versus the risk-free rate; and 2) our belief that the economic
expansion cycle would be longer than normal. Today, we are
running with a 14% underweight to government bonds; however,
this underweight is down from the 17% underweight we had em-
ployed for the five years prior to entering 2017. Key to our think-
ing is that inflation remains stubbornly low, while the ongoing
demographic bid for yield is likely stronger than the consensus
still thinks, in our view. In terms of preferences within govern-
ment bonds these days, we would have at least half of our six
percent weighting in paper from Indonesia, India, and Mexico, all
of which have large domestic economies, offer attractive yields,
and benefit from attractive local currency carry at current levels
(Exhibit 65). By comparison, we would be notably underweight, or
even short, German bunds at current levels. Details below.
We are shifting around our Public Equity allocations, includ-
ing reducing our U.S. exposure to below benchmark for the
first time. Specifically, we are reducing our U.S. Public Equity
exposure to 19% from 21%, compared to a benchmark of 20%.
Though 45% of the Russell 2000 stocks with enterprise values
of $500 million to five billion are still trading below 10x EBITDA
(Exhibit 43), overall indexes in the U.S., including parts of the
Nasdaq, appear somewhat overheated. With the reduction in the
United States, we are boosting Europe by one percent to 16%
versus our current benchmark weight of 15%, and we are adding
a percent to All Asia Ex-Japan to show our confidence in domes-
tic demand stories where reforms are taking shape, India and
Indonesia in particular (see our recent note Indonesia: Harnessing
Its Potential dated June 2017). We retain our underweight in Latin
America, which at four percent is two percentage points
below the benchmark target. We think that corruption remains a
problem in Brazil, therefore we would rather own debt than equity
in Mexico at current levels.
Our overweight to Private Equity relative to Public Equities and
Growth Investing remains unchanged. We continue to target a
three hundred basis point overweight to Private Equity relative
to our equal-weight in Public Equities and our five hundred basis
point underweight to Growth Investing. As one can see in Exhibit
42, what we found is that low return environments for Public
Equities have actually historically been decent environments for
 traditional Private Equity. From what we can tell, it seems single-
digit return environments for Public Equities tend to be markets
where fundamentals are good enough to support deleveraging
and operational improvements, but not so good that it is difficult
for Private Equity to keep pace with public alternatives. Also, we
believe that buyout opportunities tend to increase as the forward-
looking total return in public equities decreases. Within Private
Equity, we are most bullish on our de-conglomeratization theme,
which we describe in more detail below. On the other hand, we
maintain our five percent underweight to Growth Investing (i.e.,
zero versus a benchmark of five percent), driven by our belief
that near-term valuations appear largely full.
We also continue to run with a notable overweight to Energy
Assets/Infrastructure in 2017, a direct play on our long-term
investment thesis to buy Yield and Growth. Specifically, we
hold a five percent allocation to these asset classes, compared to
our benchmark of two percent. In recent months we have seen
significant selling of properties from publicly traded energy com-
panies looking to reposition their portfolios by selling non-core
producing assets as well as performing mid-stream properties.
Indeed, transaction volumes in this area of the Oil Patch have
increased from $20 billion in 2015 to $60 billion in 2016, and
year-to-date through April 2017, volume was running at $45
billion. Meanwhile, within Infrastructure we are seeing lots of
good cash flowing assets for sale. In many instances investors
are getting 500-600 basis points of premium over sovereign
debt returns, which is substantial in todays low rate environ-
ment. Interestingly, similar to what we are seeing with Energy
Assets, we are seeing lots of conglomerates selling off interest-
ing infrastructure properties in sectors like towers and energy
infrastructure.
Currency: U.S. dollar bull market is now in later stages. As we
describe below, the dollar has appreciated meaningfully since we
joined KKR in 2011, and we now see it as somewhat extended on
a real effective exchange rate basis. Moreover, given we remain
in a low rate environment, we think that the value of EM curren-
cies is again rising, particularly those countries with large do-
mestic economies and improving macroeconomic fundamentals.
We prefer carry currencies in Indonesia and India, and we even
believe that the Chinese yuan may stabilize for now.
Cash: We reduce Cash to one percent from three percent. We
use these proceeds to cover our two percent short position in
Gold, which we have shorted periodically during the past few
years. However, given heightened geopolitical tensions, we think
that this two percent asset class swap probably makes good
sense.
To be sure, there are risks that warrant investor attention at this
point in the cycle. As we describe in more detail below, we think that
the low unemployment rate overstates the health of the consumer
within the United States. In particular, credit trends within auto,
student lending, and certain card categories are all areas of concern.
Meanwhile, China continues to grow its nominal credit outstanding
well above its nominal GDP rate. In fact, if China continues growing
credit at the current pace, we believe that overall credit as a percent-
age of GDP could total nearly 300% by 2018, which is well ahead of
many investors expectations (Exhibit 20). Finally, after 96 months of
economic expansion, U.S. margin assumptions for 2018 appear too
robust, in our view.
Maybe more important, though, is that beyond the traditional macro
risks we have highlighted, it does feel to us like we have entered a
new era of political uncertainty that typically occurs during important
inflection points in history. Indeed, as a history major at the Univer-
sity of Virginia in the early 1990s, a key finding of my studies then
and one that my colleague Ken Mehlman often reminds me of today
is that industrial revolutions often produce political revolutions. At the
risk of over-hyping the hype, Ken and I strongly believe that the world
is currently undergoing multiple technological-driven revolutions that
are disrupting key industries and transforming millions of workers
from secure employment in one area to more tenuous project work
across multiple careers.
Without question, the Internet has democratized access to and
production of information with implications even more profound than
the invention of the printing press. This empowers critics of any and
all institutions; it promotes visual drama and empowers social media
trolling; and it reaffirms confirmation bias as people seek information
from trusted sources that reinforce their existing views.Moreover,
demographic changes across the U.S. and Europe are replacing the
aging Baby Boom generation with a very different workforce of Mil-
lennials.
Ken has consistently argued that these factors together are produc-
ing a generational swing towards populism, anchored by a fickle and
frustrated public with sometimes whipsawing changes in political
leadership and policy priorities.Weve described this as a political
bull market. From 2008-2015, this bull market produced policies
that favored more regulation, higher taxes, and heightened industry
scrutiny. Many governments also promoted fiscal austerity, multilat-
eral trade and aggressive monetary stimulus.
However, the 2016 U.K. Brexit vote and subsequent Tory losses in
this years U.K. special election, the U.S. election of president Donald
Trump, and Frances election of Emmanuel Macron (the founder of a
new party who rejected the traditional center left and right factions)
demonstrate that we are in a new chapter of this political bull mar-
ket.Specifically, many nations are definitely now viewing trade and
foreign investment from a more nationalist perspective, fiscal auster-
ity is being replaced by stimulus via lower taxes and infrastructure
spend, while key industries such as the Energy and Financial Ser-
vices sectors in certain developed markets, the U.S. in particular, are
likely to be deregulated.
Importantly, given that this industrial change is just starting to ac-
celerate and will likely last for a generation, political volatility will
only increase in this environment.Indeed, as Prime Minister Theresa
May learned (like Secretary Hillary Clinton before her), incumbent
leadersor those perceived as defending the status quowill face
peril among voters unless they are clearly associated with change.
Traditional polling is poor at predicting how volatile publics actually
vote, particularly in elections where large numbers are alienated
from traditional political parties, and turnout is uneven.Companies
and industries are increasingly subject to social media politicization
and scrutiny.
KKR INSIGHTS: GLOBAL MACRO TRENDS 5
In short, while we may be in a temporary lull after the recent political
storm in Europe, we likely should expect more shocks and surprises
that will impact the markets and companies in which we invest.
Smart investors will need to apply societal, political, and reputational
lenses to key markets, industries and companies if they are to cor-
rectly navigate the landscape that we currently envision.
EXHIBIT 2
of economic change. This viewpoint is not restricted to just the U.S.
Europe too has traded in austerity for growth, while our estimates
are that China is actually running an 11-15% deficit (when adjusted
for supplemental spending), compared to the target of three percent
of GDP. If we are right, then this trend has major implications for
long-term interest rates, regional growth trajectories, and global as-
set allocation trends.

KKR GMAA Target Asset Allocation Update for 2H17 Second, we believe that we have entered a world where domes-
tic agendas are being championed over global ones. In our view,
KKR GMAA Strategy KKR GMAA this trend has important implications for global supply chains; it
July 2017 Benchmark January 2017 also means that large domestic economies with sizeable consumer
ASSET CLASS Target (%) (%) Target (%) markets are likely to become a destination of choice for global capital
Public Equities 53 53 53 providers. Third, we see regulatory burdens easing relative to the
heightened regulatory environment we have been in. The U.S. finan-
U.S. 19 20 21
cial services industry is clearly a beneficiary, but the Energy sector
Europe 16 15 15 too could prosper. Finally, we expect volatility to move beyond the
All Asia ex-Japan* 7 7 6 currency market into other asset classes, including rates.
Japan 7 5 7
Section I: Macro Update
Latin America 4 6 4
Total Fixed Income 28 30 28 In the following section we provide macro updates on global GDP/
Global Government (DM and inflation, global interest rates, global EPS, and the global economic
6 20 6
EM) cycle.
Asset-Based Lending/
8 0 5
Mezzanine Global GDP Update/Inflation Outlook
High Yield 0 5 0
Well, it has been a long time coming this cycle, but our recent travels
Levered Loans 4 0 4
across North America, Europe, and Southeast Asia finally lead us to
High Grade 0 5 0 believe that we are seeing something akin to a synchronous global
Emerging Market Debt 0 0 0 recovery (Exhibit 3). China recently rebounded from its crash in
Actively Managed nominal GDP towards a more sustainable albeit more modest
5 0 5
Opportunistic Credit level, while a positive outcome in the French election has helped to
Fixed Income Hedge Funds 0 0 0 further boost growth in the Eurozone. The U.S. too is reaccelerating,
though forecasting growth in this region remains the most difficult,
Global Direct Lending 5 0 8
as it sways between the promise of meaningful tax reform versus
Real Assets 8 5 6 uncertainty surrounding the vision of the current administration.
Real Estate 3 2 3
Energy Assets/ Meanwhile, despite solid growth trends, we also see inflation mod-
5 2 5
Infrastructure erating across many regions of the world in the second half of 2017.
Gold 0 1 -2 In fact, as we show in Exhibit 4, we believe that inflation is likely to
undershoot consensus expectations in most areas of the world where
Other Alternatives 10 10 10
KKR does business except China.
Traditional PE 8 5 8
Distressed / Special
2 0 2
Situation
Growth Capital / VC / Other 0 5 0

Cash 1 2 3
*Please note that as of December 31, 2015 we have recalibrated Asia Today, almost all our work streams
Public Equities as All Asia ex-Japan and Japan Public Equities. Strategy
benchmark is the typical allocation of a large U.S. pension plan. Data as suggest that asset prices across
at June 30, 2017. Source: KKR Global Macro & Asset Allocation (GMAA).
most parts of the global capital
markets are somewhere between
Against this backdrop, we continue to subscribe to the Paradigm
Shift thesis that we laid out in January. Specifically, we believe that
fair value and expensive.
there are several notable mega trends on which to focus. First, we
see fiscal policies replacing monetary ones as incremental drivers

6 KKR INSIGHTS: GLOBAL MACRO TRENDS

EXHIBIT 3 ate, implied growth by our model could be even stronger, though we
fully acknowledge an overall political risk discount of 50-75 basis
Three-Quarters of Total Global Growth Will Likely Come
points to our quantitative growth model likely makes sense in the
From EM in 2017 current environment.
2017 Real Global GDP Growth, %
Also, after years of acting as a material drag on growth, government
4.0 +3.5
+0.5 spending is now a tailwind. All told, we think that government contri-
3.5 +0.4 bution to growth has gone from an incredible 150 basis point drag on
3.0 +1.4 GDP at its most difficult point in 2012 to a 12 basis point tailwind in
US makes
2.5 up 10% 2017 (Exhibit 5). Moreover, if President Trump does encourage more
defense spending as part of his NATO agenda, then there could be
2.0 Other Emerging
+1.2 Markets make up even further upside to our updated estimate.
1.5 another 41% of
growth in 2017
1.0 EXHIBIT 5
China alone makes up 35%
0.5 of growth in 2017 The Government Is Now a Tailwind to European Growth
0.0
China Other US Other World Government Contribution to Eurozone GDP Growth, Basis Points
Emerging 21
Markets 12
1
Data as at April 18, 2017. Source: IMFWEO, Haver Analytics.
-4

EXHIBIT 4 -31

Brazil Is the One Country Where We Are Well Below

Consensus Growth Forecasts; On Inflation, However, We -69 -73
Remain Below Consensus in Many Areas of the World
2017 GROWTH & INFLATION BASE CASE ESTIMATES

GMAA Bloomberg
Target Consensus KKR GMAA Bloomberg -149
Real GDP Real GDP Target Consensus 2011 2012 2013 2014 2015 2016 2017 2018
Growth Growth Inflation Inflation
Data as at May 11, 2017. Source: European Commission, Haver Analytics.
U.S. 2.3% 2.2% 1.9% 2.2%

