Global Insights 5 Questions for 2023
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January 2023
Global Insights
5 Questions
for 2023
1If 2022 was the year of the “policy boomerang,” 2023 seems likely to bring the
long-awaited adjustment in real activity.
With the lowest interest coverage ratios and highest share of floating rate
debt in the U.S. economy, the tech sector again looks likely to bear the brunt
of higher interest rates. Much of the rest of the economy should weather the
storm relatively well, with many management teams eager to boost capex and
build more robust logistics and production networks.
China’s emergence from “Zero Covid” seems likely to be similarly focused on
resilience and self-sufficiency, with more investment (re)directed towards
science and technology. Policy shifts may also become apparent in Europe,
where the economy has performed far better than many feared largely
because of a policy response to energy shortages that raises difficult questions
about the efficacy of past efforts to reduce carbon emissions.
Overall, 2023 could be a year that crystallizes the importance of diversification
and risk management in the minds of investors singularly focused on upside, as
portfolios (over)weighted towards pandemic-era winners take on more water.
21
Can the U.S. economy avoid a recession in 2023?
The U.S. economy held up reasonably well in 2022. The crisis” to an end (Figure 1). As the year went on, the
reported contraction in first-half GDP proved largely rebound in travel, tourism, and other “experiences”
illusory. These spending-based activity measures were spending kept payrolls expanding despite a
not designed to capture the massive post-pandemic retrenchment in sectors that boomed when people
restocking of components, parts, semiconductors, and stayed at home and spent from home (Figure 2).
other inputs that eventually brought the “supply chain
Figure 1: End of Supply Chain Crisis
Figure 1. End of Supply Chain Crisis
TTM Manufacturing Output TTM Durable Goods Demand GLOBAL CONTAINER SHIPPING COSTS
$12,000
110
$10,361
108 $10,000
106
Jan 2012= 100
Restocking $8,000
104 Boom
Per 40ft Box
$6,000
102
$4,000
100
98 $2,000
$2,120
96
$0
Oct-17
Oct-18
Oct-16
Oct-19
Feb-20
Feb-21
Feb-22
Jun-20
Feb-17
Feb-18
Jun-22
Feb-16
Feb-19
Jun-21
Jun-17
Jun-18
Jun-16
Jun-19
Oct-21
Oct-22
Oct-20
Oct-11
Oct-12
Oct-14
Apr-20
Oct-13
Apr-21
Apr-22
Apr-17
Oct-17
Apr-18
Oct-18
Apr-15
Oct-15
Apr-16
Oct-16
Apr-19
Oct-19
Apr-12
Apr-14
Apr-13
Oct-21
Oct-22
Oct-20
Figure 2: Carlyle Travel, Tourism & Live Events Index
Figure 2. Carlyle Travel, Tourism & Live Events Index
Source: Carlyle Analysis; BEA, Bloomberg, December 2022. There is no guarantee any trends will continue
TRADE SECRET AND STRI CTLY CONFI DENTI AL 1
135
125
115 109
Index (January 2020 = 100)
105
95
85
75
65
55
45
35
Mar-20
Mar-21
Mar-22
Oct-20
Oct-21
Jan-20
Apr-22
Jan-21
Oct-22
Aug-20
Aug-21
Jan-22
Apr-20
Dec-20
Apr-21
Jun-22
Dec-21
Aug-22
Sep-22
Jun-20
Jun-21
May-22
Sep-20
Sep-21
May-20
Jul-20
May-21
Jul-21
Jul-22
Nov-20
Nov-21
Feb-20
Feb-21
Nov-22
Feb-22
Figure 1. Source: Carlyle Analysis; BEA, Bloomberg, December 2022. There is no guarantee any trends will continue.
2
Figure 2. Source: Carlyle Analysis of Portfolio Company Data.
TRADE SECRET AND STRI CTLY CONFI DENTI AL
3This run of good fortune may not last. Not every Though goods inflation has reversed as sellers
interest rate increase is created equal. Taking rates discount inventories they had accumulated in recent
from 1% to 2% matters very little for anyone not months, what central banker would confidently assert
working at a fixed income trading desk. But when that price stability is at hand, particularly after the
rates are already 4%, that same 100bp increase embarrassment of labeling 2021 inflation “transitory”?
consumes all of what remains of many companies’ After 30 years of assuming price increases would be
operating cash flow. At this point, businesses are not self-defeating, management teams discovered that
only deterred from borrowing, but also forced to cut they could “push price through” to boost revenues
existing spending and expansion plans. Measured without suffering offsetting declines in sales or
relative to June 2022, Q1-2023 debt service costs are market share (Figure 3). Why not keep going back to
likely to be 50% higher for floating rate borrowers. 1 that well until it runs dry? Engineering a broad fall in
And the Fed is not done. demand is probably the only way for the Fed to deter
that next round of price hikes.
