Reflections of a Goldman Sachs Manager

time to debrief. To do that, we're joined by Goldman Sachs, Asset Management's co head of Fundamental Equity, to discuss how the firm has approached the year and also how it's positions for the future, And of course we will close out the episode with our tradition the Craziest Thing I saw in markets and Sarah, as you said, great guests this week to talk about the equity markets, because I think the big question on a lot of people's minds this year is has this market gotten sort of detached

from the fundamentals. So we have a very much a fundamentals expert this week. She, as you said, as the co head of fundamental equities at Goldman Sachs Asset Management. Her name is Katie Coch. Katie, welcome to the show. Thank you so much for having me. I'm excited to

be here. So Katy, let's get right into it. You know, as we've all noticed, the valuation expansion in the market this year has been astounding, given the economic uncertainty and the sort of nasty recession that we've already seen, and who knows how long that's gonna last. Of course, at the same time, you have real interest rates are negative. It looks like interest rates will stay low, possibly negative on a real basis after inflation for a long time.

I'll phrase it as simply as possible. Does the market make sense to you based on the fundamentals were um have what we've seen this year? Does it trouble you

how how aggressive the valuation to spenching has gotten. The way that I would look at it is when you think about the markets overall, they're effectively flat on the year, and so a lot of people will look at that and say, how is that possible given all of the you know, challenging news that's out there that you alluded to, and I want I want to make three points on this connected to the headline that we can get behind UM, the sensibility of markets if we're selective about opportunities UM.

And so you know, three things to observe is that while the markets flat on the year, there's a lot kind of happening underneath that really an exciting return UM. So we've had a huge draw down and and a tremendous recovery as you know that are involved in getting us flat. The media and SMP five hundred stock is

still you know, somewhere around twenty off. It's high, and there's a little group of companies we all know called the Fangs, which are up over thirty on the year, while actually the rest of the SMP five hundred is still down about five. And then of course we also have this wide gap between growth and value UM, although that's narrowed a little bit in the last couple of weeks,

which hopefully we'll talk about. So, yeah, the market's flat on the year, but then under that lots of different stuff happening, and so we can find great value, but you have to really hunt for it. The second comment

I would make quickly would be around valuations. You alluded to the fact that valuations are demanding UM and in fact, the US market is trading right now on a twenty two times twelve month forward multiple, which puts it in about the ninety percentile of its its most expensive I want to make two balancing comments to that, just to put people's fears at ease about how expensive the market is.

The first is, we really need to look at those valuations in other low inflation periods UM and so actually, if we look at low inflation regimes, today's valuations are really just above median levels UM. And then in addition, of course, we we do have depressed earnings because we're in a recession, as you mentioned, and so that's elevating PE level those two. And then the second point I want to make is equities relative to other asset classes.

So we look at something called the implied equity risk premium, which is just a fancy way of talking about how expensive equities are to other stuff like bonds, and it's at a very attractive three point eight percent premium, and that's only been higher about a third of the time over history UM and it certainly stands, for example, in sharp contrast to the negative equity risk premium we saw

during the tech bubble. So yes, you know valuations are demanding, but it's a little bit more of a nuanced story than that. And again, if you are selective, you can find opportunity. And then the final comment I want to make is that I do believe, and we do believe at Coleman's successet Management and on our equity team that regardless um of any of the stuff we just talked about, equity markets really do need continued monetary support and fiscal support um to to be able to hold in at

these levels. And they also need earnings to come through, at least to meet the low expectations out there for earnings. And of course we're in the middle of earning season now, so we should get a lot of interesting data on that front. So let's get back to that dispersion idea that you said. You look onto the surface of the stock market and clearly not every stock is the same,

not every stock is a thing stock. So over the last eight months, throughout the coronavirus era that we've been living in, how have you guys been trying to find

value within the market. This is a great question. And one of the things with the coronavirus environment has done UM is created a lot of differentiation between business models, and so there really has never been a more important time to embrace active management and navigate which of those business models are going to win and which ones are

are going to lose. And so I think that stock specific dynamics really matter now more than ever, and we're seeing huge differentiation within narrow parts the market, and this really creates tremendous opportunities for for active managers. So I want to give you a couple of examples to help

us understand that. So let's take restaurants, relatively narrow category. UM. We've been focused on the millennial preference for value, digital and delivery for a really long time, and COVID, of course, is accelerating a lot of these trends and drawing in more demographics beyond the millennial consumer as we have to consume more things online now. In restaurants, on the one hand, you have a company like Dominoes, and we think of Dominoes as a technology company that happens to deliver pizza.

