Inflation seems to be the biggest global concern in 2022. The rising cost of goods and services is impacting everything, from election outcomes to corporate capital expenditures. This is why inflation was also the primary focus of KKR’s recent mid-year macroeconomic outlook.

In a report titled “Walk, Don’t Run,” Henry McVey, CIO of KKR’s balance sheet and head of global macro and asset allocation (GMAA) outlined his team’s perspective on the year ahead. McVey believes rising prices will compel central banks to tighten monetary policy, which, in turn, will ultimately degrade corporate profits.

The effects have already spilled over into private deals. M&A activity was down 29 percent in the first quarter of this year, according to data published by Dealogic. Big ticket leveraged buyouts deals, such as the take-private of Citrix Systems Inc. and buyout of packaging firm Intertape Polymer Group Inc., have seen lenders taking haircuts based on market sentiment.

The KKR report went as far as saying “Public equities appear more attractive than peer-to-peer private equity,” indicating that there was more room for private valuations to adjust. “We are forecasting slowing growth, we expect to see more corporate carve-outs, more public-to-private transactions, and more capital solutions (preferred, convertibles, etc.)”

However, the KKR team wasn’t bearish on all assets. They believe companies with “pricing power and collateral-based cash flows,” were better positioned for the months ahead. The report used infrastructure and real estate companies as examples. These companies could pass along the added costs of production to their customers or rely on the steady value of hard assets to sustain their valuations.

The investment giant seems to be implementing this strategy already. Last month, KKR launched a bid to acquire UK-based ContourGlobal, a utility company with 6.3 GW of power-generating assets.

Similarly, Brookfield Asset Management raised a record-breaking $15 billion for a new fund targeting renewable energy assets. Demand for the fund actually exceeded Brookfield’s hard cap.

The KKR report also highlighted real estate as a hedge against inflation. Indeed, 26 percent of family offices surveyed by UBS said they would increase their allocation to real estate in 2022.

The report points out that this is a reversal from previous decades, where private equity investments in software and intangible assets have far outpaced industrial hard assets. Now, the team sees little downside in infrastructure and asset-based finance in private equity deals, simply because the global PE sector is underweighting this asset class.

While family offices and institutional investors focus on these inflation hedges, governments and central bankers are working to reduce inflationary pressures quickly.

The U.S. Federal Reserve is “increasing interest rates to cool demand and, by doing so, lower inflation,” says Claudia Sahm, the founder of Stay-at-Home Macro (SAHM) Consulting, a former section chief at the Federal Reserve Board of Governors and the inventor of the famous Sahm rule.

To support these efforts, Sahm believes the White House and Congress need to play a part too. “Their tools are more plentiful and precise than the Fed’s,” she says. Her recommendations include policies that encourage employees to work from home and a price floor on oil to encourage US drillers to ramp up production.

A steady or declining energy price could lower the inflation rate and encourage the central bank to slow down on rate hikes. This scenario would be a departure from KKR’s assumptions.

-Vishesh Raisinghani