EURO AREA 1.9% 1.9% 1.5% 1.6%

CHINA 6.6% 6.6% 2.0% 1.9%

BRAZIL 0.3% 0.5% 3.7% 3.8%

GDP = Gross Domestic Product. Bloomberg consensus estimates as at
July 6, 2017. Source: KKR Global Macro & Asset Allocation analysis of As corporations around the world
various variable inputs that contribute meaningfully to these forecasts.
look to optimize their global
footprints in a world that is
With these thoughts in mind, we offer the following more specific
thoughts on our outlook for GDP by region as well as latest thinking increasingly turning domestically
on where we are in the cycle: focused, we believe that this
Europe: Despite significant political uncertainty, European GDP con- transition will create a significant
tinues to chug along. As we detailed in our recent note (See Europe:
Complexity Rules), growth in Europe remains relatively robust. In fact,
opportunity for investors to buy,
we have again lifted our 2017 GDP forecast to 1.9% from 1.7% previ- repair, and improve non-core
ously, driven by better than expected investment trends. Maybe more
important, though, is that our quantitative GDP model is forecasting assets from regional and global
robust growth in Europe of 2.5% for 2017 (Exhibit 6). This forecast is
driven largely by the powerful effects of the European Central Banks
multinationals.
current monetary policy regime, partially offset by stagnant housing
market concerns. However, if mortgage lending growth does acceler-

KKR INSIGHTS: GLOBAL MACRO TRENDS 7

EXHIBIT 6 EXHIBIT 8

Our Quantitative Model Suggests Even Better Growth The Philips Curve in Europe Appears Unresponsive,
Ahead in the Eurozone, Bolstered by Easier Credit, the Which Means Wage Inflation Is Indifferent to the Labor
Falling Euro, Lower Oil and Zero Interest Rate Policy Market
Elements of 4Q17e Eurozone GDP Forecast EZ Phillips Curve Regimes on Data From 1965-2016
Unemployment Below 7.6% Unemployment Above 7.6%
+0.9% +0.1%
2.5%

Real Compens./Employee, Y/y %Chg

6%
+0.1% -0.4%
+0.3% 5%
1.5%
4%
Latest
3%
2%
1%
Easier
Baseline

Credit
Conditions

Falling TW
EUR

ECB ZIRP

Falling
Brent (EUR
terms)

Stagnant
Housing Mkt

Forecast
0%
0% 2% 4% 6% 8% 10% 12%

Unemployment Rate
Data as at June 28, 2017. Source: Eurostat, European Commission, Data as at June 21, 2017. Source: European Commission, KKR Global
Statistical Office of the European Communities, Haver Analytics. Macro & Asset Allocation, Haver Analytics.

EXHIBIT 7 United States: Tweaking both our growth and inflation forecasts lower.
Many GDP Drivers Are Positive vs. Trend in Europe, We have lowered our 2017e GDP to 2.3% from 2.5% previously. As
Though We Anticipate Some Relative Weakness in Trade such, we now remain just above the consensus of 2.2%. Second
quarter GDP was tracking around four percent as recently as the
and Remain Conservative on Regional Exporters
start of June. In recent weeks, however, 2Q17 GDP tracking has
EZ Real GDP Forecast fallen to 2.7% at a seasonally adjusted annualized rate. In isolation
thats still pretty strong growth, but it means that the uplift in 2Q17
Trend Consumption will be insufficient to fully offset the malaise in 1Q17, which is why
Investment Government we have taken our full-year GDP estimate down.
Trade EZ Real GDP
Date of
In terms of linking the macro to the micro, we note the following:
Forecast
2.5% Vehicle sales have slowed, which is consistent with our expec-
2.0% tations going into 2017, but the magnitude so far has been a bit
1.5% greater than expected. Weve been forecasting light vehicle sales
1.0% Trend = 1.3% at a 17 million seasonally adjusted annual rate (SAAR), which
0.5% would represent a decline of three percent from 17.5 million in
0.0% 2016. As Exhibit 12 illustrates, however, things have been even
-0.5% softer than anticipated so far in 2017, with the SAAR running at
GMAA Forecast Shows
-1.0% Weakness In Trade
just 16.6 million in May. Declining used car residual values are
having an important impact on new car sales.
01/16
03/16
05/16
07/16
09/16
11/16
01/17
03/17
05/17
07/17
09/17
11/17
01/18
03/18
05/18

Multifamily housing starts have fallen to a run rate of about

Data as at June 28, 2017. Source: Bloomberg, Haver Analytics, KKR 315,000 through the first two months of 2Q17, which is down
Global Macro & Asset Allocation estimates. more than 20% from around 400,000 in 1Q17. Our read of the
situation is that apartment developers may be pausing in re-
sponse to vacancy rates that have stopped improving nationally
(the rental vacancy rate ticked up to seven percent in 1Q17 from
a historic low of 6.8% in 4Q16), and to a slight inflection lower
in the pace of rental appreciation (shelter CPI made a cycle peak
of 3.6% Y/y in 4Q16 and has since moderated to 3.3% Y/y). Over
time we think multifamily starts will revert higher, as the funda-
mental backdrop for rental housing remains quite strong; however

8 KKR INSIGHTS: GLOBAL MACRO TRENDS

 the pause in the second quarter has been large enough that we may EXHIBIT 10
need to consider trimming our full-year U.S. total housing starts
Rent Increases, Which Drive Shelter Inflation, Are Now
forecast of 1.25 million by 25,000 to 50,000 units.
Showing Signs of Moderating from Cyclically Elevated
Meanwhile, on the inflation front, we have lowered our inflation target
Levels
to 1.9% from 2.25%. The consensus remains quite aggressive, in our
US: Shelter Ination Y/y (L)
view, at 2.3%. While we were correct to take a conservative view on 5% 12%
US: Rental Vacancy Rate (R)
healthcare and energy prices, shelter inflation which accounts for
42.5% of CPI has come down more than we anticipated. One can 4% 11%
see this in Exhibits 9 and 10. Also, as we discuss later, core inflation
in the goods arena remains stubbornly problematic (Exhibit 58). 3% 10%
EXHIBIT 9
2% 9%
The Core CPI Basket Is Concentrated in Categories
Where the Pricing Equation Is Dominated by Supply Side 1% 8%
Rather Than Demand Side Dynamics
0% 7%
% Weighting Within U.S. Core CPI

-1% 6%
Core Core 06 07 08 09 10 11 12 13 14 15 16 17
Services, 18.2%
Data as at March 31, 2017. Source: Bureau of Labor Statistics, U.S.
Census Bureau, Haver Analytics.

Core Core Shelter,

Goods 21.0% 42.5% Our bottom line for the U.S: Despite the soft spots outlined above,
we think the growth backdrop remains sound in 2017, both for the
U.S. and globally. Our 2.3% GDP forecast for 2017e embeds mid-
two percent growth in 2H17. We see a potent combination of easy
Tobacco, 0.9%
Telecom, 2.9%
credit conditions, improving household sentiment, and oil prices that
Health are low enough to support consumer spending, but high enough to
Education, 3.8%
Care, 10.8%
support upstream capital investment. Consistent with this view, we
Core Core goods = Goods inflation ex food, energy goods, healthcare also think that the components that make up both core and headline
goods, and tobacco; Core Core services = Services inflation ex energy inflation are likely to remain quite contained over the next several
services, shelter, healthcare services, education, and telecom. Data as quarters and beyond.
at May 31, 2017. Source: MSCI, Bloomberg, KKR Global Macro & Asset
Allocation analysis.
We also think investors focused on the soft U.S. data to date in 2017
should consider taking a step back to note that earnings trends have
been surprisingly strong and economic data have been surprising to
the upside across much of the rest of the world (Exhibit 14). Ulti-
mately, the data have been good enough to support an upbeat tone to
most global financial markets, which is an important reason we think
the Fed was willing to look past weak domestic data to hike twice so
far in 2017.

We think the drumbeat of
persistently low inflation driven
by weak commodity prices,
demographics, and technological
disruption of the wage cycle will
force the Fed to pause at some
point in coming quarters.

KKR INSIGHTS: GLOBAL MACRO TRENDS 9

EXHIBIT 11 EXHIBIT 13

Most High-Level Macro Leading Indicators in the U.S. ...And a Dip in Multifamily Construction Starts
Are Currently Quite Positive
Total Multifamily Housing Starts, SAAR,
Elements of 4Q17e GDP Leading Indicator Thousands of Units
500
Dec-16
460
0.2% 2.8% 450
0.2%
0.2% -0.1%
0.3%
400
0.3%
1.7%
350

300
May-17
298
250

Apr-15

Apr-17
Apr-14

Oct-14

Apr-16

Oct-16
Oct-15

Jan-17
Jan-14

Jan-16
Jul-14

Jan-15

Jul-16
Jul-15
Baseline

Credit
Conditions

Lower Oil Px

Rising Home
Sales

Recovering
Household Wealth

Other Factors

Graying
Workforce

Forecast
Data as at June 20, 2017. Source: Census Bureau, Haver Analytics.

EXHIBIT 14

Data as at June 20, 2017. Source: Bureau of Labor Statistics, Haver, KKR Recent U.S. Economic Data Have Been Weak, but
Global Macro & Asset Allocation analysis. Earnings and International Economic Data Have Been
Considerably More Upbeat
EXHIBIT 12 Net Economic Surprises and EPS Estimate Revisions,
...But Some Industry-Specific Factors Have Weighed on Past Three Months
1H17 Growth, Including Weak Auto Sales... 40
23
Light Weight Vehicle Sales, Autos+Light Trucks, 20 12
9 9
SAAR, Millions of Units
18.5 Dec-16
0
18.3
18.0
-20
17.5
-40 -32
17.0
-60
16.5
May-17
16.6 -80
16.0 -77

15.5 -100
U.S. Economic
Surprises

UK Economic
Surprises

EM Economic
Surprises

Japan Economic
Surprises

S&P 500 Earnings

Revisions

Eurozone Economic
Surprises

15.0
Apr-17
Apr-14

Apr-16
Apr-15

Oct-15
Jan-15

Jul-15
Oct-14

Oct-16
Jan-17
Jan-14

Jan-16
Jul-14

Jul-16

Data as at June 20, 2017. Source: Bureau of Economic Analysis, Haver

Analytics. Data as at June 20, 2017. Source: Bloomberg, Citigroup, Morgan Stanley
Research, S&P, KKR Global Macro & Asset Allocation analysis.

10 KKR INSIGHTS: GLOBAL MACRO TRENDS

EXHIBIT 15 China: Settling in at a lower rate of growth. As part of our mid-year
update, my colleague Frances Lim, who leads our macro effort in
Global Oil Inventories Are Still Quite Glutted. In Fact,
Asia, has marginally increased her target 2017 GDP to 6.6% from
Inventories Are Approximately 1.2 Billion Above Pre- 6.5%. Her upward revision is based more on 1Q17s surge in GDP to
4Q14 Trends 6.9% than her belief that growth will reaccelerate in the second half
of the year. Meanwhile, we are lowering headline CPI to 2.0% from
Global Commerical Oil Inventories (mb)
2.3%. We make this adjustment, despite core inflation rising to 2.1%
Trend
Linear (Global Commerical Oil Inventories (mb))
due to food price deflation in 1Q17 that brought headline inflation
down, and the recent leg lower in oil prices. A stronger yuan relative
6300 Jun-17 to prior expectations should also help keep inflation in check.
6,205
Inventories are above trend by ~1.2
6100 billion barrels. But If global Overall, we believe that China bears who are calling for major
production runs in decit by ~1%, we
5900 estimate inventories could normalize downside to growth from current levels are missing the point that the
closer to 5,400 in ~2 years country has already had its economic crash in nominal terms. One
5700
can see this in Exhibit 17, which shows that nominal GDP fell from a
5500 recent peak of 24.0% in 3Q07 to a low of 6.4% in 4Q15. In our view,
too many sell-side economists have focused on Chinas slowdown
5300
in real terms, which is much more subdued than in nominal terms.
Trend
5100 ~5,000 Specifically, at the same time that nominal GDP fell by 73%, real GDP
Trend
~4700 fell a more modest 55% from 15.0% in 2Q07 to 6.7% in 1Q16. The
4900
delta between nominal GDP and real GDP is significant, however, as
4700 companies generate revenues in nominal not in real terms; they
pay their employees in nominal terms not in real terms; and they
4500
'09 '10 '11 '12 '13 '14 '15 '16 '17 '18 reward shareholders in nominal terms not real terms.

Data as at June 30, 2017. Source: IEA, Bloomberg, KKR Global Macro & EXHIBIT 17
Asset Allocation analysis.
Past Its Cyclical Peak: We Think That Nominal GDP Will
Now Moderate as PPI Falls Again
EXHIBIT 16
China: PPI, Y/y, %, LHS
Global Oil Inventories Can Currently Supply 64 Days of China: Nominal GDP, Y/y,%, RHS
Forward Demand the Highest Level in Nine Years
12 Sep-07 30
Global Inventories Adjusted for Demand vs. Brent, 2008-Today 24.0 Ination
8
peaked
1Q17 25
Brent in 1Q17
7.4
($/bbl) R = 0.71 20
$140 4
15
$120 0
Overpriced
Mar-17 10
$100 11.8
-4 Dec-15 5
May-17 83% correlation
$80 between PPI and GDP 6.4
-8 0
$60 00 02 04 06 08 10 12 14 16 18
Data as at May 31, 2017. Source: China National Bureau of Statistics,
$40 Haver, Morgan Stanley, KKR Global Macro & Asset Allocation analysis.
Underpriced
$20
65 64 63 62 61 60 59 58 57 56 55 54 53 52 51 50

Global Inventories Adjusted for Demand (Number of Days)

Data as at May 31, 2017. Source: IEA, EIA, Bloomberg, Haver Analytics,
KKR Global Macro & Asset Allocation analysis.