Seventy of their sales are digital UM. They reported earnings recently, same store sales up sixteen percent year over year UM and the share price reacting very positively on the year. On the other hand, in the same category, you have a franchise like Darden Restaurants. They own a bunch of brands, including Olive Garden, which probably most people have heard of. UM. They are a dine in establishment. The delivery and digital

sales is very limited. They're reporting same store sales down and of course the stocks reacting quite negatively on the year. So that gives you a sense of how important in this environment it is to distinguish between business models. Another example would be big box retailers, and many of them were really struggling before COVID because of amazon ification of

the retail market that's taken place over the last decade. However, there are a couple of big box retailers that are succeeding despite Amazon and UH, and despite the recession that we're in. The markers of those winning companies are are really two things. They usually have products that are in demand during quarantine UH and second, they have tremendous e

commerce strategies. The pandemic is accelerating e commerce trends that were already in place, and as Toby um Luca, who's the c E Shopify, has said, e commerce has made a ten year jump in a matter of months. And so, on the one hand, you have a company like best Buy, which is an electronics retailer. They have sales that are up year over year both domestically and internationally. Now why,

First they have that relevant products set for quarantine. They have the largest product category of sales for computing, working from home appliances because we're eating more at home, and tablets because we're learning from home, so great products set for the environment. And second, they have a tremendous e

commerce footprint. Their online sales have grown two hundred and fifty five percent versus last year UM and they've even sustained that at close to a hundred and nine since stores have reopened, and the stocks obviously reacting positively on that. So that's a winner. And then on the other hand, we have a plethora of undifferentiated mall based retailers. Sales are down more than dee percent. In most cases, they're

facing many of them are facing bankruptcys. On the product side, they're not selling particularly differentiated products or products that are in demand during quarantine, A lot of clothing and as as you probably would recognize, we're not all going out and buying new clothing unless it's sweatpants. Um. And then on the the the e commerce footprints side, really they've they've done too little, too late. So those give you some examples of how UM, there is a lot of

bifurcation in the market between winning and boot losing business models. Um, this recession is really different from any other recession we've seen. But if you're selective and you can get on get behind the right business models at the right valuations, there really should be tremendous opportunities here for active managers. So, Sarah, a lot of great points in there, you know, I

Katie especially like the point about best Buy. I know personally I've been looking to upgrade my TV during the pandemic. But so Katie, talk us through then, how your team looks at those giant gorillas in the room, the top five stocks in the SMP. You know, your Apple, Amazon, Alphabet, Microsoft, you know, taking up a record weight in in indexes like the SMP. I think less. I checked something between a quarter and a fifth of the SMP was just

those five stocks. I mean, does it lead you to want to underweight those super richly valued heavyweight stocks, uh, and look for those value stocks like the ones you mentioned in retail and restaurants or is it the type of environment where you really can't afford to underweight these big names. We think the things are are great franchises, We own some of them, but we do believe that investors would be well served to diversify beyond them in the hunt for future tech leaders. UM. So, a couple

of points to make here. Um. As you know, many US investors and a lot of people listening to your program have embraced passive investing. And what I would observe at the outset here is that we need to consider whether a passive investing has in fact become too aggressive Because to your point, there's lots of concentration in a little number of companies. So it's about twenty two of the market cap in the top one percent of the names that exceeds the eighteen percent we reached in in

two thousand. Um. There's lots of of of different you know, ways of looking at this. But another way to put it into context for people is that the four largest Amazon, Apple, Microsoft, Google currently have a market capitalization that's bigger than the entire country of Japan. Uh, they're worth just shy of six trillion. Well, Japan's equity markets worth five point eight