Figure 3: Businesses Continue to “Push on Price”
Figure 3. Businesses Continue to “Push on Price”
Price Markups (YoY) Operating Income Margin (Lagged)
18% 18%
16% 17%
14% 16%
Operating Margins
12% 15%
Markups YoY%
10% 14%
8% 13%
6% 12%
4% 11%
2% 10%
0% 9%
Sep-16
May-16
Sep-17
Sep-18
Sep-19
Mar-20
Mar-21
Jul-16
May-19
May-17
May-18
Jul-17
Jul-18
Jul-19
Mar-22
Nov-17
Nov-18
Jan-20
Jan-21
Jan-22
Sep-20
Nov-16
Mar-17
Mar-18
Sep-21
Nov-19
May-20
May-21
Sep-22
May-22
Jul-22
Mar-16
Jan-17
Mar-19
Jul-20
Jul-21
Nov-20
Jan-18
Jan-19
Nov-21
Nov-22
Source: Carlyle Analysis; Bureau of Labor Statistics, Bureau of Economic Analysis, December 2022.
TRADE SECRET AND STRI CTLY CONFI DENTI AL 3
1 Calculated based on the Q4-2022 International Money Market (IMM) benchmark, which increased from 1.2% in June 2022 to 4.32% in December 2022. Assuming a 500bps credit
spread, the increase would be 50%. The lower the spread, the greater the percentage increase in financing costs.
Figure 3. Source: Carlyle Analysis; Bureau of Labor Statistics, Bureau of Economic Analysis, December 2022. 4While official Washington views the 30-year fixed By contrast, the effective interest rate on the stock
rate mortgage as a miraculous instrument whose of U.S. mortgage debt currently stands at 3.4%2 and
perpetuation should be the main goal of U.S. housing is not likely to move much over the next 12 months
policy, its existence actually makes the Fed’s job much given the collapse in mortgage origination volumes.
harder (Figure 4). In much of the rest of the world, The Fed must therefore take rates to much higher
mortgages are either adjustable rate or switch to levels to achieve the same diminution in demand,
floating after a relatively brief period. This allows for which comes mainly through financial distress in the
more efficient policy transmission, as higher policy corporate sector.
rates immediately depress household cash flow.
Figure
Figure 4. U.S. 4: U.S.Debt
Household Household Debt
Stock Mainly Fixed Rate Stock Mainly Fixed Rate
HOUSEHOLD DEBT LARGELY FIXED RATE HOUSEHOLD DEBT SERVICE
MORTGAGES & INSTALLMENT LOANS RATIO VS TSY YIELDS
DSR (LHS) 2-Year Treasury
14%
6%
13%
Rates rising much 5%
% of Disposable Income
Floating: 12% faster than DSR
24% 4%
Rate %
Rates rose 200bps
11% but DSR was flat
3%
10%
Fixed: 2%
76%
9% 1%
8% 0%
Mar-20
Mar-21
Mar-22
Mar-17
Mar-18
Mar-10
Mar-15
Mar-16
Mar-19
Mar-11
Mar-12
Mar-14
Mar-13
Mar-07
Mar-08
Mar-00
Mar-05
Mar-06
Mar-09
Mar-01
Mar-02
Mar-04
Mar-03
Source: Carlyle Analysis, Federal Reserve, December 2022. There is no guarantee any trends will continue.
TRADE SECRET AND STRI CTLY CONFI DENTI AL 4
2 Bureau of Economic Analysis, National Income and Product Accounts, Supplemental Tables. December 2022.
Figure 4. Source: Carlyle Analysis, Federal Reserve, December 2022. There is no guarantee any trends will continue.
5The good news is that by raising rates so (GFC) left the economy too dependent on fragile,
aggressively in 2022, the Fed has taken the risk overly engineered, and globally distributed supply
of an exotic, stagflationary spiral off the table. chains. More resilient production networks can only
Absent an unforeseen shock, any 2023 recession come into being if fixed investment rates rise back
seems likely to prove relatively shallow, brief, and towards pre-GFC levels (Figure 5), an outcome likely
unremarkable. That’s because genuine economic to generate higher growth and interest rates over
slumps tend to be the product of overcapacity. The the next three-to-five-years than most would have
past few years revealed the opposite problem: expected a year ago.
underinvestment since the Global Financial Crisis
Figure 5. Underinvestment in Advanced Economies Post-2008
Figure 5. Source: Carlyle Analysis of 2022 IMF WEO Database. There is no guarantee any trends will continue.
