WEBVTT - Goldman Sachs David Kostin Talks S&P 500

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<v Speaker 1>Bloomberg Audio Studios, podcasts, radio news.

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<v Speaker 2>And this week you might remember, Goldman Sachs came out

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<v Speaker 2>with a note saying that the streak of blockbuster gains

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<v Speaker 2>for the SMP five hundred it might be over. And

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<v Speaker 2>they say that we will only see around annual gains

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<v Speaker 2>around three percent over the next decade compared to the

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<v Speaker 2>average thirteen percent over the past decade. And we are

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<v Speaker 2>joined now by Goldman Sachs chief US equity strategist David Costin,

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<v Speaker 2>who led that call. He joins us. Now when you

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<v Speaker 2>think about this call, very controversial, David, and so I

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<v Speaker 2>am very curious about kind of what the caveat is here.

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<v Speaker 2>Is there kind of any upside that could be squeezed

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<v Speaker 2>out of the equity market that is outside of this

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<v Speaker 2>base case.

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<v Speaker 3>So let's talk about the base case for the next year,

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<v Speaker 3>and then we'll look at the base case for the

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<v Speaker 3>following nine years for full year decade of performance. So

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<v Speaker 3>the next year, we're looking at the S and P

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<v Speaker 3>five hundred rising around eight percent nine percent total return

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<v Speaker 3>to an index level of around six three hundred. And

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<v Speaker 3>the thought process behind that is the US economy is

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<v Speaker 3>growing in plation's coming down the fat is cutting rates.

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<v Speaker 3>Earnings are growing eleven percent in calendar twenty twenty five

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<v Speaker 3>and another seven percent in calendar twenty twenty six, and

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<v Speaker 3>that sets up with a valuation today of around twenty

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<v Speaker 3>two times earnings, slight compression in the multiple, that is

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<v Speaker 3>the building blocks to a return of the next twelve

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<v Speaker 3>months of roughly nine percent. So what we focused on

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<v Speaker 3>in this report was what's the probable total return that

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<v Speaker 3>an investor should anticipate for the cap weighted S and

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<v Speaker 3>P five hundred index, and the conclusion was a range

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<v Speaker 3>of somewhere between negative one percent and positive seven percent.

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<v Speaker 3>Midpoint of that is around three percent. What is the

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<v Speaker 3>driving force behind that thought process and that analytics, Well,

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<v Speaker 3>there are two issues. The first is valuation. We know

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<v Speaker 3>when the market trades at a high multiple, a high

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<v Speaker 3>valuation that the next ten years is typically low. Relative

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<v Speaker 3>to an environment where say the multiple is low at.

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<v Speaker 4>The beginning, you tend to get a.

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<v Speaker 3>Pretty strong return in the subsequent the substitute decade. So

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<v Speaker 3>we're sitting here with a cyclically adjusted pe multiple that's

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<v Speaker 3>different from a forward one year multiple based on the

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<v Speaker 3>cyclical adjusted earnings for the last decade of thirty eight times.

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<v Speaker 3>That's the ninety seventh percentile versus say, the last.

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<v Speaker 4>One hundred years. So it's a very very expensive starting point.

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<v Speaker 3>And what's new about the analysis is that we also

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<v Speaker 3>include a variable for concentration. We're in one of the

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<v Speaker 3>most highest concentration markets in one hundred years. Top ten stocks,

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<v Speaker 3>for example, comprise around thirty six percent of the index.

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<v Speaker 3>It's an extremely narrow concentration, and historically when you have

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<v Speaker 3>a high concentration market, you have a relatively muted return

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<v Speaker 3>in the subsequent ten years. Now, valuation and concentration are

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<v Speaker 3>two different variables, they're not correlated, and so there's two

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<v Speaker 3>different influences as to why we get a lower, relatively

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<v Speaker 3>modest return. Now, what are the implications for a portfolio manager, Matt,

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<v Speaker 3>The way you want to think.