four trillion. You know, despite the sharpest session on record, these companies have added more than a third to their market values in and I think we really do need to pause and ask ourselves this question, you know, is it justified and will it persist? So let's break it down this way. There are some real positives for these companies. So on the one hand, they've got the cleanest balance

sheets within the market. That's the first point I would make, more than two and sixty billion dollars of net cash um, lower leverage than the rest of the market, better liquidity and visibility. Uh. The second point I would make is that they do have strong growth prospects. Their near term growth expectations are about fifteen percent versus eight percent for the media and SMP five company, and their catering towards trends with both secular and cyclical tailwinds like cloud, e

commerce and digital payments. So those are all, you know, very positive. And I'd also just mentioned From a valuation perspective, you know, these are valuations are just not as demanding as they were at the peak of the tech bub bole. And these stocks are driven not just by long term growth expectations, which we saw a lot more of in in two thousand, but actually by strong realized profitability again,

lower leverage, and all these other markers of quality. UM. I'd also say, you know, something we should give them credit for is that they've shown offensive as well as defensive characteristics. They were leaders in the market correction and also the rebound, which you know generally warrant's higher evaluations. So those are all some reasons to feel good about

the Fangs. However, as I stated at the outset, I do think we need to consider the possibility of UM that we need to diversify beyond them, and that passive has become too aggressive. So on the other hand, I want to point out some some balancing comments to that. I do think there could be some clouds forming on the horizon which could threaten their dominance going forward, and this should motivate investors to to diversify beyond the Fangs.

There's tremendous turnover historically in the tech ecosystem. Over the last twenty three years, the largest tech company by market cap has changed eight different times. UM market leaders have historically not really been able to maintain their leadership positions for more than five or six years. So a decade

ago with Cisco, Intel, IBM, Oracle, et cetera. Mark Zuckerberg himself alluded in his his congressional testimony that after ten years of fang dominance, you know the next ten years and big companies in the next ten years could look different. So ecosystem turnover historically has been high. We expect that to persist. The second point I'd make is, you know these companies, and this doesn't get talked about a lot,

but they are catering to somewhat saturated markets. So if you take Apple, it's fully penetrated market for high end smartphones UM, leaving growth more dependent on replacements and services that are attached to to the phones. But it's hard to move the multiple on that. In the case of Amazon Aws, which is a real driver for that business, their cloud business obviously has real competition from Microsoft often and Google, so growth is going to naturally be slower.

And then the company is involved with online advertising. UM you know, that's now fifty percent of global advertising, so one would expect growth to decelerate over time. So the third comment would be that there is potential for increased regulation and we're obviously seeing that play out right now.

Uncertainty over government regulatory actions is generally not good for corporate decision making, and we saw that with Microsoft in the two thousands when it faced various antitrust investigations UM, and it makes doing M and A, which has historically been a driver of growth for these companies, more difficult. So that regulatory overhang, you know, we we do think UM could persist. UM. So taking all those comments together, some reasons to feel positive about the things, some balancing

comments that, you know, give us pause. I think that the headline is that passive has become too aggressive and we really need to invest and look for opportunities in tech beyond the things. And I'll highlight two areas that that we're looking at UM. The first would be in companies outside the US. We particularly like local tech leaders and emerging markets. So e M consumers are getting access

to fast, ubiquitous internet for the first time in history. UM. They're also now able to access the internet via their mobile phones, and this is giving rise to something we call the splinter neet effects. So this is local companies applying proven business models from the US in new, high

growth markets um SO. Examples of these local tech titans would be Mercado Libre Um which is the Amazon of Latin America where online penetration is only five percent versus fifteen to twenty and most developed markets, or see which is the Amazon of Southeast Asia. Um and these companies, I would note, are also trying to become leaders in other fields beyond e commerce. So Mercado Libre is getting into payments and see um is getting into online gaming.

And one might argue this would be like investing in Amazon five to ten years ago with big addressable markets. And then the second place would be going further down the market cap spectrum UM looking at small and mid cap companies versus the mega cap So we like innovative and differentiated, pure play small cap companies that are developing highly differentiated and superior technology to service new markets. Um SO.

