« Exchanges at Goldman Sachs

As Rates Reprice and Stocks Sell Off, What’s Next?

2022-01-24

In the latest episode of Exchanges at Goldman Sachs, Goldman Sachs Research’s David Kostin and Global Markets Division’s Jonathan Shugar share their thoughts on how the recent jump in bond yields and sell off in growth stocks are reshaping markets and investor strategy.

This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
This is Goldman Sachs, where we discussed developments currently shaping markets, industries and the global economy, I'm mouse Nathan s your strategist in Goldman Sachs Research. In today's episode, going to take a closer look at how the recent jump in thumbnails is battering stocks and, in particular, shares of tax and other high growth. Companies for respected we're sitting down with David Costume Chief: U S equity strategist in common That's me search engine. then sugar who manages equity sales on the cross ass? It sells team in our global markets, division David Job, The programme examined thousand bridge bigger John. Let's start with you, what can you just give us a sense of really
what is going on in the markets. What is the market pricing right now in terms of rates? So how should I think it's important that Europe, member, where we start from we ve, been on a wild walk faster when I was talking to clients back in timber last year. Twenty two is actually supposed to be a very accommodative year from the first where you are just seeing some taper, no rate pikes fivefold, the January we ve now placed in four rate Ike's this year and I think, something like one spot. Seven five percent said funds by the end of next year, so the question really is: has that done enough of the hard work for equities in terms of repressing? For one of these? worth socks. It's been a great story on the way up and a lot of hard math on the way down. So Wait. Markets obviously have replaced dramatically here, and you know, as you just said, we had a big equity sell off. It's not been a straight line. You know we're having some ups and downs but David,
just a little bit about what you are key take ways are from the price action that we generally seen over the last few weeks in the equity markets, as rates have repressed, whereas body have increased equity price, his have declined, but that that's a lot of changing dynamic beneath the surface and, for example, energy stocks are up since the start of the year and adds on the back of much higher oil prices. On the other hand, technology stocks, broadly speaking, have decline. but I think the real issue that has gravitated so much attention for fun Manders has been a particular part of the technology sector and those stocks basically, the ones that have very fast expected revenue, growth, but LO, Gazes negative profit margins losing money. Those stocks have been and severely punished in the evaluation market than the reason for that is exactly what John just mentioned, which is the idea of a higher, rate by mid reduces
the value of that future expected growth, and that's really important for these companies, where their margins are very thin and her hand their companies where there are still very rapid, forecast revenue growth, but they are currently operating very high margins. Those stocks have been comparatively less negatively affect the day, still come down on. The back the higher interest rates, but it has been much more muted decline that spend a significant component of the client dialogue that I've been here. his research analysed with fund managers on that topic. The animals- and I think it's really important understand for these high growth stocks. No one can do it. side yet if there cheap enough is six times the right number being back at Bellevue wishing you are, I prepare them at the right value, waken framework for these, or should you actually be it something cheaper and that's? It huge outstanding question that are quiet investors, are wrestling with on a day to day basis do you have a view on that? I do you think this gap between these two.
Goods can get wider Our analysis would suggest that the relative valuation between high growth, and high margin stocks and high growth and low margin stocks, which is around to multiple points in Georgia, surprise that sales that's back to where it was free pandemic, all way back to the early part of twenty twenty, two thousand twenty From that perspective, we ve now reverting back to that more historic relationship. If you will allow me it would seem that these high growth but low margin stocks are trading, levels that would be consistent with a further increase in real, Rates which is part of the Goldman Sachs Economic forecasts and so to a certain degree, is certainly been praised into the market. Anything is possible. so you go lower, but a dramatic repressing amongst fifty. Said for where it was in early December to now, he's got a long way to come back to one moment I, but is John indicated, doesn't mean a kick a lower but
there was its largely whether that is placed in the market. If we take a step back David, We ve just come off a year where companies have dealt with you, so many had once you had. The supply chain since we had labour shortages. We hadn't bearings of the mirrors speaking commodity raises, as you mentioned, but broadly speaking, receive talked about this bucket, where margins are thin but, broadly speaking, profit margins in pretty good. So as companies start to report, their fourth quarter result in this rising the environment and the throes of appointing season right now. What are you focusing? when it comes to margins and your outlook there so forecast that we have The net margins- for U S, probably traded corporations, will be increasing slightly by approximately forty basis points, bring them to round twelve and a half percent, which would be a record high level. Now, margins, starting point is already at record opposing that's on the back of really impressive nimble net.