62
Will the ‘tech’ slump deepen?
“Financial distress” conjures images of troubled It might seem reasonable to conclude, therefore,
companies operating in declining industries. Its onset that the easiest way to avoid financial distress
typically stems from technological disintermediation, would be to lend money to fast-growing businesses
as entrants employing more advanced and efficient in the ascending sectors of the economy. That may
processes displace incumbent businesses and seem especially true if such businesses have “sticky”
industries. At the onset of the pandemic, the Bank revenue streams that exhibit little year-to-year
for International Settlements (BIS) classified roughly variation, as is often the case for providers of “mission
one-in-five companies as a “zombie,” with the critical” subscription-based software. While the
meager growth rates and absence of intangible valuations of such businesses can reach vertiginous
assets (intellectual property, proprietary technology) heights, creditors can enter at a sufficiently low
characteristic of companies on the losing end of a loan-to-value (LTV) ratio to ensure an ample equity
technological transition. 3
cushion absorbs any re-rating.
3 Banerjee, R.N. and B. Hofmann. (2020), “Corporate zombies: Anatomy and life cycle,” BIS Working Paper No. 882.
7Reasonable as this strategy may look on paper, it world where three-month finance rates could exceed
hasn’t panned out quite as expected. While old 5%. Consider that “technology” accounted for 21%
economy “zombies” may indeed be the first casualties of floating-rate loan origination volumes in 2021, but
of tighter funding liquidity conditions, it is technology- less than 5% of bond issuance. Among 2021 deals,
rich industries, like software, experiencing the highest capital structures in “tech” have 6.5x as more floating-
incidence of financial distress (Figure 6). Few capital rate loans than fixed-rate bonds, far and away the
structures in this space seem to have contemplated a greatest disparity of any industry (Figure 7).
Figure 6: Financial Distress by Industry
Figure 6. Financial Distress by Industry
FINANCIAL DISTRESS VOLUMES & INTEREST RATES FINANCIAL DISTRESS BY INDUSTRY
U.S. Distress Loan Volume Fed Funds Rate
Software
$120 5.0%
4.5% Health Care Providers & Services
$100 IT Services
4.0%
3.5% Media
Billions of USD
$80
Fed Funds Rate
3.0% Specialty Retail
$60 2.5% Commercial Services & Supplies
2.0%
$40 Professional Services
1.5%
Building Products
1.0%
$20
Pharmaceuticals
0.5%
$- 0.0% Household Durables
Dec-21
Dec-22
Apr-22
Sep-22
Nov-21
Nov-22
Feb-22
Jul-22
Jan-22
Jun-22
Mar-22
May-22
Aug-22
Oct-21
Oct-22
0% 5% 10% 15% 20% 25%
Distressed Share of Loans
Figure 7: Loans vs Bonds by Industry
Sources: Leveraged Commentary & Data (LCD); Morningstar LSTA US Leveraged Loan Index, December 2022.
TRADE SECRET AND STRI CTLY CONFI DENTI AL 6
Figure 7. Loans vs Bonds by Industry
2021 BOND ISSUANCE BY INDUSTRY LOAN-TO-BOND RATIO BY INDUSTRY (2021)
Technology, 5% Technology
Commercial services
Media, 10%
Consumer products
Health Care, 10% Capital goods
Utilities
All
All Retail
Others,,
Others Materials
75%
75%
Health care
Transportation
Gaming
Food
2021 LOAN ORIGINATION BY INDUSTRY Real Estate
Automotive
Technology, 21% Media
Hotels & Leisure
Telecommunications
Media, 4% Financials
All Energy
Others, Health Care, 12% 0.0x 1.0x 2.0x 3.0x 4.0x 5.0x 6.0x 7.0x
63%
Floating Rate Loans/Fixed Rate Bonds in 2021
TRADE SECRET AND STRI CTLY CONFI DENTI AL 7
Figure 6. Source: Leveraged Commentary & Data (LCD); Morningstar LSTA US Leveraged Loan Index, December 2022.
Figure 7. Source: S&P LCD and BAML Data, December 2022.