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<v Speaker 4>About this is equal weighted.

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<v Speaker 3>The equal weighted return is likely to be probably five

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<v Speaker 3>hundred bases points greater. So instead of three percent for

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<v Speaker 3>an aggregate index, something like eight percent for the typical

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<v Speaker 3>equal weighted indexes. So that's the conclusion of the report.

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<v Speaker 5>Well, but the concentration is in I think very many

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<v Speaker 5>global champions, right, I mean, you have companies that dominate

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<v Speaker 5>their spaces globally. Plus we've got a few that are

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<v Speaker 5>likely to come on board soon. SpaceX for example, open

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<v Speaker 5>Ai may go public in the next decade. And if

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<v Speaker 5>I look David over the last decade, I actually stole

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<v Speaker 5>this chart from Data Trek. As I've pointed out before,

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<v Speaker 5>but the only time that we've had three percent returns

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<v Speaker 5>has been when we've had catastrophic events the Great Depression,

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<v Speaker 5>the oil shock, the financial crisis. Do you expect something

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<v Speaker 5>like that to come again over the next decade.

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<v Speaker 3>No, we're anticipating is a broadening of the market. The

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<v Speaker 3>relative performance of the typical stock versus.

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<v Speaker 4>An aggregate index.

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<v Speaker 3>We're focusing on is a strategy for how to perform

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<v Speaker 3>well when we deal with some of our largest institutional clients,

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<v Speaker 3>sovereign wealth funds, pension funds, endowments, insurance companies, family offices.

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<v Speaker 3>When they think about a ten year horizon, they think

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<v Speaker 3>about acid allocation.

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<v Speaker 4>Where are the risks?

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<v Speaker 3>And the idea of a very concentrated market is what

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<v Speaker 3>tends to be a risk that gets introduced. And that

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<v Speaker 3>is the emphasis of this report, and that's the thought process,

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<v Speaker 3>that's the analytics behind it. In the model that we

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<v Speaker 3>build we look at rates, we look at the economic environment,

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<v Speaker 3>we look at the offit ability in the row of companies,

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<v Speaker 3>and so all of these variables at the index level

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<v Speaker 3>relative to the typical stock. That's how we get to

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<v Speaker 3>a conclusion that it's a better strategy, a better return

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<v Speaker 3>strategy from our perspective, with an equal way to strategy.

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<v Speaker 1>Well, David, I want to talk about the cross asset

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<v Speaker 1>nature of this call too, because you say that it's

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<v Speaker 1>likely that bonds are going to outperform in this environment.

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<v Speaker 1>But reading through this call, I mean, if you're not

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<v Speaker 1>calling for a recession here, I assume the Fed doesn't

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<v Speaker 1>cut rates back to zero, wouldn't this be a call

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<v Speaker 1>for cash. Aren't cashields going to, say, relatively high and

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<v Speaker 1>you don't have any credit or duration risk there?

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<v Speaker 4>Well, I mean there's other strategies.

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<v Speaker 3>You can look at private credit, You could look at

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<v Speaker 3>private equity as a potential way of diversifying a portfolio

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<v Speaker 3>relative to right now, the idea of Treasury's tenure treasuries.

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<v Speaker 4>Yielding four point two percent.

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<v Speaker 3>So if you're at a start today and look out

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<v Speaker 3>with our centerpiece of the central case of our forecast

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<v Speaker 3>something like three percent. But if you look at the district,

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<v Speaker 3>look the idea of being at the high end. There

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<v Speaker 3>are a lot of reasons why you could be at

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<v Speaker 3>the higher end of our range closer to seven percent.

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<v Speaker 4>Identified a couple of those.

