Kathryn Koch, head of Fundamental Equity Client Portfolio Management within Goldman Sachs Asset Management, discusses key trends impacting equity markets globally, including the ongoing Greek debt negotiations, stock volatility in China, and the boom in M&A activity.
This episode was recorded on July 6, 2015.
The views and opinions expressed herein should not be construed as an offer to buy or sell any securities and such views and opinions may differ from those of Goldman Sachs Global Investment Research or other departments or divisions of Goldman Sachs and its affiliates. This information may not be current and Goldman Sachs has no obligation to provide any updates or changes. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty, as to the accuracy or completeness of the statements or any information contained in this podcast and any liability therefor (including in respect of direct, indirect or consequential loss or damage) is expressly disclaimed. Goldman Sachs is not providing any financial, economic, legal, accounting or tax advice in this podcast. In addition, the receipt of this podcast by any listener is not to be taken as constituting the giving of investment advice by any Goldman Sachs entity or individual to that listener, nor to constitute such person a client of any Goldman Sachs entity.
Copyright 2015 Goldman Sachs. All rights reserved.
This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
This is exchanges of Goldman Sachs, where people from our firm shudder insights on developments shaping markets industries in the global economy. Objects- you are global out of corporate communications are the firm with six months of the year and the books. This is a natural time to reflect.
on key trends driving market activity around the world. My guest, today's Katy catch by senior investment professional with Goldman Sachs Asset Management, Katy welcome to the programme.
Thank you for having me so. You recently convened the fundamental equity strategy group investment professionals from around the world and talked about trends drive in the marketplace willing to talk a little bit about those trends. Today, let's start with the: U S: economy short after six years of performance, strong performance, alot of people, including our clients, are starting to question valuations. What do you think you know? U S? Equity markets are about two hundred and four.
percent, since the trough in two thousand nine, and in addition to that there, in the ninety nine percent title of their evaluation. So it's very natural for investors to feel like markets have run too much and from our vantage point we actually went into two thousand fifteen, the least bullish. We ve ever been on a: U S, equities, since two thousand nine, and actually that still our view, we think overall mark
turn to US equities are going to be quite, and you did. However, we think the environments going to be really rich or stock selection, so selectively bought him up until we do find some.
I would say overall, however, we are more positive on markets outside the EU as such as Europe and Japan. Let's talk about Europe for second, Greece just held a referendum. The results are in what is a no vote mean for the markets, and how do you see-
Greek situation playing out for a country- that's only one third of one percent of global gdp. The Greeks are definitely getting their fair share of headlines and actually one of my favorite observation.
is about the current debt situation in Greece came from me in bremmer. He compared the situation
and be a game and that it's really not worth watch him at last two minutes, but now weren't. You never know when the last two minutes.
hence jurors an hour now earn double overtime. So people are watching very intently about what's going to happen from here
So, as you mentioned, there was a referendum on austerity, the vote,
now, which basically means the Greeks were unwilling to agree to all the austerity measures as a condition for remaining in the euro. So the question does
Here, though, can the revised agreement be reached? Is there going to be a drugs that are or no Greg's it?
and we would humbly admit here- that the range of outcomes is very wide and on the equity team, we don't really think we have a unique edge and making political predictions all that,
in said under either scenario. We expect really choppy markets and pick up and volatility. However, longer term, we think european equity markets look really attractive for a number of reasons. First, unlike in two thousand twelve european sovereign
a crisis. There is actually limited risk of contagion here. So let me spell it out a little bit. Eighty percent,
greek sovereign debt is actually now held by the official sector. Point to greek banks are very isolated. Sink. European banks are obviously much better capitalize now, but also they themselves. Don't have exposure to greek banks, unlike for five years ago.
in terms of real exposure through revenues and sales. Greece represents only a third of one per cent of sales of european Ex Greece companies, so the contagion risk, in our view, is very limited, and perhaps the most important is that the easy b is very committed to using queuing here it on
started earnest in March, and there is a lot of room to go. That was a very powerful elixir over the last six years for U S, equity markets and it's going to be similarly,
awful in our view and driving european equity markets higher over the long term and then finally,
I just want to make the point that the fundamentals in Europe beyond Greece are actually quite sound. The broader
an economy is accelerating and earnings
continue to look pretty decent for european corporates
in saying for a very long time that these companies have a lot of operating leverage, they're, just missing revenues and as an demand markets have firmed up for european corporates, both in the core of Europe as well as the. U S, the revenue has come through. An earnings are being left it
so near term choppy managing the volatility but long term, still very positive. On european equity market. You mentioned Japan's man's been a tough story for a long time for investors, but things seem to have changed in there's a little attraction there. Would you think about the investment opportunities right now in Japan were really optimistic about equity return potential out of Japan and are highly three reasons there as well? The first is like Europe, you have this
central bank. That's an easing posture that can drive equity markets higher. The second is that most of the buying of japanese shares- in fact, almost all of it over the last couple of years, has actually been buying by foreigners, but this year were starting to see the domestic buyer come to them.