8The arithmetic predicament is not hard to grasp. At which had become increasingly sensitized to top-line
2020-21 tech valuations, there is simply not enough growth expectations (Figure 8). Management and
cash, per unit of enterprise value, to meet elevated sponsors may face a Catch-22, choosing between
debt service costs. In some cases, the loans were 4
a payment default or a deceleration in growth that
extended on the basis of recurring revenue (not wipes out the implied value of equity.
income) on the assumption that rapid growth would
allow operating cash to arrive in advance of Fed rate Some businesses will find that they’ve been
hikes. But even “conservative” capital structures look spending money imprudently and can make sizeable
wobbly. When a company is acquired for 18x EBITDA, cuts without harming the business. This will hurt
11% interest rates consume nearly all of its operating downstream service providers and advertising spend
cash even with an equity cushion in excess of 50% of but bolster the credit and company. Others will opt
the purchase price. Suddenly, 90% gross revenue for mezzanine financing, where the equity holder
retention rates are insufficient to service debt. accepts dilution in exchange for a structured security
that reduces near-term debt service costs. Nothing
Many affected companies spend so much on attracts opportunistic credit investors more than
customer acquisition, product development, and R&D great businesses with bad capital structures. But,
that they could easily raise the cash necessary to third and finally, there will be those business models
meet payment obligations. But “turning off growth” that simply collapse under the weight of higher (i.e.
could translate to a calamitous fall in valuation ratios, non-zero!) finance costs.
Figure 8: Average Expected Annualized Revenue Growth
by Valuation Quintile
Figure 8. Average Expected Annualized Revenue Growth by Valuation Quintile
40.0x
35.0x
EV/Sales, November 2021
30.0x
25.0x
20.0x
15.0x
10.0x
5.0x
0.0x
5% 10% 15% 20% 25% 30% 35%
Expected 2022 Annualized Revenue Growth (vs. Pre-Pandemic Level)
Source: Carlyle; S&P Capital IQ, November 10, 2022. There is no guarantee any trends will continue.
TRADE SECRET AND STRI CTLY CONFI DENTI AL 8
4 Interest coverage ratios were already lowest among the “computers and electronics” industry per LCD’s U.S. Industry Review, Q3-2022.
Figure 8. Source: Carlyle; S&P Capital IQ, November 10, 2022. There is no guarantee any trends will continue.
9As valuations became more sensitized to growth, profitability seemed to lengthen even as holding
management teams faced immense financial periods shortened (Figure 9). The adjustment
pressure to achieve certain top-line growth observed thus far in public markets (Figure 10) may
rates irrespective of the impact on profitability be just a foretaste of what’s to come, as operating
or long-term value. In some cases, growth may profitability reasserts itself as the valuation metric
have been the business model itself, as horizons to of greatest (sole?) import to investors.
Figure 9: Average Technology Investment Hold Period
by Exit Year
Figure 9. Average Technology Investment Hold Period by Exit Year
Average Investment Holding Period in Years
5.3
4.8
4.3
3.8
3.3
2020
2021
2022
2016
2019
2018
2010
2011
2017
2012
2013
2015
2014
Figure 10: Evolution of Sponsored IPO Valuations
Source: Carlyle Analysis; Preqin, Burgiss, November 2022.
TRADE SECRET AND STRI CTLY CONFI DENTI AL 9
Figure 10. Evolution of Sponsored IPO Valuations
Price / Sales Enterprise
EnterpriseValue
Value
30.0x $25,000
25.0x 23.93x
Enterprise Value (USD Millions)
$20,000
20.0x
Price / Sales Ratio
16.57x $15,000
15.0x
$10,000
10.0x 8.49x
8.01x
2.79x $5,000
5.0x
0.71x
0.0x $-
Last Private Post-IPO (Median) Current (Median) Last Private Post-IPO (Weighted Current (Weighted
(Median) (Weighted Average) Average) Average)
Source: Carlyle Analysis; S&P Capital IQ, November 2022.
TRADE SECRET AND STRI CTLY CONFI DENTI AL 10
Figure 9. Source: Carlyle Analysis; Preqin, Burgiss, November 2022.
Figure 10. Source: Carlyle Analysis; S&P Capital IQ, November 2022.
103
What lessons will Europe (and the world)
draw from its energy crisis?
It is one thing to suppress the production of fossil rose by 2% over the same period (Figure 11). Even
fuels. It’s quite another to reduce consumption more unfortunately, the resulting supply-demand
of them. Over the past decade, natural gas imbalance was to be closed by imports from the
production in the European Union (EU) dropped Russian Federation that are no longer forthcoming.
by 65%. Unfortunately, natural gas consumption
Figure 11: Collapsing Natural Gas Supply, Stable Gas Demand
Figure 11. Collapsing Natural Gas Supply, Stable Gas Demand
EU DOMESTIC NATURAL GAS PRODUCTION EU NATURAL GAS DEMAND
Cumulative Change Since 2011
0% 400 +2%
EU Natural Gas Consumption,
395
-10%
Billions of Cubic Meters
390
-20%
385
-30% 380
375
-40%
370
-50%
365
-60% 360
-63% 355
-70%
2021
2012
2014
2020
2013
2017
2018
2015
2016
2019
350
2011 2019 2021
Source: Carlyle; Statista, August 2022. There is no guarantee any trends will continue.