An example here would be Ping Identity, which is a provider of intelligent identity solutions and is disrupting identity and access management market, which is you know, identity being a very big focus now and this is a very specific provider with a high growth rate and obviously not something captured when investing UM in the fangs UM and so in some way, well, I think the Fangs are are fine franchises to own. Again, some reasons to be positive,

but certainly some reasons to be concerned. What investors need to do, UM is think about allocating some capital away from those dominant franchises in search of you know, new emerging tech leaders which we can find both outside the US and with in the US down the market cap, Katie, I find it really interesting that of the industries that you've high lighted so far, so that being restaurants, retail, and tech, I mean two of them are presumably completely

coronavirus losers, except where you highlighted you can find winners. And tech has just developed into the star of once again, two ends of the spectrum. I mean between those two spectrums, are there any areas that you would just absolutely stay away from you think it's too difficult right now to really find something that's worth it to throw capital at. I think it's really important that in this environment, and really any environment, that investors run balanced portfolios and that

they capture both growth and value ideas. And I guess my my overarching point here would be that I think it's possible to find winners in every sector, but you really have to get behind the right business models. Um, and that difference between winners and losers is going to express itself in every single sector. If take energy, for example, there's a lot of reasons that everyone listening to this knows that we shouldn't be super excited about the future

of energy, and that's reflected in share prices. But what about renewable companies within the energy space. Some of those companies are up thirty to renewable fuel companies for example, which we think is the future of the energy market. So even in the sectors that are at least loved within the market, you can actually find winning franchises if you hunt, and again, you know, you get behind the right business models. I think that's always been important in investing,

but this crisis has made that more important than ever. Yeah, Katie, that mention of renewable energy is uh, it's a good segue to the topic of E S g uh And for anyone listening, who's I don't know, been asleep for the last five years and doesn't know what that is. It's basically investing with the idea of the environment, social issues, and government governance issues in mind when you're picking out companies.

And I'm kind of fast needed at how you look at that at the E s G world through the sort of the goggles of a fundamental investor, because I do think there's a case to be made that, Hey, if your company is less likely to get say a big fine for an environmental issue, or uh, you know, less likely to be boycotted over a social issue, or less likely to you know, have the CEO forced out in a governance issue, that type of thing, that there is very much a fundamental case to be made for

incorporating E s G factors in your research. Is that a big part of the reason why E s G is so hot? Is it not just sort of a clear investing with a clearer conscience, And not to say there's anything wrong with that, I'm all for that, but is there also, you know, from the work you've done, is there a fundamental case to be made for why

this stuff is important? Absolutely at Goldman Success that management and in particular within our our fundamental equity team, we think that consideration of E s G issues is often just correlates to quality UM, and we have a strong belief.

We're long term investors and have a very strong belief that quality will outperform over time, and so we consider E s G across the entire sixty billion dollars of of of assets that we manage UM, in addition to our our dedicated E s G portfolios, because focus on these issues should be a way to UH avoid risks but also to generate alpha for all investors, regardless of how focused the organization or the individual might be on

on E s G UM. I'll take a step back and maybe make a couple of quick points about the space UM. The first would be that we believe very deeply that the world is on the cusp of a sustainable investing revolution and UM we think it could be one of the biggest investment opportunities ever. It had the magnitude of the industrial revolution coupled with the speed of the digital revolution and a tale from from COVID. You know,

how do we account for that? As I mentioned earlier, we we integrate consideration of E s G issues into all the assets we manage. We also have a lot of idea generation on the back of this UH emphasis on e s G. So, in other words, we invest in solutions providers to E s G issues. And then of course we think about this a lot when we're engaging companies. So just from an environmental perspective, UM, we think that's going to continue to grow in an importance

and an emphasis. A winner on this front, by the way, is Europe. So you know, there's a lot of bad news over time around Europe UM, but this is actually a place where Europe can really excel and own and and and succeed UM. The EU estimates the additional yearly investment required to achieve the EU Green Deal targets UM, which are are mostly environmental focus, is more between a hundred and seventy five and three hundred billion euros for