KKR INSIGHTS: GLOBAL MACRO TRENDS 11

EXHIBIT 18 EXHIBIT 20

Despite Record Fiscal Stimulus If Current Trends Persist in China, Debt-to-GDP Ratios
Could Hit 300% in Less Than 24 Months
China Fiscal Deficits as a Percent of GDP, 3 Month Moving Average
O-budget Deficit China: Credit as a % of GDP
Augmented Fiscal Deficit Bear Case: Credit Growth 16%, Nom GDP 9%
Ocial Fiscal Deficit Base Case: Credit Growth 13%, Nom GDP 9%
4 Bull Case: Credit Growth 8%, Nom GDP 9%

0
400
360 Dec-21
-4 At the current pace, China will
Dec-18 356
320 reach 300% debt to GDP 293
307
-8 much sooner than expected
280
240 245
-12
200
-16 160
05 06 07 08 09 10 11 12 13 14 15 16 17
120
Data as at May 31, 2017. Source: CEIC, Wind, Goldman Sachs Global 06 08 10 12 14 16 18 20
Investment Research.
Data as at 4Q16. Source: China National Bureau of Statistics, BIS, Haver
Analytics.

EXHIBIT 19
Looking ahead, Frances believes that the government is trying to
Chinese Authorities Are Using the Current GDP Strength
temper debt growth by being more coordinated across all its financial
to Tackle Deleveraging in the Financial Sector regulators, including the PBoC, CBRC, CSRC, CIRC, and Politburo1 etc.
China: Real GDP Growth Y/y, % Without question, we view this coordination as a major positive. The
bad news is that, even with tighter controls, China continues to grow
20 its debt load in excess of nominal GDP. One can see the magnitude of
Real GDP Jun-15
the issue in Exhibit 20, which highlights our belief that Chinas debt-
18 Financials (16%) 18.8
to-GDP ratio could nearly reach 300% by next year if measures are
16 Ex-Financials (84%) not taken to slow credit growth down. Furthermore, in the near term,
14 there is likely to be heightened volatility as implementation of new
12 policies is subject to execution risk.
Mar-17
10 8.3 So, whats our bottom line? Despite its surging debt burden, we
8 believe that Chinas economy will be able to maintain real GDP
6 Mar-17 growth at or above its targeted 6.5% for the remainder of this year
Dec-16 4.4
4 versus 6.9% in 1Q17. Key to our thinking is that President Xi Jinping
3.8 will want to keep economic growth in a steady range ahead of the
2
11 12 13 14 15 16 17 government transition in October. Our expectation is that as many
as five of the seven Politburo Standing Committee members could
Data as at March 31, 2017. Source: China National Bureau of Statistics, be replaced, and as a result, we believe that President Xi will work
Haver Analytics.
with his team to ensure that economic volatility does not disrupt this
transition. To be sure, it is still too early to call, but Exhibit 18 under-
scores how much incremental spending the Chinese government is
already pursuing to ensure economic headwinds do not dominate the
governmental agenda in the fall.
We see a secular shift towards
global consumers willing to spend
more on experiences than things
these days.
1 PBoC = Peoples Bank of China; CBRC = China Banking Regulatory
Commission; CSRC = China Securities Regulatory Commission; CIRC = China
Insurance Regulatory Commission; Politburo = policy making committee of the
Communist Party.

12 KKR INSIGHTS: GLOBAL MACRO TRENDS

Brazil: Leaning towards an L shaped recovery. The ongoing political EXHIBIT 21
crisis continues to weigh on economic growth, potentially more than
We Are Moving to Two Expected Hikes in 2018 from
some investors may appreciate. Indeed, while Brazils 1Q17 GDP
growth came in strong at 4.3% (and we acknowledge fully above our
Three Previously
expectations), a full 73% of the first quarter GDP rebound was solely Current Expected Fed Funds Rates
due to agricultural production surging 13.4% during the same period.
FOMC GMAA Futures Mkt
So, when we pull it all together, we are now forecasting 0.3% real GDP 2.3%
growth for Brazil in 2017, below consensus expectations of 0.6%, but FOMC
2.1%
above our original forecast of 0.0% (given the cyclical surge in 1Q17). GMAA
Moreover, we still see the risks to growth skewed to the downside, 1.9% 1.875%
given the likely delays to pension reform and the general uncertainty 1.7% +50bp
around the direction of political leadership. Our bigger picture con- 1.375%
clusion is that, as the country exits its longest and deepest recession 1.5%
on record (the economy contracted by 8.2% over the past two years), 1.3%
an L-shaped recovery is the most likely scenario. Key to our thinking
1.1% +75bp
is that bad credit still needs to be unwound, social benefits are being
cut, and business practices are being altered. 0.9%
0.7% 0.625%
On the inflation front, large slack in the economy with unemploy-
ment still at 13.6% should keep inflation under control in the short 0.5%
term. In fact, we expect inflation to end 2017 at 3.7%, actually below YE'16 YE'17 YE'18
the 4.5% central bank target and our prior forecast of 6.0%. As such, Data as at June 14, 2017. Source: Federal Reserve, Bloomberg, KKR
we believe the central bank will be able to cut rates by an additional Global Macro & Asset Allocation analysis.
175 basis points, with the SELIC rate ending this year at 8.5%.

Global Interest Rates EXHIBIT 22

U.S. Outlook In the face of what has been a surprisingly weak back-
We Are Lowering Our U.S. 10-Year Yield Targets by 25
drop for core inflation, commodity prices, and U.S. GDP so far in Basis Points to 2.5% for Year-End 2017 and 3.0% for 2018
2017, the Federal Reserve in June made no material changes to its (Estimated Cycle Peak)
dots plot fed funds forecasts (which continue to imply one more
KKR GMAA U.S. 10-Year Yield Forecast, %
hike this year and three next year) and no material changes to its
inflation forecasts for 2018 or beyond. Moreover, it chose to preview Prior Forecast New Forecast
its balance sheet normalization plans, which we believe the central
bank will roll out this September. 3.25%
3.00%
2.75%
We clearly see the world slightly differently than the Fed, and as
such, recently modified our interest rate forecasts (both short- and 2.50%
long-end). Specifically, we have removed one 25 basis point hike
from our 2018 Fed forecast (versus our prior estimate), which means
we now expect fed funds to reach 1.875% at our expected cyclical
peak at the end of 2018, down from 2.125% previously (Exhibit 21).
Though we respect the Feds seeming resolve to continue its tighten-
ing campaign, we think the drumbeat of persistently low inflation driven
by weak commodity prices, demographics, and technological disruption
will force it to pause at some point in coming quarters. In light of our
revised Fed forecasts of one more hike in 2017 to 1.375% and two 25
YE'17 YE'18 (Cycle Peak)
basis point hikes in 2018, our 10-year yield target falls to 2.5% from
2.75% for 2017 and to 3.0% from 3.25% at our expected cycle peak Data as at June 14, 2017. Source: KKR Global Macro & Asset Allocation
in 2018 (Exhibit 22). analysis.

KKR INSIGHTS: GLOBAL MACRO TRENDS 13

By moving towards balance sheet reduction mode later this year, EXHIBIT 23
the Fed will also be confirming our expectation that global developed
European Bonds Appear Overpriced Relative to Treasuries,
markets will move to a net issuance of government debt in 2018
(Exhibit 26), reversing the trend of what has been three consecutive
Particularly if One Adjusts for Inflation Differentials
years of net purchases. At the same time that the Fed starts reducing Spread Between U.S. and Germany 10 Year Yield and CPI
its balance sheet, other global central banks notably the European
Central Bank may also be less aggressive in its bond buying pro- +/- One StDev Median Memo: 2017e
gram. Furthermore, U.S. issuance may be heightened by President

Spread Between U.S. and Germany 10yr Yield

Trumps tax agenda. Collectively, these forces explain why we think 3.5% Very high bond yield spread
10-year yields can continue to rise a little, even as inflation remains 3.0% relative to only moderate
2.5% ination dierential
controlled and the cycle becomes more mature.
2.0%
1.5%
Overall, we think the Fed has moved from being data dependent to
1.0%
now being somewhat data defiant. Put another way, we think mar- 0.5%
ket participants should appreciate that a flat Phillips Curve today 0.0%
(i.e., low unemployment, low inflation) will not necessarily act as a -0.5%
brake on Fed tightening. In fact, if the Fed becomes convinced that -1.0%
its rate decisions now have relatively less importance for the path of -1.5%
inflation, it could become more focused on its role as a regulator of < 0% 0% to +0.5% to +1.0% to +1.5% to > 2%
+0.5% +1.0% +1.5% +2.0%
financial market excesses, including high risk-asset valuations and
rising credit balances globally. Spread Between U.S. and Germany CPI

Data as at November 15, 2016. Source: Bloomberg, KKR Global Macro &
Looking at the big picture, our view is that the Federal Reserve is Asset Allocation analysis.
using its public commentary to signal three important messages.
First, the neutral rate is likely to be much lower this cycle. Specifi-
cally, we believe that the neutral rate, which is the interest rate that EXHIBIT 24
neither stimulates nor cools down the economy, could be closer to
2.5%, compared to a historical average of closer to 4.0%. We link While Chinas Economy Is Just $11.2 Trillion vs. $18.6
this downshift to demographics (note the participation rate is now at Trillion for the U.S., It Has 1.6x the Amount of U.S. Savings
62.7% versus 67.1% twenty years ago), disruptive technologies (e.g.,
the traditional retail sector has lost 51,000 jobs during the last three Gross Domestic Savings, US$ Trillions
months ending May 31, 2017 at a time when overall employment
China Japan US
grew by 362,000 during the same period), and uncertainty around
China and its excess capacity in industries such as steel. 6
2016
5.5
Second, the Fed will likely be extremely conservative around the un- 5
winding of its balance sheet. Said differently, it learned an important
lesson during the 2013 Taper Tantrum. Given that the maturing of the 4
balance sheet is non-linear, we think that this approach makes sense. 3.4
Also, given that quantitative easing is actually a novel concept, there 3
is little to no precedent about how shrinking a $4.3 trillion balance
sheet might affect market liquidity, volatility, etc. 2
1.3
1

0
We think that the low employment '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 '15

rate overstates the health of the Note: Total savings estimated by deducting final consumption expenditure
from nominal GDP. 2016 number for Chinas saving is our own estimate.
consumer within the United Data as at December 31, 2016. Source: Maybank Kim Eng Economics
Research, Chinas Rising Wall of Savings, April 2017; CEIC.
States. In particular, credit trends
within auto, student lending, and Third, barring a surge in wage growth to north of 3.5%, we be-
lieve that the Federal Reserve will remain measured. There are just
and certain card categories are all too many unusual forces for them to consider, including a poten-
areas of concern. tial change in leadership, tax reform, and China. Also, the Federal
Reserve will likely have to wrestle with the reality that the repeal of
the Affordable Care Act could dent consumer spending more than
markets now think. Indeed, low income consumers have a higher

14 KKR INSIGHTS: GLOBAL MACRO TRENDS

marginal propensity to spend than the average American, and as
such, incremental spending on healthcare costs could offset the ben-
efits of lower taxes to the upper-middle and high-end earners of the
U.S. working population.
EXHIBIT 25
With the ECB in Full QE Mode, European Rates Are
Helping to Suppress U.S. Rates, Even as the Federal
Reserve Becomes More Conservative
U.S. - Germany 10yr Rate Spread, %
International Rate Outlook After discussing the outlook with my
colleague Aidan Corcoran, we envision German yields backing up
towards one percent at some point during the next twelve months
versus just 30 basis points today. Key to our thinking is that mon-
etary conditions in Germany are at their most accommodative in
recent history (Exhibit 27). All told, German nominal GDP growth is
now more than 300 basis points above the 10-year bund rate, further
fueling an economy that is already performing well. Also, the spread
between U.S. and German rates has gotten quite wide, a trend we
expect to self-correct by German bunds resetting higher versus U.S.
bonds rallying heavily.

Jun-17 In terms of market implications, we do view this readjustment as po-

2.5 1.86
tentially disruptive for holders of long duration assets in Europe (i.e.,
Apr-89
2.0 2.16 bond prices are too high), though there could also be beneficiaries
May-99 (notably in the Financial Services sector). Maybe more important,
1.5 1.51 Sep-05 though, is that we believe the Eurozone economy can handle a bund
1.18
sell-off of this magnitude, given that it is actually an expression of
1.0
stronger growth versus a major shift in monetary policy.
0.5
Meanwhile, in Asia our colleague Frances Lim sees a more stable in-
0.0 terest rate outlook for Japan than what we are forecasting for Europe
-0.5 in the second half of 2017. True, the BoJ has shifted from growing its
balance sheet to yield curve control, but it has largely been inconse-
-1.0 quential. In fact, long rates remain essentially unchanged since the
announcement in late 2016. Maybe more important to the rate out-
-1.5
89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 look and the BoJs thinking is that the country is likely to miss its
inflation target again, supporting her strong view that the policy rate
Data as at June 28, 2017. Source: Bloomberg. will stay at -0.1% and a 10-year yield will continue to hover around
zero percent for the foreseeable future.

EXHIBIT 26 Looking at the bigger picture, we think it is worth mentioning that in

G4 Sovereign Issuance Less Central Bank Purchases nominal dollar terms both the ECB and BoJ balance sheets are now on
pace to finally eclipse the Fed. One can see this in Exhibit 28. While we
Shows that Net Issuance Is Now Actually Negative.
normally focus on central bank balance sheet size relative to GDP,
However, This Trend Will Change in 2018
the absolute value is also important, as it drives very large sums of
money into and out of the key sovereign bonds across the world.
Central Net
Net Y/y % Bank Y/y % Issuance Y/y % Given this important baton hand-off at a time when the global QE
Issuance Change Purchases Change Less QE Change cycle is getting mature, our view is that investors should begin to
prepare for interest rate volatility to finally increase, as the invest-
2011 2,446 1,032 1,414 ment community begins to parse every new piece of information on
2012 2,064 -16% 508 -51% 1,556 10%
the health of the economy, inflation, and central bank balance sheet
management.
2013 1,890 -8% 1,063 109% 826 -47%

2014 1,482 -22% 809 -24% 674 -18%

2015 1,044 -30% 1,091 35% -48 -107%

2016E 964 -8% 1,477 35% -514 -971%
Looking at the bigger picture,
we think it is worth mentioning
2017E 947 -9% 1,108 2% -161 -235%
that in nominal dollar terms
2018E 1,302 35% 510 -65% 792 254%
both the ECB and Bank of Japan
TOTAL 12,139 7,598 4,540
balance sheets are now on pace to
G4 = BoJ, BofE, Fed, Eurozone. QE = Quantitative easing. Data as at May
31, 2017. Source: National Treasuries, Morgan Stanley Research.
finally eclipse the Fed.