By management in twenty twenty one when confronted The delta variant supply chain disruptions challenges in the labour market, sir, commodity prices, all these headwinds normally be associated with lower margins management, were able to manage around that an actually increase margins in pretty much every sector to record high levels and so going forward as we come into the fourth quarter, earning season and, more importantly, guidance and focus on the twenty twenty I'll look, we're gonna be focusing on company commentary regarding costs, push inflation the idea that high input costs supply chain all those incremental costs that are built into the system. And we are going to be pushing through pray increases or looking to raise prices. Hopefully, the buyer will then stick, but the idea of pushing through these higher prices then maintain their marges number one and another two don't understand. The operating left that may exist with more technology, so many companies in the pandemic have used that
opportunity, almost forced by circumstances to incorporated didn't use more technology to try to improve their productivity. This, again is in the publicly traded sector of the market were, broadly speaking, please have a reasonable amount of leverage are already operating with high margins and to try and those margins improving and it's more of a challenge from the smaller companies and private companies. It maybe dont have waited many levers deposit. Those are some of the things were looking at the next by three weeks or so will have the bulk of the jaded company. The United States will be releasing their fourth quarter? Urine resolves and were expecting pretty strong season earning season expectations? Nearly twenty percent, but really the focus for investors- is going to be much more on the outlook for twenty twenty two and there were expecting profit growth of around Eight percent largely a function of steady improvement emergence,
Yeah. Listen. The guidance point is super important, because no one knows how much of these companies were over for the last two years. Given the pandemic, you had a ton of stimulus to date, and I both have kids, I'm sure he had cardboard box. from watering online outside of door every day. At the same way, we did does some of that. You know go away as people get back to a more normal force. Wife does that sustain our enterprises, who heads Mabel their entire were forced to work from home gonna. Do this amount of tax spending in the earth? Those are the big questions that people wrestling with on their portfolios. Right now, so lots questions out their margin, vulnerability, a key focus. The increase in Bonn yields a key focus. John, you speak declines every day. Our investors, thinking about their strategies, changing their strategies to take account of this evolving environment
So the number one thing that we have seen this year is actually what people who is different than when we started going through this roller coaster back in November. So if you look at the Goldman Sachs Prime Brokerage, sadder, investors are the most underweight, TIM, she stocks and the most overweight energy materials and are chosen banks verse the ESA. Ninety five hundred names in the last five years. The other big thing is structure does much more cognizant of all of the other players out there in the market and what that may be doing to their portfolios. So these are things like city is passive and confers which have really been driving a lot of these moves on the way down in a lot of people's opinion. How you make were true is this quota year defy, Catalyst, Aurelians, huge focus, so thou be things like merger arm, spreads or anything. That is a definitive date that people can work say: hey Aspen's gonna happen. A cash return is gonna happen,
that's gonna have a lot of value to the stock. What's actually interesting on the side, where last year, everyone was in defining mood for most of the year on the guard beside everyone's doing work, but the sense of urgency see that you need to add high quality companies actually if we allowed going in by now, people feel like you can, I have a long path ahead of rates hitting markets, and so there is no sense of urgency to act which is interesting, because if you went back to the store, the pandemic. Where we had a massive so often than a recovery. A lotta people felt that they had taken damage at those opportunities quickly enough. Just for those who don't know gossipy John, can you just to find that how sure sir you know David, give you the technical definition by white good high quality company that are growing their revenue and our trading at a reasonable price, or you could try to it into financial model and walking to your CIO or pm's office and say: hey here's. What devaluation
actually website and the growth of. What's put this in the boy we touched a little bit factors in this conversation and David you're really freaking this out between companies? Ruth Opportunities and profitability versus sectors, but is something to say about you know some sectors performing in this environment Why well ahead of a interest rate hiking cycle that the affair and anticipated to begin in March history and the poor. Book would suggest that were sickly oriented stocks traditionally have done well I'll performed in the run up to the beginning of the tightening cycle. That would suggest some of the more settled companies being some financial would be one of the top of the list which we have done well in a rising rate environment. That's a big area focused part. it has to do with. Why is the fellows are likely to be increasing interest rate, and the idea of the economy going say more rapidly and above trend we also see net associated with energy price.