Get. It spent very well announced that the b o J, the Bank of Japan as part of their easing policies by inequities, in addition, GPS, which is a one point, one trillion dollar pension fund, the government Pension Fund of Japan, is coming to the market to buy it
What he's together? Those institutions are going to do about a hundred billion dollars of equity buying, but very notably weave spoken. A lot tore team on the ground in Tokyo and their starting to see the retail buyer come back to the market. So there are some pull through: there's the retail buyer and that domestic buyer. We think and help drive markets higher and then the last point I would make on japan- and this is actually the most profound in the most important one for us as equity investors-
that there has been a significant improvement on corporate governance across Japan, so under Prime Minister Abe's leadership. He said that
what or to revitalize Japan. One of the things that he wants to do is focused on corporate profitability and on the back of
the new governance code. That's coming out in Japan has stated start
this month June of two thousand fifteen. I s ass, which is the service that votes proxies for corporates around the world in Japan. I assess has been given permission to vote against management of companies to use and chairman who are not
to achieve at least five percent are away. So LO and behold, that's really changing management behaviour in Japan and when we're doing our company meetings were starting to see companies that never talked about
or are we or return on equity before really putting out targets and giving us very specific steps as to how we are going to achieve higher levels of profitability?
and if you look at the japanese market in the ten years up to two thousand and thirteen return on equity was only about six percent
versus the world average at twelve percent or we'll ask
for years. The return on equity in Japan has lifted by about a third, while the developed market averages actually fallen. So here you seem very tangible evidence of a pick up and profitability of the corporate sector. We take those three things together and easing central bank, domestic buyer coming to the market and a stronger corporate profitability. The picture looks pretty attractive to us and Japan going back to the: U S: the lower energy prices and generally just improving economy, lower unemployment rate tippet glued me
higher consumption needs. We haven't seen dramatic growth in consumption here in the: U S: r: U bullish on the consumer should be expecting to see and uptake at some point, or is this just a new status quo? We actually I'm pretty constructive on the? U S castle
so we should unpack it a little bit, because I recognise that there has been some bad data on the. U S: consumer coming out this year, where there actually is deflationary pressure for the? U S: consumer is in peril and there's two reasons for that. The first reason that you ve seen deflationary pressure. There is because of
find retailing, which means that there is transparency and prices and people are demanding lower price points. The second reason that there's been to play story pressure. There is something called fast retail, which is basically getting a pair.
Very quickly from the runway into the hands of the consumer's, mostly the millennials in this instance, which way we will get a chance to talk about an that's done through really optimizing and supply chains etc. But, overall, you see a lot of price compression in the apparel space. However, if we put that aside, we actually still see pockets of resilience in other parts of the- U S, consumer and in fact again,
backdrop of of higher savings savings rate. Fer you s. Consumers is somewhere in the maid Single Digits and what were seen as a much smarter. We would call kind of healthier. U S, consumer, that's being much more discriminating about how they're going to spend their consumer dollars. We tilted our portfolios to benefit from that trend, so we, like
mine, retailers, for example. We also see strong spending in areas like restaurants and entertainment. As U S, consumers are willing to spend four experience
So, overall, there is strengthened the consumer, but it's gonna be a healthier, smarter consumer and you have to be selective about how to play that so from an investment
that you mentioned the millennial generation
how they spend their money, how they use technology.
Different. We really gonna see different behaviour out of this generation, and what does it mean for investors
This rise of the millennials is, can have a profound impact on
way that economies develop and the way that corporates need to position themselves so taking a step back? This is obviously a topic that Gorman stacks has written about extensively and millennials means the cohort of people between the ages of fifteen and thirty five and there's ninety two million of them. So as a starting point, there's just
it's a large group of people and by the way, as an aside, I found out by reading that research in working on this
I actually Emma Millennia, because I was born in nineteen. Eighty and none
Saying that one of my analyst to observe back to me? Oh yeah, that's right! Europe,
we are really really old millennia. So I've, a fake MILAN,
of April audio, so I think I am
I'm going to self identify instead is a really young generation access, but in all seriousness mean this is, as I said, a very profound trend.
