Jason Thomas, head of global research and investment strategy at The Carlyle Group, shares his US macro outlook and explains why valuations in Asia – including China – look attractive on a relative basis

Q: What’s going to happen to interest rates?

A: The Fed has a bias towards supporting demand. Whether rate cuts are warranted or not, and they are probably not based on data coming in, there is an expectation that if there’s no bump in the road and inflation is at low enough levels, the Fed will act. That’s what is supporting asset prices in the US. The bigger question is where will rates average now. It feels like we are in a very different world, for many reasons. Fixed investment in the US is running at 3x the rate it was prior to the pandemic – a lot of that is related to industrial policy such as subsidies for green industry – while corporate savings have declined as more money is invested and household savings are down by about 50%. And then, with protectionism, there’s a sense that the period of max global capital efficiency is over. Add all that up and you have markets that are now pricing 4% interest rates over time. People are adjusting to that. A lot of this has been offset by much easier financial conditions as it relates to credit spreads. The spreads on single B bonds in the US are 300 basis points, not far from the all-time lows recorded in 2007; leveraged loans are fatter than that, but spreads have come down considerably.

Q: What role has private credit played in creating these easier financial conditions?

A: When Silicon Valley Bank failed last year, a massive credit crunch was expected in the US, but it didn’t happen. The growth of private credit was a major reason. With so many alternative financing channels in the US, the bank share of credit provided to the wholesale corporate sector has diminished. But they will respond aggressively, especially in the USD 200m-USD 400m EBITDA space, because these are the banks’ most prized customers. It’s not about interest income generated by loans. These companies are candidates for IPO, they are often acquisitive, so there are lots of M&A fees and advisory fees – cutting into this part of the market, you are cutting into relationships. So, the 130-180 basis point premium to the liquid leveraged loan market that private creditors have been collecting will become very difficult to obtain. That’s the constraint the industry will face as it starts to compete for borrowers.

Q: Are banks already fighting for this territory?

A: We saw record issuance in the first quarter. Almost all of it was refinancing of existing leveraged loans and existing private credit loans – and private creditors had to agree to refinance those borrowers at rates that were competitive with the banks.

Q: And all this has fed into elevated valuations?

A: Public market valuations exceed private valuations – at the end of March, they were about 16x average enterprise value to EBITDA. There’s a lot of optimism, with the equity risk premium in public markets back at 2021 levels. We will see if companies deliver on earnings growth. Some people are forecasting 17% EPS [earnings per share] growth over the next 12 months, which is a high hurdle to clear. However, there has been better-than-expected volume growth because companies reduced their cost base in anticipation of a recession in 2022 and 2023 that never materialised. There seems to be more earnings power as a result.

Q: Where are valuations in Asia relative to the US?

A: As Asian economies have stabilised and post-pandemic volatility has normalised, people are willing to step in, but there are no signs of the valuation gap narrowing. If you look at public comps to private markets, there is a 40% discount across Asia to the US. China has some of the fastest-growing companies in technology, software, and business services, but they are at 60% discounts. The exception is India where valuations are comparable to those in the US. I think investors are now coming to terms with being overallocated to the US; they are recognising there is too much home bias in their portfolios, and they are starting to take advantage of some of those valuation discounts.

Q: Why is India the exception?

A: In a global context, the trajectory for India’s economy is different to that of any other major economy. It priced similarly to the US, but it has more favourable long-term growth prospects and that growth is not resource intensive. If you look at return on incremental capital – the real return per unit of investment – China is on 8%-10% and the US is comparable to that. India is on about 20%. The market isn’t priced for perfection, but it’s priced so that one could easily make mistakes.

Q: You are also particularly interested in South Korea…

A: What we’ve seen happen in Japan over the past decade is unfolding in Korea now. Both countries have experienced demographic shocks that mean fewer people will participate in the labour force. Initially, both addressed that through delayed retirements and increases in female labour force participation. But it only works to a point. Japan realised that and moved to increasing productivity. It improved profitability in the corporate sector by focusing on return on equity and operational efficiency. Japan made much of the fact that 43% of TOPIX constituents have a price-to-book ratio of less than 1x – which implies the carrying cost of assets exceeds the return on equity – saying they are at risk of delisting if they don’t produce turnaround plans. And then for larger businesses, there is a recognition that the easiest way to get return on equity is to spin off unwanted divisions that are dragging down group-wide return. In Korea, the problem is worse. There are more listed companies on a per capita basis than Japan and almost two-thirds of KOSPI constituents have price-to-book ratios below 1x.

Q: Are there signs of change?

A: In February, Korea announced the corporate value-up initiative [which includes guidelines for disclosing value creation plans as well as tax incentives and other benefits for companies that act on those plans]. We are at a stage where the bureaucratic machinery is fully on board with the critique that’s been made for the past decade. There is institutional support for a solution. It helps that they’ve seen what Japan has done. The impact of the Abenomics reforms and the Tokyo Stock Exchange reforms has been enormous, and it has led to more inflows. Activists are the best thing in the world for take-private transactions. Once a management team finds out that someone has just acquired a 5% or 10% position and wants to tell them how to run the business, they have a choice. It’s no longer a question of whether you will have a partner; it’s a question of whether you want to pick your partner or have your partner picked for you in an activist sense. This has been a huge motivator for take-privates in the US and elsewhere. I don’t think it will be an eight-year process in Korea like we saw in Japan, but it won’t be overnight either.

Q: Regarding valuations in China, is the reward now large enough to justify the risks?

A: Just comparing like-on-like companies – same growth rates, same margins, same prospects based on proprietary technology and other indicators – you are talking 40%-60% discounts. To me, that is more than sufficient to compensate for the risk. Moreover, what’s been interesting about China is most people, including me, expected the growth model to pivot to a much greater reliance on the consumer. Korea grew 6% per year between its credit crisis in 1998 and the global financial crisis by leaning on the consumer – that’s essentially how it offset a 16% decline in investment. This seemed to be the template China would follow, but instead there’s been a shift in the allocation of credit and capital away from real estate development towards higher value-added manufacturing – electric vehicles, batteries, green industry. There has also been a change in the geography of exports. These products are going to Southeast Asia, the Middle East, and Central Asia, which has more than compensated for any issues in the US.

Q: Presumably, it can’t rely on industrials-led growth forever?

A: Not forever. The consumption share of GDP must go up – there’s so much room with consumer credit and other sorts of stimulus to support it. Right now, though, given strategic competition with the US, the recognition of energy transition, and the need to invest in semiconductors because of export controls, China is prioritising value-added manufacturing. It appears to see that as a better use of resources.

Q: And with that shift in exports, US tariffs shouldn’t be a concern?

A: A 100% tariff on EVs doesn’t matter if you’re not selling any EVs in the US. I don’t know how many Chinese EVs will ever be sold in the US, but 15 years ago, US multinationals were investing in China under joint ventures where they transferred technology know-how in return for market access. What’s happening today is the reverse. Chinese companies are signing JVs to license technology and gain access to US markets. Both Ford and General Motors will produce cars in the US for the North American market powered by CATL batteries.