KKR INSIGHTS: GLOBAL MACRO TRENDS 15

EXHIBIT 27 margin expansion of 30 basis points. Previously, we assumed 6.1%
revenue growth with no margin expansion. Consistent with this more
German Monetary Conditions Are at Historically
conservative view, we remain below the consensus of $132 (which is
Accommodative Levels in Europe. In Our View, This down from $133 at the beginning of the year).
Growth Trajectory Makes Bunds Vulnerable
EXHIBIT 29
Germany Nominal GDP Growth Rate
4%
Less 10yr Bund Rate For the S&P 500 in 2017, We Look for Revenue Growth of
4.7% and EPS Growth of 7.1%
2%
$/SHARE Y/Y %CHG
0%
2016 EPS $119.1
-2%
REVENUE GROWTH $5.6 4.7%
-4%
MARGIN EXPANSION $4.2
-6% 2009 Nominal GDP
Growth Crash EARNINGS GROWTH $9.8 8.2%
-8%
BASELINE GMAA 2017E EPS $128.9 8.2%
1992
1994
1995
1996
1997
1998
1999
2001
2002
2003
2004
2005
2006
2008
2009
2010
2011
2012
2013
2015
2016
2017
ADJ. FOR TAX RATE CHANGE - 0.0%
Data as at June 21, 2017. Source: European Commission, KKR Global
Macro & Asset Allocation analysis, Haver Analytics. ADJ. FOR STRONGER US DOLLAR -$1.0 -0.8%

ADJ. FOR LOWER ENERGY -$1.5 -1.3%

EXHIBIT 28 ADJ. FOR BUYBACKS $1.2 1.0%

We Expect Greater International Rates Volatility as Both PRO-FORMA GMAA 2017E EPS $127.7 7.1%
the ECB and BoJ Balance Sheets Eclipse the Fed In USD
Terms Data as at June 15, 2017. Source: KKR Global Macro & Asset Allocation
analysis.
Central Bank Balance Sheets, US$ Trillions
Fed ECB BoJ
EXHIBIT 30
5.0
Our 2017 EPS Estimate Is $128, Which Is 3.4% Below
4.5 Consensus Estimates
4.0
2017 S&P 500 Earnings Per Share Estimate
3.5 (US$/share)
3.0 $132.1
2.5 $128.9 +$0.0
+$1.2 $127.7
-$3.2 -$1.0
2.0
-$1.4
May-17
May-16
May-15

Jul-16

Jan-17
Jul-15

Mar-17
Jan-16

Sep-16
Jan-15

Sep-15

Mar-16
Mar-15

Nov-16
Nov-15

Data as at June 21, 2017. Source: ECB, Fed, BoJ, Haver Analytics.

Global Earnings: Rebound Still Under Way

Assuming Lower

Stronger US Dollar

Lower Energy
Consens us 2017

Margin Growth

GMAA 2017e
Baseline EPS

Trump Tax Cuts

Contribution

Buybacks

GMAA 2017e EPS

After a multiple year hiatus, global earnings are growing again.

Interestingly, though, while the U.S. growth has been solid, Europe
and EM actually represent the lions share of the upward thrust in
earnings momentum. As we detail below, we expect these trends to
continue. To this end, we note the following:
Data as at June 15, 2017. Source: KKR Global Macro & Asset Allocation
2017 S&P 500 EPS UpdateWe have revised upwards our 2017 EPS analysis.
forecast for the S&P 500 to $128, compared to our prior forecast of
$127 (now implying 7.1% growth versus 2016 actual EPS of $119).
Driving the increase is 4.7% of top-line growth coupled with modest

16 KKR INSIGHTS: GLOBAL MACRO TRENDS

Why then the lower number relative to consensus? Our more con- EXHIBIT 32
servative outlook for 2017 is predicated on two factors. They are as
In Our View, the Energy Sector Contribution Is Just Too
follows:
Optimistic, Embedding What We Believe Is an Oil Price
Point #1:Energy earnings for publicly traded companies appear too op-
of $64 for End-2017
timistic, in our view. As we show in Exhibit 32, we estimate that the
WTI Spot vs. SPX Energy EPS
consensus estimates for 2017 embed a $64 year-end oil price versus
its current level of $45 on June 30, 2017. This optimistic assump- Actual WTI spot
tion is significant, as a full 27% of EPS growth in 2017 is expected to Regression Model (based on S&P 500 Energy EPS)
come from the Energy sector (Exhibit 31). As such, we have baked in
a 30% haircut to Energy earnings, which reduces our S&P 500 EPS 140
R2 = 85%
by $1.50 in 2017. Overall, while we remain bullish on the ability to
120
buy attractively priced properties from energy companies, including
producing wells and midstream assets (hence, our overweight to En- 100 Sep-18
ergy Assets), we hold a more cautious view of many of the publicly $69
traded stocks within the S&P 500 Energy sector. 80 Dec-17
$64
EXHIBIT 31 60

Consensus Expectations Are for 72% of the 2017 U.S. EPS 40

to Come From Just Three Sectors: Energy, Financials and
20
Technology
0
S&P 500 2017E Consensus EPS Growth, % '04 '06 '08 '10 '12 '14 '16 '18
Regression = 4.5% + (27.7% * Delta in S&P 600 Energy EPS.) Data as
S&P 500 10.9% at June 28, 2017. Source: IBES, KKR Global Macro & Asset Allocation
analysis.
Gro
Telcos 0.0% wt
hC
Utilities 1.3% ont
rib
uti
Materials 2.6% on
Point #2: Margin assumptions across many sectors of the S&P 500 are
REITS 2.7% too optimistic, in our view. As the investment bank Goldman Sachs
Cons. Disc. 3.5% has pointed out, around 50% of the total margin expansion since
Staples 3.6% 2009 has come from just the Technology sector, with Apple account-
Health Care 6.2% ing for a full 20% of total margin expansion during this same period.
Industrials 8.1% Otherwise, our work shows that corporate margins have already
Financials 21.1% peaked, something that many economists have already seen for nine
Info Tech 24.4% quarters in the U.S. governments Bureau of Economic Analysis
Energy 26.6% National Income and Products Account (NIPA).
0% 5% 10% 15% 20% 25% 30%
So, when we look at forward margin estimates, we conclude that
Data as at June 28, 2017. Source: KKR Global Macro & Asset Allocation
sell-side forecasts in sectors such as Consumer Discretionary and
analysis, IBES.
Industrials are just too optimistic. These sectors are less equipped to
absorb higher labor costs while maintaining profitability at this point
in the cycle (Exhibit 33). Hence, we assume a conservative margin
expansion of 30 basis points in 2017, which is now about 40 to 50
basis points lower than consensus expectations (Exhibit 34).

Overall, our message is that the
earnings cycle is likely to remain
solid through the first half of 2018,
which influences the way we think
about both equity and credit
assets at this point in the cycle.

KKR INSIGHTS: GLOBAL MACRO TRENDS 17

 EXHIBIT 33 2018 S&P 500 EPS Update As we think about 2018, we have also
taken some additional time to adjust for potential tax reform legisla-
Consumer Discretionary and Industrials Margins Have
tion that we think might be put forward and passed. At the risk of
the Unfortunate Combination of Being High Relative to stating the obvious, we continue to think that any benefit to EPS will
History but Low in Absolute Terms likely remain a 2018, not a 2017, event. We also see a Border Adjust-
ment Tax (BAT) as a non-starter.
S&P 500 Sector Margins Relative to History
20yr Max/Min Range 2017e On the other hand, we do still expect some corporate tax reform in
2018.Specifically, we are assuming a lower statutory corporate tax
20% rate of 25%, mandatory repatriation of overseas profits, partial loss
18%
of interest deductibility, and a softening dollar. To this end, we note
16%
the following assumptions we have made:
14%
12%
10% Lower Corporate Tax Rate: Consistent with what we detailed in
8% our January outlook, we still assume the statutory tax rate falls to
6% 25% from 35% today, with the effective tax rate dropping to 22%
4% from 28% during the same period. To calculate the impact on
2% S&P 500 earnings, we divide the change in effective tax rate by
0% (1 the current effective tax rate), which theoretically provides a
Utilities

Industrials
Materials

Cons Disc
S&P 500
Health Care

Staples

Energy
Telcos
Tech

full $11.10 boost to EPS. However, we believe this likely over-

states the actual impact on profits, as a portion of these benefits
would likely be passed on to consumers via lower prices or be
competed away. As such, we take a 20% haircut and assume just
Data as at June 28, 2017. Source: BofAML, KKR Global Macro & Asset $8.90 of the EPS boost (or 80% of the $11.10) falls to the bottom
Allocation analysis. line.

Repatriation/ Buybacks: Given that the repatriation tax is likely to

EXHIBIT 34 be mandatory, we assume that all of the approximately $1.2 tril-
lion of accumulated overseas profits will be brought back onshore
Despite the Bullish Shift Towards Higher Margin at a one-time tax rate of 10%. We then assume that 50% of the
Technology Stocks Within the S&P 500, Overall Margin after-tax proceeds are used for share buybacks in the first year.
Assumptions Still Look Aggressive to Us If we are right, then this addition could add three to four dollars to
EPS, we believe.
S&P 500: Net Income Margin

S&P 500 Consensus Estimate (2017-18) Potential Partial Loss of Interest Deductibility: We estimate that
S&P 500 non-financial companies had roughly $2.8 trillion of net
12%
debt and roughly $150 billion of interest expense for fiscal year
11% 2016. So, at a 25% corporate rate, the loss of all interest expense
10.7% deductions would cost the S&P 500 roughly $4.40 per share in
10% 10.1% earnings. In our view, a shift towards immediate 100% expens-
ing of interest costs is highly unlikely. So, for our base case we
9% 9.7% assume 50% of this number (or $2.20 in EPS), which handicaps
the probability that there is some grandfathering provision on
8% existing debt.
7%
U.S. Dollar: See our commentary below in the where are we in
6% the cycle section, but we now assume that the dollar bull market
has largely run its course. Case in point, the dollar has already
5% depreciated five percent year-to-date. Even so, the average dollar
'96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16 '18 '20 price in 2017 year-to-date remains three percent above the aver-
Data as at June 28, 2017. Source: BofAML, KKR Global Macro & Asset age price for full year 2016. Assuming no further appreciation or
Allocation analysis. depreciation from current levels, 2018 EPS would be adversely
affected by two dollars per share in our base case.

When we bring it all together, our 2018 EPS forecast for the S&P
500 is now $141, compared to our prior forecast of $143 and a cur-
rent consensus of $148. One can see a breakdown of our forecast in
Exhibit 35. Included in our base case for 2018 is 4.1% top-line growth
and flat margins, both forecasts slightly more conservative than the

18 KKR INSIGHTS: GLOBAL MACRO TRENDS

consensus (Exhibit 36). Overall, our message is that the earnings International EPS For the first time in years, we are seeing interna-
cycle is likely to remain solid through the first half of 2018, which tional EPS outshining U.S. estimates. In rough terms, we expect both
influences the way we think about both equity and credit assets at Europe and Asia to grow EPS by 20% in 2017, versus mid-single
this point in the cycle. digits for the United States. Moreover, earnings revisions for Europe
and the Emerging Markets appear quite favorable relative to the
EXHIBIT 35 United States. One can see this in Exhibit 37.
We Look for 2018e EPS to Reach $141, Which Is 4.6%
Below Consensus Estimates In terms of what to look for, our message is pretty clear. Specifically,
work done by my colleague Brian Leung shows that earnings are in-
2018 S&P 500 Earnings Per Share Estimate creasingly being driven by just a few sectors. For example, Financials
(US$/share) are supposed to account for a full 38% of total European earnings
growth in 2017, while Technology is supposed to account for 37% of
+$3.3 -$2.2
-$2.0 total EPS growth in EM in 2017.
+$8.9 $140.8
EXHIBIT 37

EPS in EM and Europe Are Expected to Grow

+$5.3
Approximately 20% in 2017, Outpacing Growth in the US
$127.6
Consensus 2016 vs. 2017e EPS Growth
25% 2016 2017e
20.7%
19.4%
20%
GMAA Earnings Tax Buyback/ Lose Stronger GMAA
2017e growth Rate Repatri- Interest USD 2018e 15%
EPS Change ation Deduct. EPS
10.9%
Data as at June 28, 2017. Source: IBES, MSCI, KKR Global Macro &
10%
Asset Allocation analysis.

5%
EXHIBIT 36

We Have More Conservative Revenue Growth and 0%

US Europe EM
Margin Assumptions Relative to Consensus
Data as at June 28, 2017. Source: IBES, MSCI, KKR Global Macro &
2018 S&P 500 EPS Growth Assumptions Asset Allocation analysis.
14% GMAA Consensus
11.9%
12% 10.7% 10.4%
10.0%
10%

8%

6% 5.1%
4.1%
4%

2%
0%
We now are more inclined to
Revenue Growth
Estimate
Profit Margin Earnings Growth
Estimate
lean in on emerging market
Data as at June 28, 2017. Source: IBES, MSCI, KKR Global Macro &
opportunities, particularly if they
Asset Allocation analysis. are linked to GDP-per-capita
stories at appropriate valuations.