What were observing from an investment perspective is that this is going to be very important for consumer spending,
so millennials are coming into their prime spending years. We expect, even on an annexed five year, view that the increase in spending from
cohorts gonna be someone the magnitude of about two to five percent, whereas
we ve rumours are actually going to be spending less aggregate dollars, so we start
thinking a lot about what is this generation care about? What are the types of things that they could in fact spend money on and,
we again are looking to benefit from some of those trends through the portfolio. There's too,
finding markers of this generation. The first is that, of course, they are tech savvy, but the second is that they are commanding weaker incomes because of growing up and having most their professional life in the global financial crisis. Now
from an investment perspective? We observed that the combination of these two factors means they prefer access over ownership, and this
given rise to the concept of the shared economy and trends like booking a car on demand
rather than only one and pain, to stay in someone else's apartment rather than a corporate hotel. And then you can extend that example. In many different ways- and we are very focused on bottom up- finding the companies that will benefit from the trend. Ok, let's move onto China, we were seeing a lot of ups and downs, even more perhaps than in Europe in the markets. Would you
beyond the recent volatility in China and where might we go from here and we ve been very vocal about our concerns of over exuberance and chinese equity markets? Deauville asked several months, so I think we ve been unsurprising
the recent reversal in fortunes of chinese equity markets, but probably a bit surprised by both the
all activity as well as the magnitude of the cell off. So just to recap, the chinese local market was up a hundred and twenty percent to its recent peak and then last three plus weeks, we ve seen the sell off in the magnitude of twenty five percent. So too
point. These are very big moves for us. The reason that we have been bearish on the outlook for chinese equities over the last couple of months.
and we continue to be bearish. I is that there appears to us to be a very big disconnect between where the government, for example, is reporting growth and where we actually perceived to be growth. The growth on the ground from a real economic indicator standpoint so just walking through that it bent the government's reporting that GDP in China has slowed
the level of about seven percent, but I spent a lot of time in China. My colleague spend a lot of time in China when you're on the ground. There doesn't really feel like a seventy percent growth economy. We also follow what we
a real economic indicators in China. So we look at electricity consumption and rail cargo electricity consumption has essentially flat lined. As I said, we fall rail cargo and that's gone
It is, in fact, even more negative than it was during the financial crisis, so we put those pieces of the puzzle together and to us. It feels like there is actually a deceleration of growth in China, or at least in the manufacturing sector in China, which has an important part of the economy, so that's all giving us pause and then, at the same time new also see this very big disconnect between
fundamentals and performance just within the equity markets. Let me give you an example of some odd performance and individual companies. President Jake
a couple of months ago, very supportive about the future of soccer and China. He wants China to rise to be a dominant soccer country.
and we wish them all the luck in the world. They probably will be very successful at that, but we were a little bit worried to see that companies with very tangential relationships to soccer were up anywhere between ten to twenty percent. On the day of that announcement, that seems disconnected from fundamentals to us. Then there is the question of who is actually active in the equity markets, whose the buyer
here. We would observe that there is more than four million accounts being open every week in China, the exuberance is widespread across the retail investor and there,
always driven by fundamentals and they're, not always sticky money and then final point. I want to make us how those retail investors have been buying chinese equities, which is a huge
buying happening on margin, so margin buying only became legal
China in the last couple of years
and now Marshal had taken off it's it's taken off tremendously
now margin buying, as a percentage of the market cap, is higher in
then it is in the U S, Australia, Japan, etc. So that definitely gives us pause. So do question, obviously, is what happens from here. We ve had somewhat of a correction. Will there be more of a correction?
I would say here- and maybe this doesn't sound very brief, but I think it's really talk to predict, because the government is very committed to supporting the markets because of the well the fact
Certainly we wouldn't want to be in a position to bet against the chinese government, and also we think China is an important place for clients to have capital invested over the long term. But what we would say here is that this is the moment to be highly selective and how to build up your China exposure. So we would favour China eight share companies.