the next couple of decades. And this will be met with the mix of both public and private capital UM so giving rise to a lot of interesting opportunities at the company level. And again Europe, with its combination of UM you know, taxes, UH incentives, government and academic partnership, is going to give ride continue to give rise to a lot of companies that will win in this space in the US. I would also just just mention um

we talked about the dominance of the fangs companies. One of them knock on impacts of that from an E s G perspective is that when these sizeable companies choose to do something about their environmental responsibility, it has unbelievable impacts on the market. UM. So Amazon recently announced that they're going to target a hundred percent renewable power for their operations. By they've actually moved that goal forward, they're

currently at forty two percent. They've leaeve that they'll be carbon neutral by including using for transportation a lot of electric vehicles. They've already ordered a hundred thousand units of electric vehicles UM. And so you know, these these types of announcements can have given the scale of these companies, will have an incredible impact UM. And so that gives all together gives you some sense of just that the

scale of the opportunity and the environmental part. Successful companies will UM integrate the way that they think about environmental sustainability. And then there's also this investment opportunity for US to to invest in companies that are going to be the solutions providers in this space. UM. I will actually give a quick example here on a sustainable environmental company called Ball Corp, which you know may not be known by everybody. It is an aluminum can manufacturer UM relegated to to

the boring value bucket. For for most of the last ten years, UM it was it was x growth because most products UM were that they made were soft drinks and then domestic beers, which we're both effectively rejected by millennials. But they've seized on consumer discussed with the plastic UM in in landfills and oceans, and they've been lobbying more companies to to make what we call the the can

king again. UM. Now, virgin aluminum is actually quite expensive to make, but aluminium can be recycled forever with no loss of properties, and it's pretty cheap to recycle. So there's a sixty five percent recycling rate of aluminium in the US. We actually recycle a hundred thousand cans a minute UM and it's actually even higher in other countries. UM. It has a lower energy consumption UM when recycling aluminum

versus making new aluminum UM. And and just for comparison purposes, the recycling rate of plastic is in the low single digit and now because of people's focus on moving away from plastic, which is less sustainable, to aluminium, which is more sustainable, volumes are now growing again at five UM per year and um. As a result, the share price has has really moved upwards, uh quite aggressively. And so that's an example of a solutions provider to this environmental issue.

Great points all around, Katie. You know, yeah, you hear a lot about that culture at Costco and I think you know, people that work there really treated as a career, not sort of a a mick job that you hop from uh and and have a lot of turnover. Um, so uh, kudos to them. You did miss a big catalyst for them, Katie. I'll tell you what it is. Their roads history chickens are incredible. Have you had have you guys had one of their roots history chickens. They're

delicious root history chicken. But I have been known to sample all those those free samples. Next time we go, I I will. My husband's actually the the CFO and our family he tracks are spending and I do know that we're spending uh much more now on Costco than than we used to um and that will have to add the rotisserie chickens to the shopping list. Samples are the best part of Costco, but I would imagine that

that's had to be up pulled back in these days. Yeah, I'm gonna start bringing a disguise so I can hit the samples twice. They won't realize it. Alright, Sorry, you know what time it is. I think I do stand clear of the craziest things we saw in markets this week. Alright, So mind dates back to our conversation that we were having about the Fank stocks and really just mega caps in general. So the statistic is a little bit dated, but it's as of late July. So I'll give you this,

and I just find it pretty mind boggling. This comes from Michael O'Rourke over at Jones Trading, and he pointed out that so far this year, on sixty two and a half percent of trading days, the Nasdaq one hundred has actually closed in positive territory and that is a record for any year in the last thirty four years. And I think it's just pretty crazy to think at

in the year of we're dealing with the coronavirus. We're dealing with such deep recession at the same time, then as E one hundred has had its largest share of positive trading days ever at least uptil this point. I got ahead at you, Sarah, that one's pretty good, Katie, can you top that one? That's a pretty good. Crazy thing, though, I would say one of the craziest things that we're seeing in this market is just really a typical behavior for a recession, and so I would I would call

out here, for example, home builders. During a typical economic downturn, people hold off surprisingly from buying homes and home builders suffer. UM. However, the home builders have been doing really well, growing profits and stocks have have been rewarded. And why because in the COVID specific recession we've got record low mortgage rates and also mass exoduses from cities, so mortgage applications at and the median listing price of homes up up seven UM.