KKR INSIGHTS: GLOBAL MACRO TRENDS 19

EXHIBIT 38 Where Are We in the Cycle?
Europe EPS Growth Driven by Financials, EM Driven by
Since we arrived at KKR in 2011, we have been arguing for a longer
Technology and U.S. Growth Driven by Energy cycle. Several factors have influenced our thinking over the years.
Contribution to Consensus 2017 EPS Growth Estimates First, given how bad the environment was for jobs and growth in
2008/2009, it would only make sense that it would take longer
than normal to create a sustainable economic recovery. Second, as
38% of Europe the world transitions away from manufacturing towards more of a
Financials services-based economy, our research leads us to believe that the
EPS growth
cycles have on average gotten more extended. Third, the level of
monetary stimulus this cycle has been unprecedented, and as such,
37% of EM it will likely take much more time for central banks to unwind what is
Technology now a $14.5 trillion global QE experiment.
EPS growth

Though it may not feel this way to some, we are actually now 96
27% of US months into an economic expansion in the United States (Exhibit 40).
Energy Our base view is that the expansion continues through 2018, and
EPS growth
then we run into a soft patch of economic growth thereafter. While
economic expansions do not die of old age, they are affected by
0% 10% 20% 30% 40% 50%
issues like peaking margins, heightened leverage, and deteriorating
Data as at June 28, 2017. Source: IBES, MSCI, KKR Global Macro & credit. For our nickel, we see all three as potential concerns being
Asset Allocation analysis. issues by 2019.

EXHIBIT 40
Our bigger picture comment, which we think is bullish for EM, is We Are Quite Long in the Tooth in Terms of Pure Cycle
that Technology has now become become bigger than Financials, Duration at 96 Months
measured as a percentage of MSCI market capitalization (Exhibit 39).
In our humble opinion, this baton hand-off points to not only an im- Duration of U.S. Economic Expansions (Months)
portant maturing of emerging market economies but also that public
investors are now able to own securities and indexes that are more June 2009 Current (Jun-2017) 96
directly levered to EMs rising GDP per capita stories. In the past, November 2001 - December 2007 73
this was clearly not the case, as many EM indexes were heavily tilted March 1991 - March 2001 120
November 1982 - July 1990 92
towards just commodity and financial companies. July 1980 - July 1981 12
March 1975 - January 1980 58
EXHIBIT 39 November 1970 - November 1973 36
February 1961 - December 1969 106
The Technology Sector Has Taken Over as the Largest April 1958 - April 1960 24
Driver of EM Returns May 1954 - August 1957 39
October 1949 - July 1953 45
MSCI EM: Sector Weight, % October 1945 - November 1948 37
June 1938 - February 1945 80
Financials Tech March 1933 - May 1937 50
30% November 1927 - August 1929 21
July 1924 - October 1926 27
July 1921 - May 1923 22
25% March 1919 - January 1920 10
December 1914 - August 1918 44
20% January 1912 - January 1913 12
June 1908 - January 1910 19
August 1904 - May 1907 33
15% December 1900 - September 1902 21 Median = 37

10% Data as at June 30, 2017. Source: NBER, KKR Global Macro & Asset
Allocation analysis.
5%

0%
'97 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17
Data as at June 6, 2017. Source: Bloomberg.

20 KKR INSIGHTS: GLOBAL MACRO TRENDS

EXHIBIT 41 EXHIBIT 43

Eight Years of Consecutive Positive Performance for the Despite the Strong Bull Run, 45% of Private Equity Core
S&P 500 Is Highly Unusual; We Are Now at Eight and Addressable Market As Measured by the Russell 2000 Still
One-Half Years Through June 30th, 2017 Has EV/EBITDA of Less than 10x
# OF CONSECUTIVE EV/EBITDA of U.S. Stocks With EVs of
YEARS OF POSITIVE CUMULATIVE $500mm-$5bn
RETURNS START END RETURN CAGR 45% of R2K has
Negative < 6x an EV/EBITDA
of under 10x
3 1904 1906 67% 19% EBITDA 9%
7%
3 1954 1956 111% 28%
6-8x
3 1963 1965 60% 17% 16%

3 1970 1972 40% 12%

4 1942 1945 143% 25%

>10x
4 1958 1961 102% 19% 8-10x
49%
20%
5 2003 2007 83% 13%

6 1947 1952 148% 16%

Enterprise Value to next twelve months estimated EBITDA, based on
8 2009 2016 194% 20%
consensus EBITDA estimates per Bloomberg. Universe = 1,070 Russell
3000 stocks with EVs of $500 million - $5 billion and EBITDA estimates
8 1921 1928 435% 23% available in Bloomberg. Data as at June 7, 2017. Source: Bloomberg, KKR
Global Macro & Asset Allocation analysis.
8 1982 1989 291% 19%

9 1991 1999 450% 21% Importantly, though, we just do not see the leverage in the system to
argue for a major, broad-based recession in the U.S. (Exhibits 44 and
AVG. CAGR 19% 45). Rather, we think that we are entering peak margin season for
corporations at a time when low-end consumers appear to be strug-
Cumulative total return on an annual basis. Data as at December 31,
2016. Source: http://www.econ.yale.edu/~shiller/, Bloomberg.
gling, despite robust employment growth. We are not sure, but lack
of productivity may have driven corporations to employ more but pay
less, a backdrop that we think is not ideal when profits are histori-
EXHIBIT 42 cally high this late in the cycle.

Private Equity Typically Outperforms in Lower Return Another important part of the where are we in the cycle story
Environments revolves around the currency, the U.S. dollar in particular. Our base
view continues to be that the U.S. dollar is in a near-term lull before
U.S. Private Equity Average Relative Returns in its last rally, likely driven by a U.S. recession in 2019. From a valu-
Various Market Environments, % ation perspective, the U.S. dollar now appears overvalued on a real
effective exchange rate basis while most other currencies are either
11.6
10.2 undervalued or close to fair value, suggesting the longer-term trend
6.3
is in favor of a weaker U.S. dollar (Exhibits 46 and 47).

Driven by factors such as
increased activism amidst
< 0% 0-10% 10-20%
-7.5
> 20%
declining returns on equity in
S&P 500 Total Return
foreign markets, we see many
U.S. Private Equity returns as per Cambridge Associates. Data based
CEOs now striving to better
on annual returns from 1989-2016. Source: Cambridge Associates,
Bloomberg, KKR Global Macro & Asset Allocation analysis.
simplify their global footprints.

KKR INSIGHTS: GLOBAL MACRO TRENDS 21

EXHIBIT 44 tum. By comparison, developing markets are just emerging from the
bottom of the cycle, and Europe still has more to go in the current
We Envision an Economic Drawdown Closer to 2001
economic cycle, which would suggest funds flowing away from the
Than 2009 in Terms of an Overall Growth Slowdown U.S. Finally, the Federal Reserve now seems more cautious about
0% unwinding its balance sheet at a time when the current Republican
administration is less likely to able to pursue as ambitious of an
-5% agenda in areas like Border Tax adjustability.
Peak-to-Trough Real S&P 500 EPS

-10%
EXHIBIT 46
-15%
Global Imbalances Have Narrowed, Which Suggests Less
-20%
Misalignment of Global Currencies
-25% 2001
Current Account as a % of GDP
-30% 1991

-35% U.S. Latam** Europe *

Germany Oil Exporters Japan
-40% China & ASEAN Rest of World
-45% 2009
-50% 2 B
-5% -4% -3% -2% -1% 0%
1
Peak-to-Trough Real GDP
Data as at May 31, 2015. Source: KKR Global Macro & Asset Allocation 0
analysis.
-1

-2
EXHIBIT 45

We Forecast a Mild U.S. Recession in 2019, With -3

97 99 01 03 05 07 09 11 13 15 17
Attributes More Similar to 2001 Than 2007
Oil exporters include Middle East & North African countries, Netherlands,
U.S. Real GDP, Y/y, % Norway, Nigeria, Russia and Venezuela. * Europe includes all European
Union countries except Germany, Netherlands, and Norway which are in
Recession Real GDP other categories. ** Latam includes all of Latin America & the Caribbean
10% ex-Venezuela which is under Oil Exporters. Data as at April 18, 2017.
Source: IMF, Haver Analytics.
8%

6%

4%

2%

0%
-2%
Though it may not feel this way
to some, we are actually now
-4%
80 85 90 95 00 05 10 15 20 96 months into an economic
Data as at May 31, 2015. Source: Bloomberg, KKR Global Macro & Asset expansion in the United States.
Allocation analysis.
Our base view is that the
expansion continues through 2018,
Second, with the bulk of the political headwinds in Europe passed,
the euro is likely to remain reasonably strong against the U.S. dol- and then we run into a soft patch
lar, in our view. This viewpoint could be significant for markets, as
the euro makes up approximately 20-60% of most trade weighted
of economic growth thereafter.
currency indexes that many investors follow. Third, from a cyclical
perspective, the U.S. is late cycle and growth is likely to lose momen-

22 KKR INSIGHTS: GLOBAL MACRO TRENDS

EXHIBIT 47 EXHIBIT 48

In Addition, the U.S. Dollar No Longer Appears Rate of Returns for FDI Are Declining in Many Areas of
Undervalued on a Real Effective Exchange Rate Basis the Global Economy
Real Major Trade-Weighted US Dollar REER: Rate of Return on Outward Foreign Direct Investment, %
% Over (Under) Valued
US UK Germany Netherlands
Mar-85 16%
40% 40.8% Commodity
ASEAN
Crisis, Feb-02 Producer Crisis 14%
30% Russian 24.8%
Latam Default 12%
Dec-16
Crisis
20% 16.6% 10%
+1W
Jun-17 8%
10% 13.5%
Avg 6%
0%
4%
1W
-10%
2%
Oct-78
-20% -11.8% Jun-95 Jul-11 0%
-15.9% -16.9% 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15
-30%
70 75 80 85 90 95 00 05 10 15 20 Data as at December 31, 2016 or latest available year. Source: National
Statistics, OECD.
Data as at June 28, 2017. Source: Federal Reserve, Bloomberg, Haver
Analytics.
EXHIBIT 49

Local and Regional Competitors Are Increasingly

Section II: Key Themes/Trends Update Challenging the Returns of Multinational Firms
In the following section we detail several key investment themes that Top 500 Global Companies Return on Equity, LTM as at 2016, %
we think can create differentiated alpha for long-term investors. They
Multinational Firms Local Firms
are as follows:
Technology
De-conglomeratization: Corporates Shedding Assets Is Yielding
Results Across Energy, Infrastructure, and Private Equity, we are Other Consumer
seeing a notable acceleration in divestitures and carve-outs from
the multinational community. In our view, this idea is a big one; it is Industrial
global, and it has duration. It also reflects a push by more activist
investors for management teams to optimize their global footprints, Cyclical Consumer
particularly as domestic agendas take precedence over global ones. Utilities
Central to this story is that, as we show in Exhibits 48 and 49, respec-
tively, returns are falling for many multinational companies. All Sectors

Financial

Diversified

Basic Materials

Media & Communciations

Energy
Our base view continues to be -5% 0% 5% 10% 15% 20% 25%
that the U.S. dollar is in a near- Data as at January 31, 2017. Source: National Statistics, OECD, The
term lull before its last rally, likely Economist.

driven by a U.S. recession in 2019.

KKR INSIGHTS: GLOBAL MACRO TRENDS 23

EXHIBIT 50 below two percent. Finally, as we show in Exhibit 51, enterprise value
to EBITDA multiples in Japan are still below historical averages, a
Investors Can Now Look to the More Mature Economies
setup that we cant find in many other markets around the world.
as Funding Sources, Particularly in Todays Slower
Growth World We also note that we are seeing a lot of corporate streamlining occur-
ring outside of the traditional multinational sector. Indeed, after several
DEPOSITS AS A % OF GDP
% OF GDP IN LOCAL CURRENCY TERMS
quarters of inactivity, we are finally seeing U.S. energy companies
rightsizing their footprints, as Wall Street encourages many of the com-
INDONESIA 29.8% panies to shed slower growth assets in favor hot shale basins. While
this activity may not necessarily be long-term bullish for the stocks
PHILIPPINES 43.1% of publicly traded energy companies, it is creating significant, near
KOREA 72.8%
term value-creation opportunities for the buyers of these properties
(Exhibit 52), particularly for players with expertise in the production
THAILAND 87.5% and midstream segments of the oil and gas markets. Also, within the
Infrastructure sector, we have seen a notable number of divestitures of
JAPAN 135.5% hard assets in recent quarters. From our perch, it appears that Europe
SINGAPORE 137.1%
has emerged as the most active region for Infrastructure carve-outs,
but trend lines in both the United States and Asia are firming too.
CHINA 196.6% Importantly, this carve-out opportunity in Infrastructure is in addition to
the some of the structural increases in infrastructure investment that
HONG KONG 219.4% we think will occur as governments rely more on fiscal spending than
Data as at December 31, 2015. Source: Respective national statistical
monetary spending to bolster growth in the years ahead.
agencies, JPMorgan.
EXHIBIT 52

We Believe That Private Energy Assets Often Offer Less

EXHIBIT 51 Beta and More Alpha Than Pure Commodity Assets
Complex Corporate Structures Amidst Compelling
CHARACTERISTICS VS. GSCI ENERGY SPOT INDEX: 1Q05 - 4Q16
Valuations Make Japan an Interesting Play on Our
Corporate Carve-Out Thesis GSCI
Private Public Spot
14 Japan EV-to-EBITDA Stocks Bonds Cash Energy Energy Energy

13 CORRELATION 51% 7% 4% 74% 77% 100%

12
ALPHA VS. SPOT
+1W 5.4 3.1 1.5 11.6 6.2 0.0
11 (ANNUALIZED)

10 Jun-17
Avg 9.0 BETA VS. SPOT 0.2 0.0 0.0 0.3 0.5 1.0
9
Data as at December 31, 2016. Source: Bloomberg, Cambridge Associates.
8
-1W
7
6
5
01 03 05 07 09 11 13 15 17
Data as at June 28, 2017. Source: Factset Aggregates.