We're trying to Asia companies. We would avoid state owned enterprises, which are run in the interest of the government rather than the shareholder. So we are very underweight those types of companies, things that we like would be stock exchange than China. Let and those be companies that are basically monopolistic, highly cash flow generative and there
I ve been a fisheries of the high trading volume and then finally, we also like select consumer companies where consumers have a lot of brand affinity for those specific companies and therefore they have pricing power. So ok to have some exposure there, but you wanna be position for long term and you really gotta be highly selective. So you cut your teeth and emerging markets more generally. What you think about some of those markets, thoughts about some,
opportunities out there for investors now. So when we talk about emerging markets with our clients, we advised them to do three things. The first is that we think that they should have brought exposure to emerging markets as a theme. That simple reason for that is. It gives
an exposure to a higher growth area of long term at pretty attractive valuations, because emerging.
Could equity evaluations currently are at a thirty percent discount to the? U S and a ten percent discount to their own history, so growth that good valuation is a good reason to have a strategic allocation to emerging markets. Second, we also advise our clients to take an active approach to investing in these countries. We think that the benchmark for emerging markets is severely flaw
First of all, it is very over exposed to the mega cap space. It's dominated about. Forty percent of the index is, in those state owned enterprises again focus on the needs of the government and not the shareholder. It's over exposed to sectors like energy and under exposed to sustainable growth stories like the emerging consumer, so
to get active in emerging markets and then finally- and I'm certainly going to admit my bias he's here, but we also think that investors would be well served to invest with managers that are focus on individual bottom up. Stock selection
we're doing a lot of the heavy lifting to identify companies that can earn a return on capital, that's in excess of the corporate outbreak,
and when we do that and we apply that lends in a disciplined way, we ultimately arrive at a portfolio that has half the exposure off the benchmark and forty percent of it in the small in mid cap space and its tilted to what we think are much more sustainable growth stories in the fixed income markets. Katy. We ve been thinking in talking about
french war rise in interest rates for a while now and every day every month seems like it's getting a little bit closer. How do you think about what will eventually happened here in the? U S and the rise in interest rates in terms of equity investments? So we
I think that yes, rates are likely to arise in the next couple of months, were encouraged by the fact that equities have tended to outperform other asset classes when rates rice slowly off of low levels, and they do it because the backdrop of growth is actually reasonably strong. Hence the central bank and start to raise rates so equities have actually done. Ok,
environment and were encouraged by that. What we would also emphasise and contain emphasised to our clients, is in
environment, selectivity,
we'll company level is going to be exceptionally important because it's going to create a much sharper lying between winners and losers and so
really focused on investing and tilting the portfolios towards companies that can do well in a rising rate environment, for example, like banks and insurance companies, and we are taking underweight positions in companies that will be in that environment like reads, for example, or utility.
He's emanates at very high levels and has been over the past eighteen twenty four months. That's help fuel equity markets as valuations, get pushed higher on acquisitions or or the the prospect of acquisitions do expect that trend to continue and help propel
markets. Yes, I think the boom in emanate will continue against a backdrop of benign global growth and low financing costs uniquely,
as cycle acquiring companies have actually seen a boost in their stock price. That is actually quite unique to this cycle. And
that's telling us is that seals are getting a very strong message, particularly in
U S in Europe to go after growth to get access to new markets and new technologies, and we think that will continue because growth is scarce
now. Obviously, the target companies have also seen significant share price appreciation and we have been fortunate to own many of the targets, particularly in the health care, as well as the technology
sector and while we're long term investors in the
businesses and we
Onam and look to realize significant value over time. Sometimes corporate activity can unlock that values sooner. It's just another demonstration of the inherent value in the names that we choose to known for our clients. Peace will last question. We should have covered the world here, but big picture the rest of the year, what he say about global equity markets and then what do you think we'll be seeing as.
These rates right here in the U S so lacking the proverbial crystal ball, but I'll, try and give my best answer. We are reasonably optimistic that we're gonna get high single digit returns from global equity markets. That's what we said going into the year. That continues to be our view, and we think that the ability for active managers to add meaningful out on top of that continues to be very strong. I'm already seen early signs of that, so we think invest
There's should continue to maintain their holdings in equities for the remainder of the year and again get more active to help them navigate and environment that could be dislocated when rate start to rise. That's great Katy. Thank you very much for joining. That concludes this episode of
changes, the Goldman Sachs objects. You were as follows. This podcast was recorded on July, sixty two thousand. Fifty the views and opinions expressed here and should not become
rude as an offer to buy or sell any securities, and such views and opinions may differ from those of Goldman Sachs. Global investment, research or other departments are divisions of Goldman Sachs and its affiliates. This information may not be current, and Goldman Sachs has no obligation to provide any updates or changes. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty as to the accuracy or completeness of the statements or any information contained in this podcast and any liability, therefore, including in respect of direct,
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