TRADE SECRET AND STRI CTLY CONFI DENTI AL 11
Figure 11. Source: Carlyle; Statista, August 2022. There is no guarantee any trends will continue.
11Many observers anticipated this energy shortfall Europe is not out of the woods. A recent cold
would lead to a steep decline in economic activity. snap led to drawdowns in gas storage that could
That hasn’t happened, as yet, thanks to (1) effective complicate matters in the coming months. And
planning, which allowed Europe to enter the winter these complications could prove trivial relative to
with ample levels of gas stored underground (Figure those facing policymakers later in the year when gas
12); (2) fiscal subsidies to limit the extent to which storage levels will almost certainly be far below those
wholesale price increases have flowed through entering this winter. Price cap schemes have yet to
to consumers; (3) a price cap scheme that has be tested. But, overall, the energy crisis tends to be
worked, thus far, to dampen the amplitude of price interpreted as a salubrious event that will accelerate
spikes in futures markets, and (4) the alacrity with the transition to a clean energy future. 5
which European economies switched to coal as an
alternative to gas-fired power.
Figure 12: EU Gas Storage as a % of Annual Consumption
Figure 12. EU Gas Storage as a % of Annual Consumption
29% % of Annual Consumption Filled (Average Sep - Nov) 2012 - 2019 Average
28%
27.5%
27%
26% 25.6%
25%
24%
23%
22%
21%
20%
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
Source: Carlyle; Bloomberg; Viborc, accessed November 7, 2022. There is no guarantee any trends will continue.
TRADE SECRET AND STRI CTLY CONFI DENTI AL 12
5 C.f. https://www.investmentweek.co.uk/news/4047138/fink-recent-global-events-accelerate-energy-transition-long-term
Figure 12. Source: Carlyle; Bloomberg; Viborc, accessed November 7, 2022. There is no guarantee any trends will continue.
12The data seem equally capable of supporting a far carbon dioxide per megawatt hour (MWh) as gas-
more pessimistic conclusion. European governments fired generation,6 , yet EU coal consumption is up by
currently spend 3% to 6% of GDP, on average, to 22% over the past two years (29.7 million tonnes in
subsidize carbon-based energy consumption (Figure 2021 alone, Figure 14). In 2019, the EU consumed 8%
13). Carbon fuel subsidies have never before existed less coal than the U.S.; in 2022, it consumed 3% more.7
on this scale. Coal-fired electricity emits 2.3x as much
Figure 13: Energy Subsidies by Economy
Figure 13. Energy Subsidies by Economy
Percentage of GDP Allocated Funding (RHS)
9.0%
€ 250
Allocated Funding (Billions of EUR)
8.0%
7.0%
€ 200
6.0%
5.0% € 150
% of GDP
4.0%
€ 100
3.0%
2.0%
€ 50
1.0%
0.0% €0
Lithuania
Austria
Netherlands
Norway
Luxembourg
Slovakia
Ireland
Poland
Germany
Italy
Croatia
Romania
Latvia
Cyprus
Malta
Portugal
Belgium
Bulgaria
Finland
France
Estonia
Denmark
Czechia
United Kingdom
Spain
Greece
Slovenia
Sweden
Source: Bruegel, November 2022. There is no guarantee any trends will continue.
TRADE SECRET AND STRI CTLY CONFI DENTI AL 13
Figure 14: Projected Change in Coal Consumption
Figure 14. Projected Change in Coal Consumption
PROJECTED CHANGE IN COAL USAGE 2021 TO 2022
40
+29.7
30
20
Million Tonnes of Coal
10
0
-4.6
-10
-20 -17.2
-21.34
-30
China United States Russia European Union
Source: Carlyle Analysis; IEA: Coal Market Update July 2022. There is no guarantee any projections will materialize.
TRADE SECRET AND STRI CTLY CONFI DENTI AL 14
6 Energy Information Administration, June 2021.
7 International Energy Agency, Coal 2022, December 16, 2022.
Figure 13. Source: Bruegel, November 2022. There is no guarantee any trends will continue. 13
Figure 14. Source: Carlyle Analysis; IEA: Coal Market Update July 2022. There is no guarantee any projections will materialize.Perhaps all of this will prove temporary. But it sends Policymakers’ fears of electoral backlash are hardly
an important message about contemporary political imagined. Inflation is unpopular, especially when it
economy. It is easy to engineer shortfalls of natural seems causally linked to energy policy. Most alarming
gas through policies to suppress its exploration are recent polls that suggest inflation associated
and production. But these shortfalls only reduce with carbon fuel shortages arouses skepticism of the
carbon emissions to the extent that they translate risks of climate change itself, undermining political
into demand-destroying price increases. If at the support for the entire planet-saving project.8 While
moment of truth policymakers opt instead for massive well intended, the divestment approach to energy
subsidies to mask higher prices, then all the shortfalls transition trivializes this contingency, failing to
have done is create a fiscal black hole. perceive how feedback effects of the sort observed
in Europe could contribute to a catastrophic increase
in carbon emissions over time.