At the moment, Japan has emerged as one of the most compelling
50% of the total margin expansion
pure play examples on our thesis about corporations shedding non- since 2009 has come from just
core assets and subsidiaries. Without question, the macro backdrop
is compelling for at least three reasons. First, many of Japans
the Technology sector, with Apple
largest companies have literally hundreds of subsidiaries that could accounting for a full 20% of total
be deemed non-core, and as corporate governance and shareholder
activism gain momentum, they are increasingly being identified as margin expansion during this
potential sources of value creation. Second, the deposit to GDP ratio same period.
is 135.5% (Exhibit 50), underscoring that banks are hungry to lend to
acquirers of these subsidiaries. In many instances, a private equity
firm can get at least 7x leverage, with an all-in cost of funds that is

24 KKR INSIGHTS: GLOBAL MACRO TRENDS

EXHIBIT 53 EXHIBIT 55

The Lions Share of Rig Count Growth by Basin Over the Interest by European Investors Towards Infrastructure Has
Past Year Has Been All Permian Generally Increased in Recent Years
Operating Rig Count, Oil European Infrastructure Investors Level of Focus for
May-16 = 100 Investments by Region, 2016
1 = Not Under Consideration 5 = Significant Focus
125 Permian Bakken
2010 2016
Eagle Ford Niobrara
120
Western Europe
115 South East Asia
North America
110
Middle East
105 India
Eastern Europe
100
Mar-17 China
Nov-16

Apr-17
Oct-16

Jan-17
May-16

Feb-17
Aug-16
Jul-16

Sep-16

Dec-16
Jun-16

Central / South America

Data as at May 26, 2017. Source: Bloomberg. Australasia
Africa

EXHIBIT 54 -1 1 3 5

U.S. Upstream Activity Has Focused on Streamlining, Data as at 2016. Source: Deloitte European Infrastructure Survey 2016.
With Many Energy Companies Selling Assets to
Reposition Their Portfolios for Faster Growth Experiences over Things While this theme is not a new one for us, the
pace of implementation appears to have accelerated in recent months.
U.S. Upstream Transactions: Deal Value and
Count by Year, US$ Billions Importantly, as we describe below, we do not think that the trend
towards experiences is just the Amazon effect. Rather, we believe
Deal Value Deal Count that key influences such as increased healthcare spending, heightened
$120 500 rental costs, and rising telecommunications budgets (e.g., iPhones)
385 442 450 are leaving less and less discretionary income for traditional items,
$100 400 particularly mainstream retail. One can see this trend in Exhibit 56.
$98
$80 285 350
300
$60 $69 250
$40
200 Given that global central bank
150
$20 $32 100 balance sheets have expanded
50 by $14 trillion in recent years, we
$0 0
2015 2016 2017 YTD continue to find examples around
(Actual Thru
May 31, the world in both equities and
Annualized)
debt where investors appear to be
Data as at May 2017. Source: PLS.
over-paying for quality assets but
are not willing to pay fair price
for assets that may have stumbled
and/or require some fixing to
achieve their potential.

KKR INSIGHTS: GLOBAL MACRO TRENDS 25

EXHIBIT 56 Recent trips to continental Europe as well as Asia lend support to
our view that this trend towards experiences is global in nature and
Disposable Income Available for Traditional Things Is
cuts across a variety of demographics. For example, in Japan and
Waning At a Time of Significant Change in Consumer Germany aging demographics are boosting the use of later stage
Spending healthcare offerings, while younger individuals in the U.S. are em-
bracing more health, wellness and beautification. Meanwhile, in the
Share of Consumer Wallet as a % of Total Spend and Total Retail
emerging markets we continue to see demand for basic healthcare
Tech/Telco/Media as a % of Ttl Spend (LHS) offerings, including private insurance and specialized surgery care,
Rent as a % of Ttl Spend (LHS) especially in fast-growing consumer markets such as Brazil, China,
Healthcare as a % of Ttl Spend (LHS)
Brick & Mortar as a % of Ttl Retail (RHS) Indonesia, and India.
32% 100%
Importantly, the trend towards services extends well beyond just
30% 99% the Healthcare sector. Recreation, travel, and leisure all appear to be
market share gainers versus basic things that consumers tradition-
28% 98% ally bought with their disposable income. Moreover, consumers are
26% 97% more willing to use the Internet to price shop, making them more
fickle in some instances.
24% 96%
EXHIBIT 58
22% 95%
Core Core Goods Are in a State of Secular Deflation
20% 94%
'Core Core' Goods CPI Y/y,%
18% 93%
3.0
16% 92%
00 02 04 06 08 10 12 14 16 2.0
Data as at December 31, 2016. Source: Bureau of Economic Analysis,
1.0
KKR Global Macro & Asset Allocation analysis.
0.0

EXHIBIT 57 -1.0
May-17
The Trend Towards Greater Spending on Experiences Is -2.0 -1.6
Accelerating in Europe Too
-3.0
EU Consumer Spending Breakdown, Volume
Index, 1995= 100 -4.0
Apr-08

Apr-15
Apr-01

Aug-10
Dec-98
Feb-00

Aug-03

Dec-05
Oct-04

Jun-09

Oct-11
Feb-07

Dec-12
Feb-14
Jun-02

Jun-16
160 Experiences Other Spending

150 Core core goods = Goods inflation ex-food, energy goods, healthcare
goods, and tobacco. Data as at May 31, 2017. Source: Bureau of Labor
1 Percentage Point Statistics, Haver Analytics, KKR Global Macro & Asset Allocation analysis.
140
of Outperformance
per year
130

120
A more ominous conclusion is
110 that, because this cycle has been
100 defined by adding employees and
not boosting productivity in recent
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

Experiences Includes Recreation & Culture, Oth Recr Items & Equip,
years, we now have an excess of
Gardens & Pets, Package Holidays, Restaurants & Hotels, Personal Care,
Personal Effects n.e.c. Data as at December 31, 2016. Source: Eurostat,
employees in the workforce relative
Haver Analytics, KKR Global Macro & Asset Allocation analysis. to long-term growth potential.

26 KKR INSIGHTS: GLOBAL MACRO TRENDS

EXHIBIT 59 EXHIBIT 60

...Driven by Negative Pricing Across Many Traditional Chinese Millennials Not Only Save Less But Also Allocate
Goods Three Times More of Their Income to Leisure
U.S. CPI Ination, Y/y, % Spending Breakdown China Overall vs. Chinese Millennials

Textbooks 2.4 Leisure Shopping, Non-Food

Books & Magazines 1.7
Shopping, Food Housing, Transport, Utilities
Alcohol 1.0
Pet Supplies -0.7
100%
Most goods categories
Stationary -0.8 9%
Apparel are in deation -0.9 14% 30%
Vehicles & Parts -1.3 80%
Personal Care Products -1.3 28%
60% 16%
Houshold Furnishings -1.4
Ttl. 'Core Core' Goods Ination -1.6 16%
40%
Sporting Goods -3.2
Baby Supplies -4.9 49%
20% 37%
Computers, Software, and Pers Tech -5.6
Toys & Games -7.8 0%
AV Electronics -10.2 China Overall Chinese Millennials

Core core goods = Goods inflation ex food, energy goods, healthcare Data as at December 31, 2016. Source: Goldman Sachs Global Investment
goods, and tobacco. Data as at May 31, 2017. Source: Bureau of Labor Research.
Statistics, Haver Analytics, KKR Global Macro & Asset Allocation analysis.

EXHIBIT 61
The downside of the environment we are describing is that many The Trend of Experiences Over Things May Force Tough
traditional retailers, malls, and product providers are likely to see Decisions in the U.S. Brick and Mortar Community
waning demand for their offerings. Moreover, pricing power in many
areas of the goods market is negative. All told, goods inflation has Retail Square Feet and Sales per Capita
been negative on a year-over-year basis for the past 16 consecu-
Retail Square Feet per Capita, LHS
tive quarters and negative for 50 of the last 69 quarters since 2000
(Exhibit 58). These trends are noteworthy, because as we show Retail Sales per Capita, USD Billions, RHS
30 $16,000
in Exhibit 61, a lot of infrastructure has already been built to support $14,623
$14,000
consumer expenditures. As a result, if we are right that the shift 25 24
towards experiences over things is more secular than cyclical (which $12,000
we believe it is), many companies across the global supply chain may 20 $10,557
$9,628 $10,000
need to reconsider their existing footprints to better accommodate 16 $9,169
15 $7,921 $8,000
the preferential shifts that we are highlighting. $6,003
11 $6,378 $6,000
10
$3,065 $4,000
5
5 4 4
3 2 $2,000

We believe that key influences 0 $-

U.S.

China
Japan
Canada

Germany
Australia

France
U.K.

such as increased healthcare

spending, heightened rental costs, Data as at December 31, 2016. Source: ICSC Country Factsheets, Green
and rising telecommunications Street Advisors.

budgets (e.g., iPhones) are leaving

less and less discretionary income
for traditional items, particularly
mainstream retail.

KKR INSIGHTS: GLOBAL MACRO TRENDS 27

Emerging Markets over Developed Markets As we indicated in our EXHIBIT 62
2017 outlook, our quantitative model is turning more positive on Pub-
It Has Been a Long, Hard Road in EM
lic Equity Emerging Markets. Higher real rates, smaller deficits, less
institutional sponsorship, and more stable currencies all lead us to Relative Total Return, MSCI EM/DM
believe that Emerging Markets as an asset class are bottoming. This (Dec-'87 = 0%)
viewpoint is consistent with what we laid out in our October 2016
Insights Asia: Pivot Required. This insight is significant, as periods of
350% Sep-10
emerging market outperformance tend to extend for multiple quarters 81 Sep-94 305%
(Exhibit 62). months 288% 108 81
300% months months
Importantly, when we do a simple Dupont analysis to decompose 84
return on equity, our work shows that operating margins are finally 250% months
improving across all of EM, which is now boosting return on equity.
200%
While the margin increase is broad-based by region, commodity re- Jun-17
lated companies are driving the lions share of the increase, reinforc- 137%
150%
ing our earlier point that commodity prices must at least stabilize at
current levels for our EM dashboard to remain positive. Meanwhile, 100%
financial leverage across EM is declining, while asset turnover re- Sep-16
mains essentially unchanged in recent quarters. 135%
50%
Sep-01
To our surprise, one area that has actually turned down since our 17%
0%
last check-in in August 2016 is momentum. Our belief is that the 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17
momentum pullback is more of a temporary blip around the Brazil
political situation, but we will be watching the situation closely. In the Data as at June 30, 2017. Source: Factset, KKR Global Macro & Asset
past, the momentum pullback has helped to boost flows from non- Allocation analysis.
dedicated EM managers, which is often critical to boosting returns
over the cycle. Given the strength of our model and the importance
of this input, we think that it will be critical for this variable to turn EXHIBIT 63
up again if we are to be right on our call that we are on the cusp of
experiencing a secular turn in relative performance of EM. But Our Work Shows That EM Is Bottoming
RULE OF THE CURRENT
In addition to the more positive attitude we have been sharing about
ROAD MAY15 JAN16 AUG16 SIGNAL
certain EM Public Equities, we are also more constructive on local
debt, including both sovereign (as reflected by our earlier shift out of Buy When ROE Is
100% developed market sovereign debt towards areas like Mexico,
1
Stable or Rising
Indonesia, and India) and corporate fixed income securities. Indeed,
Valuation: Its Not
with the U.S. dollar now above what we believe is fair value, EM cur- 2 Different This
rencies are likely to perform better. Moreover, many EM governments Time
and companies have pared back some of their excessive spending,
which all else being equal increases the potential for debt repay- EM FX Follows
3
EM Equities
ment. One can see the magnitude of the improvement in corporate
behavior of late in Exhibit 64. Commodities
4 Correlation in EM
Is High

Momentum
5 Matters in EM
Equities

Despite the threat of deregulation
in financial services in the U.S., Overall
Early-stage re-
covery is starting
we still view the illiquidity to unfold
EM valuation and ROE have turned supportive.
The recovery could prove bumpy at times until
fundamentals such as FX and the commodity
backdrop offer more definitive support, but on net,
the outlook has improved

premium as compelling, Data as at June 28, 2017. Source: KKR Global Macro & Asset Allocation
particularly in todays low interest analysis.

rate environment.