Oil prices, president oil stocks and energy started particularly outperforms, I mentioned earlier, and that's an air that is a lot of focus, Knowledge is actor, which is a big area of focus for fund managers because of the rise in aids that we ve been talking about on the spot gas and has such a negative effects. undervaluation, those Companies in the tech sector, operating now with twenty five percent NED margins twice as high as the rest of the market and what that does that leaves a lot of free cash flow for these companies to be re, purchasing stock, whose John indicated one of the measures that we think about is: where is the source of demand for shares? And in this particular case, We have seen about one and a quarter trillion dollars of authorizations by company boards. To just stock that was authorizations last year. Much of that is to be executed in the course of this Here too, there is a certain bed.
to the share that are likely to come from corporate buyback, but in responses, I a question on leading to higher interest aids and our tightening cycle- that would be something more sickly want to stocks traditionally have up of want garrison, crazy thing is tat ass, you get through some These rate Ike's may actually be a huge beneficiary. If people thing there's can be some type of policy misstep in that, as we start wiping some of these inflationary comes if GDP growth The slow than secular growth should search traded a premium again. We just don't know how that's gonna play out yet David touch on energy, but the commodity, sector in general, thing within metals the info, missionary environment is great for those stocks and givens but the longer term trends that you see with yesterday in terms of the ability to put money into round and build a new copper mine being quite challenging these days. We think that something that's gonna, be a durable trends the outside, and not just to clarify where
just talking about a FED taking cycle here, we're talking about a flat mean yield. her environment so are their particular implications that David, maybe you can take that line while the idea of a flat curve is the concept that the Federal Reserve will be raising interest rates on the short and long term interest rates and the forecast who governs economics is around ten hikes over the next several years. For in particular this year, followed by three twenty twenty three and another three and twenty twenty four. So that is the path of a higher short term interest rates and the idea that long term interest rates in this case will look at ten year. U S treasure wheels will be. Creasy get a more modest patience was resolved that flattening you'll curve. That does lead to some questions about which stocks will do better. Stocks will do worse. Obviously, from the sector point of view, the financials with and to do well, when rate arising that net interests more
in that they are actually will diminish if the yogurt patents, which is what we are anticipating over the next couple of years, and so there is an issue. Beware! It's about now your term investments gee versus Halibut, longer term investment strategy, so near term lotta focus on the exact timing and the pace of the tightening cycle of the FED, whereas the tenure Treasury yields both criminal in real terms, I have already had a huge move, enormous moving, a verse! couple of weeks of the year, and so perhaps there is less upside on the risk of longer term rates idea. Flattening curve is an important part of a sort of strategic concept, as we look out for the bounds of twenty twenty two and either any under it. Strategic areas that you think this macro environment will generate activity and everything about arising rate environment. You know flattening you'll, curb emanate and so forth of improving corporate margins is
a singular focus for the perverse Reggie team Golden right now and the idea company management Decelerating economic growth environment is often chat aging to have accelerating top line revenue growth. Therefore, a lot of This is going to be put on the idea of improving the margins idea of improving margins. One way to achieve that women, it is spin out a division, whether that is in the form of a sale of a business, to us back a special purpose acquisition. preparation or sale to a private equity funds or in fact, to spin out a fully formed public company. That is, I gotta, be a theme that many men whose,
we'll be exploring in twenty twenty June expect, that's a big area focused as a method or a vehicle for companies to try to improve the margins for the remaining business, and I think, there's gonna be a key theme for the your head. Yes, David said it's very much about corporate self help. So, on the credit side, in anticipation of interest rates going higher, know enough. So I knew it would happen this quickly in terms of market expectations, you saw really record issuance last year with a lot of corporates. Pre funding credit need, so how they use that cash is gonna, be very interesting and then also you're. Actually gonna have, I think, negative net issuances here so with incredible. Some of the high yield companies who are now in a better position, as David said, on the margin side, getting upgraded to invest in grade don't be a lot of currents under the surface that are going to provide opportunities for investors. We talk a lot about
this environment, changing an interesting ways for investors and John you ve talked about. You know how investors are navigating this one, doing in terms of managing the overall risk in their portfolios. This point: are they hedging on they hedging in a different way? What is that look like, so everyone has to search for sugar, so. What does that mean? It means you run a lower net exposure and lower growth Spencer. On your book, you have more cash to take advantage of the just locations and I think most investors are coming around to the view that you have to be a lot more tat. Go on this market so by selling a lot more frequent. Why, as a whole, Sir. Writing, structural themes higher, which was the predominant trend over the last few years. I think one of the big changes which we saw start last year in January, with the retail frenzy on some of the Irish names is just invest There are a lot more mindful of the short sighted, the buck and so