8 “Climate change: a growing skepticism,” https://www.ipsos.com/en/obscop-2022.
144
How does China emerge from ‘Zero Covid’?
The only policy that seems to have garnered more The relationship between economic and public
criticism than “Zero Covid” was China’s sudden health ultimately proved far more complex than
abandonment of it. Mass containment proved many understood at the onset of the pandemic.
unsustainable, but the alternative looks even worse, Outbreaks can depress economic activity every bit
with more than 200 million residents infected with as much as lockdowns. At the same time, policies
the virus in the first week of reopening. 9
to slow the spread of disease can contribute to
a sharp deterioration in mental health and an
Epidemiological curves exhibit symmetry. The worse increase in excess deaths from other causes (Figure
the outbreak, the faster it recedes. This must be 15). But in this case, China’s abandonment of Zero
the hope of Chinese authorities, at least, whose Covid should be understood as part of a broader
steadfast commitment to “Zero Covid” signaled effort to reignite economic activity.
a recognition of how bad the initial phase of full
reopening could prove to be.
Figure 15. Drug Overdose Deaths Spike After Lockdowns
9 National Health Commission, Cited in Bloomberg, “China Estimates Covid Surge Is Infecting 37 Million People a Day,” December 23, 2022.
Figure 15. Source: Carlyle Analysis; CDC, November 2022.
15China’s social safety net is inadequate, not only a commitment to robust economic growth and the
when measured relative to those of advanced employment opportunities and real wage gains
economies but also compared to emerging market it generates. No surprise containment proved
economies’ (Figure 16). In place of public insurance politically unsustainable once cumulative GDP
schemes, China meets its social obligations through growth fell as much as 5% below target (Figure 17).
Figure 16: China Meets its Social Obligations Through
a Commitment to Growth
Figure 16. China Meets its Social Obligations Through a Commitment to Growth
Adequacy of Benefits for Lowest Quintile Coverage for Lowest Quintile Current Social Assistance Spending (RHS)
120% 1.6%
1.5%
100.0% 1.4%
100%
85.0% 1.2%
80%
1.0%
0.7%
% of GDP
60% 0.8%
%
41.0% 0.6%
40%
28.0% 0.4%
20%
0.2%
0% 0.0%
China EMEs
Figure 17: Chinese Economic Activity Slows Materially
Source: IMF Article IV, January 2021. There is no guarantee any trends will continue.
TRADE SECRET AND STRI CTLY CONFI DENTI AL 16
Figure 17. Chinese Economic Activity Slows Materially
CHINA CARGO THROUGHPUT VOLUMES:
Sales Customer Traffic PORTFOLIO COMPOSITE (YOY% † )
100%
YoY % Growth in Sales and Foot Traffic
130%
80%
110%
YoY% Growth In Cargo Volumes
60%
90%
40%
70%
20%
50%
0%
30%
-20% -12%
10%
-40% -35% -10%
-60% -30%
-30.2%
-80% -50%
Apr-20
Dec-20
Apr-22
Dec-22
Sep-21
Mar-21
Feb-20
Nov-21
Jun-20
Jul-21
Jun-22
Aug-20
May-21
Jan/Feb 2022
Aug-22
Oct-22
Oct-20
Apr-20
Dec-20
Apr-22
Dec-22
Sep-21
Nov-21
Jan / Feb-22
Jul-21
Jun-22
Jan / Feb-20
Mar-21
Jun-20
Aug-20
May-21
Aug-22
Oct-20
Oct-22
†2021 values compared to 2019 due to COVID base effects in 2020.
Source: Carlyle Analysis of Portfolio Company Data.
TRADE SECRET AND STRI CTLY CONFI DENTI AL 17
Figure 16. Source: IMF Article IV, January 2021. There is no guarantee any trends will continue.
Figure 17. Source: Carlyle Analysis of Portfolio Company Data.
†
2021 values compared to 2019 due to COVID base effects in 2020.