28 KKR INSIGHTS: GLOBAL MACRO TRENDS

EXHIBIT 64 that many pensions and insurance companies face today. As a result,
Private Credit as an asset class remains one of our largest non-
Free Cash Flow Is Up Across EM
benchmark weightings.
Emerging Market Capex-to-Sales and Free
EXHIBIT 66
Cash Flow Yield
14% 7% The Illiquidity Premium Has Remained Fairly Constant
EM Capex to Sales, %, LHS
EM Free Cash Flow Yield, %, RHS Across a Variety of Environments
13% 6% Illiquidity Premium
Weighted Average Yield of Originated Senior Term Debt
12-Month Average Yield of Traded Loans
12% 5%
12.0%
11.2% 11.4%
10.8%
11% 4%
9.7% 9.6%
11.3%
10.7% 8.6% 8.3%
8.2% 8.5%
10% 3% 7.8%

8.3%
5.8% 5.8% 6.0% 5.5%
5.9%
5.5%
9% 2% 5.0%
5.1% 4.9%

3.9% 3.6%
3.3%
2.9% 2.7% 3.0% 2.7% 2.8%
8% 1% 2008, 2.8%
00 02 04 06 08 10 12 14 16
0.7% 0.7%
E= Credit Suisse Research Estimate. Data as at May 31, 2017. Source:
Credit Suisse HOLT, Credit Suisse Research.
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Q1
2017

Data as at March 31, 2016. Source: Bloomberg, Ares company filings,

EXHIBIT 65
KKR Credit analysis.
Within EM Debt, We Generally Favor Local Currency
Across Both Sovereign and Corporate
EXHIBIT 67
10-year Government Bond Yield, Local Debt, %
and a Variety of Private Credit Markets
Illiquidity Premium
Germany
Canada Wgtd Avg Yield: Originated Senior Subordinated Term Debt
AAA 12-Month Average Yield of US Traded High Yield
Singapore
Australia
14.9%
14.5%
UK 13.7% 13.6%
13.2%
Korea AA and
US 11.9% 11.6% 11.7% 12.0% 11.9%
11.2%
Malaysia 13.3% 13.5%

Spain 8.6%
8.1%
Italy 7.5% 7.3% 7.6%
7.0% 6.5% 6.8%
India 6.5% BBB 8.5% 6.2%
Indonesia 6.8% 5.1% 5.0% 5.1%
4.7% 5.0%
Mexico 6.8% 4.4% 4.4%
2008, 4.2% 3.8%
Russia BB
1.6%
Brazil
0.2%
-1% 1% 3% 5% 7% 9% 11%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Q1
Data as at June 22, 2017; Source: Bloomberg. 2017

Data as at March 31, 2016. Source: Bloomberg, Ares company filings,

KKR Credit analysis.
Fixed Income Illiquidity Premium In todays low rate environment
we continue to migrate towards securities that harness the 2.5-3.5%
illiquidity premium that we now believe is available across many
parts of Private Credit. Without question, in a world where risk free
rates are still close to zero in many instances, we think that this ad-
ditional cushion is important for overcoming the mounting liabilities

KKR INSIGHTS: GLOBAL MACRO TRENDS 29

However, we do continue to shift our portfolio within Private Credit. On the other hand, we see a growing opportunity within the Asset-
Specifically, similar to what we did at the beginning of the year, we Based Lending part of the market. Central bankers in Europe now
are again dropping our Global Direct Lending allocation to a 500 understand that yield curve steepness is of paramount importance,
basis point position, down from 800 basis points in January and and with rising stock prices, we have seen a flurry of performing as-
1000 basis points last year. Strong technicals amidst sluggish supply sets coming off bank balance sheets (Exhibit 69). We have also seen
are driving a wider array of yield hungry allocators of capital towards more opportunities either through platforms or joint ventures to
Private Credit products, often rendering terms less attractive than partner alongside local banks in countries such as Ireland, Italy, and
they were 12-18 months ago. Meanwhile, a flood of new capital in the Spain. Given this view, we are topping up our Asset-Based Lending/
low end of the market is compressing spreads somewhat. Mezzanine exposure to 800 basis points from 500 basis points in
January and 300 basis points in 2016.
EXHIBIT 68

Foreign Banks Have Pulled Back from Indonesia, Creating Separately, we also see an emerging trend no pun intended in
Opportunities in Certain Instances for Private Credit many of the emerging markets that we have visited in recent quar-
ters. Indeed, as we show in Exhibit 70, more and more corporates in
Loans By Foreign/Joint Venture Banks in places like India and Indonesia are shifting from traditional financial
Indonesia as a % of GDP intermediaries in favor of complex solutions that can be underwritten
Sep-15 by leading private credit players.
16%
EXHIBIT 70
15%
Emerging Market Private Credit Is Increasingly Another
14% Interesting Play on Our Illiquidity Premium Thesis
13% Yields as at June 22, 2017, %

12% Mar-17 Indonesia: Struct.USD Loans 15 18

13% India: High Yld INR Loans 14 18
11%
Mezzanine (Unlevered) ~12
10% India: Perf. INR Bank Loans 10 12
Mar-15
Mar-10

Mar-11

Mar-13
Sep-12

Sep-14

Sep-16
Mar-17
Mar-12

Mar-14

Sep-15
Sep-10

Sep-11

Mar-16
Sep-13

Indonesia: Perf. IDR Bank Loans 9 12

US: Direct Lending (Unlevered) 7 10
Indonesia: Govt Bond 10 Yr. 6.8
Data as at March 31, 2017. Source: Badan Pusat Statistik, Haver Indonesia: Perf. USD Bank Loans 58
Analytics.
India: Govt Bond 10 Yr. 6.5
EM High Yield 6.3
EXHIBIT 69 US High Yield 6.2
Europe: Bank Loans 4.7
Banks Assets in Europe Have Decreased by 22% from
US: Bank Loans 4.4
2.9x GDP to 2.3x Since the Great Financial Crisis
Indonesia: USD Govt 10 Yr. 3.6
EZ Banking System Total Assets to GDP Ratio US: Investment Grade 3.6

2.9 China: Gov 10 Yr. 3.6

US: Govt Bond 10 Yr. 2.1
Germany: Govt Bond 10 Yr. 0.3

2.7 Japan: Govt Bond 10 Yr. 0.1

2.6 Data as at June 22, 2017. Source: Bloomberg, KKR Estimates.

2.6 2.6

Finally, given our 300 basis point overweight to Energy Assets/In-

frastructure, we did want to highlight that we view this cash flowing
2.4
sector as a back-door play on both our Illiquidity Premium and Yield
2.3 2.3 and Growth thesis. Importantly, for those concerned about where we
2.3 are in the economic cycle, Infrastructure credit performed notably
better than many traditional credit products, both public and private,
2008 2009 2010 2011 2012 2013 2014 2015 2016
during the last economic downturn.
Data as at December 31, 2016. Source: European Central Bank, Haver
Analytics.

30 KKR INSIGHTS: GLOBAL MACRO TRENDS

Embrace Complexity/Dislocation Simply stated, we want to buy
capital markets dislocations that are increasingly occurring around
amongst other things geopolitical tensions and/or perceived
changes in monetary policy. It might not feel this way right now, but
since 2011 the VIX has increased by 50% or more over eight percent
of the trading days, compared to an historical average of around
4.9% during the pre-crisis period.
EXHIBIT 71
Post the Global Financial Crisis, Volatility Spikes Have
Become the Norm
% of Trading Days When VIX was up 50%+, Y/y
Given that global central bank balance sheets have expanded by
$14 trillion in recent years, we continue to find examples around
the world in both equities and debt where investors appear to be
over-paying for quality assets but are not willing to pay fair price for
assets that may have stumbled and/or require some fixing to achieve
their potential. Within public equities, we currently think that certain
MLPs appear attractive (Exhibit 75). Our work shows that this asset
class is one of the few high yielding asset classes that have not com-
pressed with the dramatic decline in interest rates that we have seen
in recent years. To be sure, there are some broken business models
in the sector (particularly roll-up stories), but we have also been able
to find some cheap cash-flowing assets that we believe will create
substantial long-term value for shareholders.

EXHIBIT 73
8.2%
The Wide Range of Equity Performance Has Created
Significant Opportunities to Both Buy and Sell
4.9%
S&P 500 Price Return, 12-Month % Change

50%
40%
30%
Apr'03-Sep'07 Apr' 09-Current +1stdev
20%
Equity Market Expansion Cycles
10%
Data as at June 28, 2017. Source: CBOE, Bloomberg, KKR Global Macro Avg.
& Asset Allocation analysis. 0%
-10%
-1stdev
EXHIBIT 72 -20%

Global QE Has Been Significant. We See a Shift From -30%

Monetary Stimulus Towards More Fiscal Stimulus Ahead -40%

Central Bank Balance Sheet as a % of GDP -50%

'17
'12

'14
'07

'16

'18
'02

'04

'15
'06

'08

'10
'11

'19
'05

'09

'13
'03

100 Fed ECB BoJ

Dec-16 Data as at June 28, 2017. Source: Bloomberg, KKR Global Macro & Asset
90 Allocation analysis.
89
80
70
60
50
40
34

30
20
24 Across Energy, Infrastructure,
10 and Private Equity, we are
0
06 07 08 09 10 11 12 13 14 15 16 17 seeing a notable acceleration in
Data as at December 31, 2016. Source: European Central Bank, Bank of divestitures and carve-outs from
Japan, Federal Reserve.
the multinational community. In
our view, this idea is a big one; it
is global, and it has duration.

KKR INSIGHTS: GLOBAL MACRO TRENDS 31

EXHIBIT 74 On the debt side, we note that many areas of the traditional liquid
markets appear expensive. One can see this in Exhibit 74, which
Given the Flight to Quality, Individual Credit Picking and
shows that many parts of the credit markets, high yield in particular,
Understanding Relative Value Across All Spread Assets in are trading well inside of their historical norms (e.g., BB spreads less
a More Concentrated Way Can Add Material Alpha BBB spreads, B spreads less BB spreads). By comparison, parts of
the CCC universe for loans actually look quite interesting relative to
% Above / Below 25-Year Median Credit
Spread in the Developed Markets the B sub-segment of the market. To be sure, not every CCC credit is
worthy of investor attention, but we do believe that looking for these
30% types of anomalies does make sense in a market that generally does
Bonds Loans
not offer that much relative value, in our view.
20%
Section III: Risks to Consider
10%
In terms of risk on which to focus, we think the following consider-
0%
ations are worthy of investor attention.
-10%
Potential U.S. Consumer Disconnect While aggregate statistics by the
-20% government for the U.S. consumer are reporting record low unem-
ployment amidst surging household net worth, we have come to an
-30% increasingly more conservative outlook for the U.S. consumer, partic-
ularly at the low end of the market. Key to our thinking is that, as we
-40% show in Exhibit 76, basic household expenses continue to increase
faster than overall wages, which is a growing issue for the large seg-
Overall Index

Overall Index
BB-BBB

B-BB

B-BB
CCC-B

CCC-B

ment of the U.S. market that has not built net worth in recent years.
Moreover, debt loads in areas such as student lending and autos has
crept up to what we view as concerning levels. Sub-prime credit
cards too should be an area of investor focus, in our view. How else
Data as at February 28, 2017. Source: Credit Suisse.
can one explain rising auto defaults that now approximate 2007 lev-
els with unemployment below the natural rate of employment?
EXHIBIT 75 EXHIBIT 76

There Are Very Few Asset Classes Offering Above Healthcare and Shelter Inflation Have Largely More Than
Average Yields. MLPs Are Currently One of Them Offset Any Acceleration in U.S. Wage Growth
+/-One StDev 10yr Avg. Current U.S. Wage Growth vs. Healthcare and Shelter
13 Ination, Y/y, % Change
MLPs are One of Few
12 Assset Classes that Currently
11 Oer Above-Average Yields
4.0%
10 3.5%
9 3.5%
Indicated Yield

3.1%
8
7 3.0%
2.5%
6
5 2.5%
4 2.0%
3
2 1.5%
1
0 1.0%
MLPs

Bbg NA REIT
Index

DJ Dividend
Index

Leveraged
Loans

US High
Yield

US
Corporates

EM
Sovereign

EM
Corporates

0.5%
0.0%
Wage Growth Healthcare Shelter Ination
Ination
Averages and standard deviations based on 10-year history from June
2007 - June 2017. Data as at June 9, 2017. Source: Bloomberg, KKR Data as at April 30, 2017. Source: Strategic Insight, SimFund, BofAML
Global Macro & Asset Allocation analysis. Global Research.

32 KKR INSIGHTS: GLOBAL MACRO TRENDS

EXHIBIT 77 EXHIBIT 79

21-34 Year Olds Likely Make Up the Greatest Share of 60-Day Plus Delinquencies in the U.S. Are Up Across
U.S. Consumer Default Risk Over the Next 12 Months Prime and Subprime, With the Latter Approaching Global
Financial Crisis Peak Levels
21-34 Year Olds Consumer Debt as % of GDP
(Population Adjusted) U.S. Prime and Subprime 60+ Day Deliquencies
4.5%
Prime (LHS) Subprime (RHS)
Credit Cards
4.0% 0.8% Crisis Peak 6%
Auto Loans 0.78%
3.5% Student Loans 0.7%
Crisis Peak 4.47% 5%
0.6% 4.69%
3.0% 0.53%
4%
2.5% 0.5%
0.4% 3%
2.0%
0.3%
1.5% 2%
0.2%
1.0% 1%
0.1%
0.5%
0.0% 0%

2007

2012

2014
2006

2008

2016
2010
2011

2015
2009

2013
0.0%
'89 '92 '95 '98 '01 '04 '07 '10 '13 '16
Data as at December 31, 2016. Source: Bloomberg. Data as at March 24, 2017. Source: Federal Reserve Board, Morgan
Stanley Research.

EXHIBIT 78
EXHIBIT 80
We Believe U.S. Auto Companies Have Moved Down the
Credit Quality Ladder to Sustain Growth Americans Under the Age of 35 Now Hold the Largest
Percentage of Non-Mortgage Debt
Consumer Credit Outstanding: Motor Vehicle
1200 Loans (EOP, NSA, US$ Billions) Estimated Total Consumer Debt ex-
Mortgages by Age, %
1000 35%

800
26%
600

400
16%
14%
200

0 7%
Mar-08
Mar-98
Mar-00

Mar-10
Mar-90

Mar-02
Mar-04

Mar-12
Mar-14
Mar-92
Mar-94

Mar-06

Mar-16
Mar-96

2%

Data as at March 7, 2017. Source: Federal Reserve Board. < 35 3544 4554 5564 6574 >=75
Data as at December 3, 2016. Source: Federal Reserve Board.