And then of course there's also some UM associated companies that are are benefiting as we spend more time in our existing homes and buy new homes like UM, like Sherwin Williams, for example, who of course sells paints they're showing pain sales up in the second quarter as more people again focused on decorating the homes that they're they're spending more time in UM, which also supports the fact that UM in this quarantine, watching paint dry has actually

become an exciting exercise. I mean, we have to get creative, right, Yeah, that's pretty good. The housing data lately has been pretty amazing to watch. I think it's caught a lot of people off guard as well. It is remarkable. Yeah, well, Katie, I hope my wife doesn't listen to this and get ideas about us repainting the house. I cannot stand painting. I as you said, your your husband's the CFO. I'm

the official house painter of our house. My wife's actually our our CFO, and I'm the official house paint and the I T guy. I gotta fix all the kids. Uh, computers, they sort, they do. It's it's usually you know, if if you restarted and it doesn't fix it, then I'm out of ideas. So I don't know but that you'd be abased how many times that fixes it? All? Right? You guys, You guys came pretty pretty well this this

week with the crazy things. I'll give you mine. Sorry, mine's a few weeks old, I confess, but I can't believe it hasn't come up in the Crazy Things uh episode yet or Crazy Things segment whatever. We call our gimmick. And it's a story from the Financial Times a few weeks ago about what they called mafia bonds and as their leader of their story says, international investors bought bonds backed by the crime proceeds of a Italy's most powerful

mafia according to financial and legal documents. So basically the mafia and Italy had set up a bunch of sort of fake front companies and then issued bonds not on the not on public markets, but in private markets um basically backed by these fake front companies. So that sort of one billion euros worth of these bonds. Amazing story from the FT. I will say they left out. There's one big important thing they left out. They didn't say

what the yield was. If I'm gonna buy some mafia bonds, I want to I want a nice yield, I want a nice spread. They did say that investors in the bonds included pension funds, hedge funds, and family offices quote, all looking for exotic ways of earning high returns at a time of record low interest rates. So that is certainly one exotic way. I don't know, Katie, if I don't know how mafia bonds fair in the in the E S G. I imagine that wouldn't fit your E S G bill, right, I don't think it fit the

E s G bill. And if people are looking for better returns, I would encourage them to first look at equity markets. We we've got a lot of returns and on offer from some very responsible companies, and some of them trading at attractive euasians. That's right, it's all. It's all about risk adjusted returns. Your risk with these bonds

is quite unique. I think. Yeah, from now on, when people say or talk about the Tina trade and say there is no alternative because interest rates are so low, Mike's going to go ahead and just point them to mafia bonds I have in New Jersey here, so you know there might be a different class investors interested in news than Okay, a couple of weeks old, but that one was worth it. I had Listerine perpetual bonds the

other week. Mafia bonds beat that, all right? Well, I think we all came prepared this week housing Mafia bonds and then also just the Nasdaq continues to make its way onto the list. So with that said, Katie Cox, thank you so much for coming on the show this week. It was really fun. Thanks so much to both of you for having me What Goes Up. We'll be back next week. Until then, you can find us on the Bloomberg Terminal, website and app, or wherever you get your podcasts.

We love it if you took the time to rate interview the show on Apple Podcasts, so more listeners can find us, and you can find us on Twitter, follow me at at Sara Pantzeck, Mike is at Reaganonymous, and you can also follow Bloomberg Podcasts at Podcasts. Also thank you to Charlie Pellett of Bloomberg Radio and the voice of the New York City Subway System. What Goes Up is produced by Jordan Gospore. The head of Bloomberg Podcast is Francesca Levi. Thanks for listening, See you next time.