16While it seems reasonable to expect monetary, some observers as absurd, consider the implications
fiscal, and credit policy to be oriented towards of news reports that Chinese battery manufacturer
achieving above-trend growth in 2023, the Contemporary Amperex Technology Co. Ltd. (CATL)
bigger story may be the form that growth takes. is in talks with Ford to build a plant in the U.S. 11
“Onshoring” is typically used to describe efforts to Under the proposal, Ford would own the plant and
“bring supply chains home” to the U.S. and Europe, related infrastructure, but CATL would operate
but it also describes China’s current strategy. the facility. The complex structure seems designed
Export bans have made painfully obvious China’s to capture the subsidies provided under the U.S.
reliance on Western technology. The key message Inflation Reduction Act (IRA) for domestically
from the 20th Party Congress was policymakers’ produced batteries while simultaneously protecting
determination to increase China’s economic self- CATL’s intellectual property from expropriation. 12
sufficiency through long-term investment in science The U.S. brings the subsidies for domestic
and semiconductors, as well as “workaround production; the Chinese company delivers the
technologies” to bypass embargoed U.S. intellectual state-of-art technology.
property in the near-term. 10
Don’t be surprised if similar stories of Chinese
Could Chinese companies close the gap with companies’ technological leadership become a
Western competitors, or even leapfrog them recurring theme of the economy’s emergence from
technologically? While such a suggestion may strike Zero Covid.
10 C.f. “China’s Xi Jinping Urges Self-Reliance in Tech Amid Rivalry With U.S.,” Wall Street Journal, October 17, 2022.
11 Bloomberg, “Ford, China’s CATL Mull Workaround for New US Battery Plant With US-Chinese Tensions High,” December 14, 2022.
12 “Report: Ford And CATL Are Considering LFP Battery Plant Investment,” Inside EVs, December 15, 2022. 175
When will U.S. investors overcome ‘home bias’?
Most observers agree that past returns provide In other words, a momentum play tends to gather
valuable data on which to base future allocation strength at precisely the moment when market
decisions. Disagreement abounds regarding how participants do not recognize they’re participating
these data should be interpreted, however. in one. High returns attract additional capital by
increasing the seductiveness of the investment
Two of the most well-established empirical facts thesis on which the initial investment was based.
in financial economics are that asset price returns Bubbles form rationally as incoming returns data
exhibit both “momentum” and “mean reversion.” make bullish narratives more compelling.
These findings are in obvious conflict. The first says
that yesterday’s “winners” are likely to outperform Some of these dynamics seem to have manifested
today, a finding that serves as the basis for themselves in crypto markets. Liquidity inflows
many “trend-following” quantitative investment generated returns that were (mis)interpreted as the
strategies. 13 The second suggests that today’s natural fruits of transformative fintech innovation.
winners will inevitably underperform in the future, But the issue appears more widespread.
the insight on which most “value” or “contrarian”
investment strategies are based. 14 Recent U.S. equity market outperformance has
led many domestic investors to wonder why they
The apparent contradiction is resolved by time should allocate capital abroad if they can generate
horizon: momentum tends to dominate in the short- better returns in growth sectors at home? To ask
term while mean reversion asserts itself over time. No this question is to answer it. If you know which
one can reliably predict when one factor will give way geography or industry will perform best, there is no
to the other because liquidity flows create their own case for diversification; over 90% of U.S. investors’
space. This is the core insight of Soros’ application of stock allocations were directed to U.S. equity
“reflexivity” to financial markets. A sector or asset
15
markets in 2022. 16
class comes to be seen as an attractive destination
for investment. Funds flow into it. These fund flows
bid up the price of assets, generating returns that
seem to validate the initial investment thesis. This
attracts subsequent rounds of inflows that bolster
returns and strengthen convictions.
13 Moskowitz, T. J. et al. (2012), “Time series momentum,” Journal of Financial Economics.
14 For a history of such understandings, see De Bondt, W.F.M. and R.H.Thaler. (1989), “A Mean-Reverting Walk Down Wall Street,” Journal of Economic Perspectives.
15 Soros, G. (2014), “Fallibility, Reflexivity, and the Human Uncertainty Principle,” Journal of Economic Methodology. 18
16 “U.S. Remains ‘Only Game in Town’ for Stock Investors,” Wall Street Journal, November 21, 2022.Has liquidity-driven outperformance been recast paying more for a given amount of growth (Figure
as something intrinsic to the U.S. market? Since 2013, 19) rather than the growth itself. When accounting
U.S. corporate valuations have nearly doubled, for the strength of the dollar and extent to which
while those in other advanced economies have past returns cannot be explained by fundamentals
remained roughly constant (Figure 18). While most (Figure 20), investors would seem to ignore the
of the increase has been attributed to the more prospective benefits of geographic diversification
favorable growth dynamics of a larger technology at their own peril.
sector, the returns have come largely from investors
Figure 18: Post-2013 Rise in Valuations Mostly a U.S.