If there was one take-away from
the Global Financial Crisis, it was
to follow the leverage.

KKR INSIGHTS: GLOBAL MACRO TRENDS 33

EXHIBIT 81 EXHIBIT 82

The Unemployment Rate and Education Levels Go Hand- Unemployment Has Dipped Slightly Below Its Natural
in-Hand Rate (NAIRU)
2016 Unemployment Rate and Earnings by U.S. UnemploymentRate
Educational Attainment % Above/(Below) Natural Rate of Unemployment
5
Median Typical Weekly Earnings, US$
Unemployment Rate 4
$1,800 $1,664 7.4% 8%
$1,600
3
7%
$1,380
$1,400 6% 2
$1,156
$1,200 5.2%
4.4% 5% 1 1Q97
$1,000 $819
$756 4% 4Q63 1Q17
$800 $692 0
3.6% 3%
$600 2.7% $504
$400 2.4% 2% -1 1Q78 2Q05
1.6% 3Q87
$200 1%
-2
$0 0%
-3
Doctoral Degree

Master's Degree

Bachelor's Degree

Associate's Degree

Some College,
No Degree

High School Diploma

Less Than a High

School Diploma

1Q81

1Q88

1Q95

1Q09
3Q91

3Q98

3Q05
1Q74
1Q67

3Q77

1Q02
1Q60

3Q70

3Q84

3Q12
1Q16
3Q63
Data as at May 7, 2017. Source: Bureau of Labor Statistics, Congressional
Budget Office, KKR Global Macro & Asset Allocation analysis.

Data as at December 31, 2016. Source: Bureau of Labor Statistics.

EXHIBIT 83

Real Unit Labor Costs May Already Have Peaked This

To be sure, we do not see the leverage in the system that brought Cycle
about the mortgage crisis in 2007. However, we do wonder whether
any slowdown in employment could portend a notable slowdown in Eight Quarter Average of Real Unit Labor Cost,
not only consumer spending but also meaningfully impact consumer 1980-2017
delinquency trends. As we mentioned earlier, corporate margins Recession
appear full at time when employment is below its natural rate of Real Unit Labor Cost* (8-quarter average)
unemployment (Exhibit 82). At the same time, productivity has been 1.0%
lagging. Said differently, productivity is now growing slower than
0.5%
wage growth, so that the marginal benefit of adding employees to
growth has essentially disappeared (Exhibit 83). 0.0%
-0.5%
-1.0%

-1.5%

Our base view is that investors -2.0%

must focus on those select areas -2.5%

where a manager can gain what -3.0%

is believed to be an advantage -3.5%

'80 '83 '86 '89 '92 '95 '98 '01 '04 '07 '10 '13 '16
in sourcing, operations, strategy, * Real Unit Labor Cost Growth = Wage Growth - Productivity Growth -
and/or execution. He or she must Core Inflation. Data as at March 31, 2017. Source: Bloomberg.

also be looking for investments in A more ominous conclusion is that, because this cycle has been
the right ponds of opportunity. defined by adding employees and not boosting productivity in recent
years, we now have an excess of employees in the workforce relative
to long-term growth potential. This insight is significant because it
could lead to a potentially surprising number of layoffs if corporate

34 KKR INSIGHTS: GLOBAL MACRO TRENDS

earnings growth does slow in the coming quarters. We are watching
this inter-relationship quite closely, as consumer defaults in areas
like autos and cards are increasing in what many view as an attrac-
tive backdrop for U.S. consumers.
Market Flows/Leverage Warrant Investor Attention As has been well
documented in recent years, active management has had a woeful
performance run. According to my colleague Brian Leungs work,
85% of large cap active managers have underperformed their bench-
mark during the last 10 years, while 91% of small cap managers have
suffered a similar fate. Not surprisingly, money has gushed out of
active funds and into passive funds.
EXHIBIT 84
At the same time, robust global Quantitative Easing has reduced
overall sustained volatility. This development is important because it
means that many hedge fund managers are being forced to lever up
to maintain the volatility metrics that they have promised their inves-
tors (Exhibit 85).
In our view, the combination of high leverage and low volatility is not
a good one, particularly at a time in the cycle when index flows are
luring performance chasers into an increasingly select number of
stocks. If history is any guide, any material and sustained increase
in volatility could force the growing number of levered managers to
reduce their gross exposures by selling over-owned index names at
potentially an inopportune time.

Since 2009, Investors Have Poured $1.8 Trillion Into Credit Spreads Are Tight From almost any vantage point, credit
Passive Funds and Redeemed $600 Billion from Active spreads appear tight. Our favorite measure for quantifying potential
over-optimism in the credit markets is to assess the implied default
U.S. Equity Funds
rate that the liquid high yield market appears to be discounting. As
Cumulative Flows to U.S. Equity Funds, US$ Trillions we show in Exhibit 86, the model is currently suggesting an implied
default rate of 0.9%, well below the historical average and a far cry
Passive Active 2.6 from levels seen as recently as 1Q16. In terms of absolute yield lev-
2.5
els, high yield spreads too feel compressed, trading now at 369 basis
2.0 points above the risk-free rate. In the past, this spread has averaged
closer to 580 basis points.
1.5 EXHIBIT 86

1.0 Early Last Year, the Implied Default Rate Increased to

0.8 8.7%. Today, by Comparison, It Is Just 0.9%
0.5
High Yield Implied Default Rate, %
0.0 Implied Default Rate (%) Avg (4.4%)
'96 '99 '02 '05 '08 '11 '14 '17 '20
15
Data as at April 30, 2017. Source: Strategic Insight SimFund, BofAML
Global Research. 13 Oct-02
11 12.0 Feb-16
8.7
9
EXHIBIT 85
7
Volatility Is Now at Its Lows While Equity Long/Short
5
Hedge Fund Gross Leverage Is Near Its Highs
3
Equity L/S Hedge Fund Leverage in Contrast to Volatility
1
US L/S Gross Leverage VIX (RHS) -1 Jun-17
0.9
170% 50 -3
95 97 99 01 03 05 07 09 11 13 15 17
165% 45
40 The high yield spread is the incremental spread investors require to
160%
35 compensate for risk. Based on historical spreads and recovery rates as
155% 30 well as the current high yield spread, we estimate the implied default
150% 25 rate which represents the true underlying credit risk. Data as at June 28,
20 2017. Source: Bloomberg, KKR Global Macro & Asset Allocation analysis.
145%
15
140%
10
135% 5
130% 0
Aug'11 May'17
Data as at May 30, 2017. Source: Morgan Stanley Prime Brokerage,
Bloomberg.

KKR INSIGHTS: GLOBAL MACRO TRENDS 35

EXHIBIT 87 EXHIBIT 88

High Yield Spreads Have Tightened Significantly, and As High Yield Spreads Appear Mispriced Relative to Those
Such, Are Now Well Below Average of Bank Loans at This Point in the Cycle
U.S. High Yield Spread and Average, Basis Points High Yield vs. Leveraged Loan Spread, Basis Points
400
US High Yield Spread (bps) Avg (580 bps)
350
1200
300
Oct-02 Feb-16
1000 1036 Oct-11
250
278bp
876 200
800 Sep-11
150 184bp
100
600
50
400 0
Jun-17
Jun-17
-50 May-13 -41bp
200 -53bp
369 -100
'07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18
0
95 97 99 01 03 05 07 09 11 13 15 17 Data as at June 15, 2017. Source: Bloomberg.

Data as at June 28, 2017. Source: Bloomberg.

EXHIBIT 89

Relative value within and across the high yield asset class also feels High Yield Energy Credit Looks Expensive Relative to
somewhat disconnected with reality. For example, despite being Equities at Current Oil Prices
lower down in the capital structure, high yield spreads are now trad-
ing 41 basis points tighter, on average, than bank loans (Exhibit 88). Performance of HY Energy, Oil, and Energy Stocks,
Also, when we look at high yield debt relative to equities in volatile Dec-14=100
sectors like energy, credit appears expensive. One can see this po- US HY Energy (LHS)
tential disconnect in Exhibit 89. US Energy Stocks (LHS)
102 WTI-spot (RHS) 105
101
100 100
99
98 95
97
96 90
95
94 85
93
92 80
1/15 7/15 1/16 7/16 1/17 7/17
Performance data in log terms, indexed to 100 in December 2014. Data
Moreover, we expect an extended as at June 28, 2017. Source: Bloomberg.

period of heightened social and

geopolitical tensions because
as my colleague Ken Mehlman
has noted, industrial revolutions
produce political revolutions.

36 KKR INSIGHTS: GLOBAL MACRO TRENDS

Leverage in China If there was one take-away from the Global Finan-
cial Crisis, it was to follow the leverage. In 2007, for example, U.S.
banks levered up their balance sheets to hold billions of dollars of
mortgages from highly levered U.S. consumers not a great combi-
nation. Today, by comparison, U.S. banks run with about one-third of
the leverage they did at the peak, (10x versus 30x), and consumers
have not levered up their single biggest asset their house to the
same degree.
On the other hand, China has added an enormous amount of lever-
age in recent years (Exhibit 91). What some folks may not appreci-
ate is that China became the worlds growth engine after the 2007
downturn by extending credit the same way the United States did
with mortgage credit after the tragic events of 2001. As we showed
earlier in Exhibit 20, credit as a percentage of GDP spiked to 180%
from 140% during the financial crisis, and it is now on track to reach
300% possibly as early as 2019.

EXHIBIT 90 To be sure, while China can maintain strict capital controls in the
Chinas Current Account Surplus and Its Capital Account short-term, it cant do it forever. Moreover, if the country continues
Have Diverged to run nominal credit growth above nominal GDP for an extended
period of time, we believe that the currency will be forced to adjust.
China: LTM Current Account Surplus vs Capital
Outows (US$B) Section IV: Conclusion

Current Account Surplus As we peer around the corner today on what tomorrow might bring,
Net Capital Flows Incl Errors & Omissions our work leads us to forecast lower overall returns. Key to our think-
600
ing for the next five years is that margins and multiples are high,
400 while interest rates are low. Also, we potentially expect an increase
200 in companies cost of capital, as interest rate volatility increases.
Dec-16 Moreover, as we indicated earlier, we have entered a period of
0
210 heightened social and geopolitical tensions, tensions that are not
-200 likely to abate during what our colleague Ken Mehlman refers to as a
-400 Dec-16 global political bull market.
-650
-600 Against this backdrop, however, we still see some attractive oppor-
-800 tunities. Our base view is that investors must focus on those select
05 06 07 08 09 10 11 12 13 14 15 16 17 areas where a manager can gain what is believed to be an advantage
Data as at 4Q16. Source: State Administration of Foreign Exchange, in sourcing, operations, strategy, and/or execution. He or she must
Haver Analytics. also be looking for investments in the right ponds of opportunity.

As we have detailed in this piece, we see five areas of focus that we

EXHIBIT 91
Chinas Banks Are Levering Up Similar to U.S. Banks
Before the Global Financial Crisis
China: Bank Assets as a % of GDP, LHS
China: Interbank Assets as a % of GDP, RHS
350%
312%
believe can help drive both absolute and relative outperformance.
First, we believe that we have entered an important period of change
in global corporate structures. Driven by factors such as increased
activism amidst declining returns on equity in foreign markets, we
see many CEOs now striving to better simplify their global footprints.
Importantly, this theme is not contained to just the corporate sec-
tor. In addition, we see our corporate carve-out theme playing out
100% across both the infrastructure and energy complexes.

300% 80%
78%
250% 60%
200% 40%
Overall, we believe that China
bears who are calling for major
150%
06 07 08 09 10 11 12 13 14 15 16
20% downside to growth from current
Data as at December 31, 2016. Source: Peoples Bank of China, Haver
levels are missing the point that
Analytics. the country has already had its
economic crash in nominal terms.

KKR INSIGHTS: GLOBAL MACRO TRENDS 37

Second, we believe that investors can still deploy more capital behind
the trend towards consumer experiences over things. Importantly,
this theme appears to be gaining momentum across both developed
and developing economies. Third, we now are more inclined to lean
in on emerging market opportunities, particularly if they are linked to
GDP-per-capita stories at appropriate valuations. Fourth, we still see
the illiquidity premium as compelling. Given our base view that rates
remain low in historical context, the opportunity to earn 200-400
basis points of excess spread in fixed income (and not necessarily be
extending duration) makes a lot of sense to us. Finally, we continue
to embrace complexity, particularly during periods of market disloca-
tion. Right now we think parts of healthcare, MLPs, and low-rated
credit all warrant investor attention.

Our strong view is that now is not the time to overpay for growth
and/or to over rely on margin expansion for growth. As indicated
earlier, we are now 96 months into an economic expansion, and we
now expect a shift in both global monetary policy and net issuance by
2018. Also, consumer trends are likely not as positive as the headline
data suggests in the United States, while increasing debt growth in
China relative to nominal GDP is unsustainable at current levels, in
our view.

As such, we continue to run with an asset allocation portfolio that

is lower risk than it was two to three years ago. However, given
the strong growth that we are forecasting in earnings amidst low
inflation and low rates, we do not believe that the bull market in risk
assets has at this point fully run its course.

By moving towards balance sheet
reduction mode later this year, the
Fed will also be confirming our
expectation that global developed
markets will move to a net
issuance of government debt in
2018, reversing the trend of what
has been three consecutive years
of net purchases.

38 KKR INSIGHTS: GLOBAL MACRO TRENDS

KKR INSIGHTS: GLOBAL MACRO TRENDS 39
40 KKR INSIGHTS: GLOBAL MACRO TRENDS
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