we have a lot of clients coming into us in saying: hey are index, hedges aren't working verse. What we on? What are you able to do to put it there's something that more accurately mimics our restore portfolio. So that's one really interesting thing in the Bin. This, where I sit, which is cross asset simply what is left is cheap to hedge with it, and that's all different now than it was last year. Last year we actually spent a lot of time talking to investors that the? U s rate market who knew when It takes we're, gonna come, but nothing was praised him so. This is probably a pretty cheap heads that you might want to take. A walk at with there are some more opportunities on a global rate spaces, so markets like Japan, because inflation is really a global problem. A lot of things that drove up here were seen overseas and the number two is just what else is really tight relative to history. So credit spreads, for example, despite be positive margins, that David has
I did fur corporates. Who knows whether these companies were over running any rising rate cycle? Should be wider, and what's the right way to hedge those last that's cool. Maybe number one discussion were having a people right now, so everything about all of these various forces that are putting us in different directions. Yet what our investors watching that would signal to them. You know that the market arrogance confidence, at least at the market. Gotta be moving higher from here, though, from here? You know one of the main things people watching on the four side. I would forward guidance, because this question of over running, if people are actually hitting there, that says you move through the year. We think that something. That would be a really positive signal for the market in terms of your of some of these ass was in a lot of the stuff that sold off. It's really eminently whether its strategic weather it's private equity doesn't really matter as much as we me
He regulatory concerns within TAT. Four words have emanated, but looking at it, they want. Some ass to come in and help set before it wish and now would have a really Bush effect for the rest, the space, the inflation pictures. Alot more complicated people will be watching them. Very closely you're, starting to laugh much more inflationary comes from last year, and you should see some supply chain clean up, so that should have a damaging effect on inflation. Investors are gonna, live with three and a half or two and a half percent inflation going forward and how that impacts. Your portfolio that's a whole different set of companies. You own, depending on what environment. That is really. No one has the right answer as somewhat that can be a David out. No, what do you think? I think your point, as an extra one in the next several weeks out, and we have four hundred or so companies that will be releasing their fourth clear results. But, more importantly, comments and discussions about the outlook for twenty twenty year will help drive. There
your term sentiment in market. My opinion, that's key issue. The inflation The data is coming in its expected to be above trend, particular reason why the fetters is anticipated to be hiking rates, inflation data people are poised foreign prepared for two negative news on that. So it's really about the court, and whether they be able to push through there, higher operating expenses, their higher costs. Can they push that due to the ultimate customers? Without having to two degradation. There will achieve that then the earnings will be there in the evaluation ends up with a situation that is now out of alternatives to equities, in the sense that body rising would suggest that bind portfolios. Broadly speaking, will decline in value, is so equities become a pretty attractive area focused. We look at all of the investment. the investor classes, the households, the mutual funds, a foreign investors, the panel funds. You look at all those major categories. They comprise the primary
owners of? U S stocks they are allocated right now. Fifty percent of their assets into equities too. He presented the bonds and twelve percent of cash. the record high level of equity allocation right now the balance would be commodities real estate goal things like that, the principal areas of equities bonds and cash already having jeopardy allocation, but the other authors aren't particularly attractive at this juncture, and so we, conversations with chief investment officers. The idea ass, an allocation becomes a singular discussion. Point about what else there is with nine USA: what is perhaps maybe more attractive revalued but other than U S, equities, that becomes it what else is cheap, if you well, that's it. The more macro the delegation chief investment, also level, and then you get to the individual fund, whether to me a fund or hedge fund. And, conversely, it is much more tactical. As John was indicating about how position around day, flattening YO curve,
round the FED hike around higher come the prices which companies or industries would be beneficiaries and all Coming back to the real issue on the table, which is the idea of the big jump bon yields which has made equities your turn more challenging does lead to a question about the largest fastest growing up Does it have negative margins that are losing money? They have come down so dramatically and Finally, what is the time to get some over falling? Knife, David you're, just even talking about the public market ones. Let's talk for a second about private markets where you ve had this ever racing valuation for these private companies does capital further this year. Are those companies able to take up rounds today to take down rounds or other solutions cause for investors, all of whom have had companies ip In the last twelve months, they now see the companies they know the best that are the fire this in their lifecycle trading, really cheap in public markets.
It's actually argument that, if your private investor is better value for you in public markets, Dave and appoint more capital, privately so much Dickens dinner will be watching at all David and John. Thank you. So much for joining us today were examined. Those thousand that concludes this item. set of exchanges that Goldman Sachs things for listening and if you enjoyed this show, we hope you subscribe and apple pie. Only by reading and comment. This podcast was accorded unfair play Jenner twentieth? Twenty twenty two, all price references and market forecasts correspond to the date of this recording, despite cash should not be copied, distributed, published or reproduced in whole or in part. The information contained in this package does not constitute research or recommendation from any Goldman Sachs Entity to the list
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Transcript generated on 2022-01-25.