Phenomenon
Figure 18. Post-2013 Rise in Valuations Mostly a U.S. Phenomenon
4.50x
Germany France Italy UK Spain U.S.
4.00x
3.50x
Enterprise Value/Book Value
3.00x
2.50x
2.00x
1.50x
1.00x
0.50x
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2021
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2022
Source: Carlyle Analysis of CRSP Database, November 2022. There is no guarantee any trends will continue.
TRADE SECRET AND STRICTLY CONFIDENTIAL 18
Figure 18. Source: Carlyle Analysis of CRSP Database, November 2022. There is no guarantee any trends will continue.
19Figure 19: Increase in Valuations, 2016-2021
Figure 19. Increase in Valuations, 2016-2021
VALUATION QUINTILE, FROM FASTER (TOP) TO SLOWER (BOTTOM) EXPECTED GROWTH
70.0% 65.3%
Percentage Change in Valuation Ratio
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
Top Quintile Second Quintile Middle Fourth Quintile Bottom Quintile
Enterprise Value/Book Value Price-to-FCF Ratio
Source: Carlyle Analysis of CRSP Database, November 2022.
TRADE SECRET AND STRI CTLY CONFI DENTI AL 19
Figure 20: Potential Peak in U.S. Dollar & Returns
Figure 20. Potential Peak in U.S. Dollar & Returns
REAL USD EXCHANGE RATE NEXT 5-YEAR PRICE RETURN (EXCL. DIVIDENDS)
140
25% Actual Expected
USD Real Exchange Rate Index
130 20%
(Jan 2006 = 100)
Annualized 5-Year Return
120 15%
110 10%
100 5% 3.0%
90 0%
80 -5%
70 -10%
Feb-97
Jun-06
Jun-99
Oct-15
Dec-16
Apr-19
Apr-12
Aug-07
Aug-00
Apr-98
Apr-05
Oct-08
Dec-09
Dec-02
Oct-01
Jun-20
Jun-13
Feb-18
Feb-11
Aug-21
Oct-22
Aug-14
Feb-04
Jan-20
Jan-21
Jan-22
Jan-17
Jan-18
Jan-10
Jan-15
Jan-16
Jan-19
Jan-11
Jan-12
Jan-14
Jan-13
Jan-06
Jan-09
Jan-07
Jan-08
Source: Carlyle Analysis; Bloomberg; S&P Capital IQ, December 2022.
TRADE SECRET AND STRI CTLY CONFI DENTI AL 20
Figure 19. Source: Carlyle Analysis of CRSP Database, November 2022.
Figure 20. Source: Carlyle Analysis; Bloomberg; S&P Capital IQ, December 2022.
20Jason Thomas
HEAD OF GLOBAL RE SEARCH
jason.thomas@carlyle.com / (202) 729-5420
Jason Thomas is the Head of Global Research at Carlyle, focusing on economic and statistical analysis of
Carlyle portfolio data, asset prices and broader trends in the global economy.
Prior to joining Carlyle, Mr. Thomas served on the White House staff as Special Assistant to the President
and Director for Policy Development at the National Economic Council. In this capacity, Mr. Thomas acted
as the primary adviser to the President for public finance.
Mr. Thomas received a BA from Claremont McKenna College and an MS and PhD in finance from George
Washington University, where he studied as a Bank of America Foundation, Leo and Lillian Goodwin
Foundation, and School of Business Fellow.
Mr. Thomas has earned the chartered financial analyst designation and is a Financial Risk Manager
certified by the Global Association of Risk Professionals.
Economic and market views and forecasts reflect our judgment as of the date of this presentation and are subject to change without notice. In particular, forecasts
are estimated, based on assumptions, and may change materially as economic and market conditions change. The Carlyle Group has no obligation to provide
updates or changes to these forecasts. Certain information contained herein has been obtained from sources prepared by other parties, which in certain cases
have not been updated through the date hereof. While such information is believed to be reliable for the purpose used herein, The Carlyle Group and its affiliates
assume no responsibility for the accuracy, completeness or fairness of such information. References to particular portfolio companies are not intended as, and
should not be construed as, recommendations for any particular company, investment, or security. The investments described herein were not made by a single
investment fund or other product and do not represent all of the investments purchased or sold by any fund or product. This material should not be construed as
an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. We are not soliciting any action
based on this material. It is for the general information of clients of The Carlyle Group. It does not constitute a personal recommendation or take into account the
particular investment objectives, financial situations, or needs of individual investors. 21You can also read