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<v Speaker 3>You know, you typically get around three and a half

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<v Speaker 3>percent of the constituents in the S and P five

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<v Speaker 3>hundred turnover every year, So we look out for a decade,

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<v Speaker 3>you're probably looking at a third of the index. There's

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<v Speaker 3>going to be new stocks that don't exist today in

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<v Speaker 3>the index. So there's certainly a lot of variables that

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<v Speaker 3>could happen. The economy could be growing more rapidly, more

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<v Speaker 3>slowly than.

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<v Speaker 4>A baseline forecast. Those are their issues.

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<v Speaker 3>AI in terms of artificial intelligence, could raise productivity. I

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<v Speaker 3>mean lots of reasons why it could be better than

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<v Speaker 3>our base case scenario, which is why we have a

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<v Speaker 3>range to the upside of the down here.

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<v Speaker 2>You know, one thing that struck me in this note,

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<v Speaker 2>as well as a one third chance that you have

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<v Speaker 2>the S and P five hundred lagging inflation through twenty

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<v Speaker 2>thirty four, what's the role of inflation here and what

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<v Speaker 2>is the risk that it could be higher? What if

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<v Speaker 2>the neutral rate is higher? What kind of impact would

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<v Speaker 2>that happen on equity market returns?

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<v Speaker 3>Well, so you think about inflation right now, the tips

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<v Speaker 3>break evens are around two point two percent, for example,

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<v Speaker 3>and so based on a scenario where you have a

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<v Speaker 3>return that could be negative one percent annualized versus positive

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<v Speaker 3>seven percent, kind of there's a distribution around that relatively

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<v Speaker 3>normal type distribution. The part tail of the distribution would

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<v Speaker 3>give you a prospect of a return that's less than inflation.

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<v Speaker 4>That's not the base case, but it's only a is

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<v Speaker 4>a scenario.

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<v Speaker 3>You know, when deal with portfolio managers, they want to

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<v Speaker 3>think about what are the risks that are introduced into

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<v Speaker 3>their portfolio. And the argument behind a broadening of the

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<v Speaker 3>market is an important construct. So one of the arguments

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<v Speaker 3>on why mid cap stocks are likely to do better

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<v Speaker 3>than than the rest of the market in the coming year.

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<v Speaker 4>They have the.

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<v Speaker 3>Best torque to the idea of the FED cutting rates.

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<v Speaker 3>They got twenty five percent of their balance sheet is

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<v Speaker 3>floating rate, so you have the FED cut rates, They

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<v Speaker 3>have less interest expense, they have higher earnings, positive rarnings, revisions, drives,

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<v Speaker 3>equity prices, and so those are tactical issues opportunity these

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<v Speaker 3>in the market so we think about tactics, we think

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<v Speaker 3>about strategy longer term. And that's the purpose of writing

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<v Speaker 3>the report and response to questions and clients about how

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<v Speaker 3>should we think about the perspective ten year forward returns inequities?

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<v Speaker 1>Right, David, we don't have a lot of time left.

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<v Speaker 1>I know I have a question. I know that Matt

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<v Speaker 1>has a question as well. So let me ask you

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<v Speaker 1>this quickly. I want to get existential about the business

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<v Speaker 1>that you're in because you think back to January and

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<v Speaker 1>actually Wall Street strategists, on average, we're expecting the S

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<v Speaker 1>and P five hundred to rise about two percent this year.

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<v Speaker 1>It's up twenty three percent. And I'll flip the question

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<v Speaker 1>to you, is it getting harder to model to forecast

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<v Speaker 1>where the index is going to go?

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<v Speaker 3>Well, it is challenging because a third of the index

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<v Speaker 3>is comprised right now of about ten stocks. That's not

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<v Speaker 3>just tech stocks. You have some healthcare socks, Eli Lilly,

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<v Speaker 3>You've got Berkshire, Hathaways in the top ten companies for example.

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<v Speaker 3>Depends on the day we're looking at it could be Visa, Broadcom,

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<v Speaker 3>different different constituents along with the big tech companies that

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<v Speaker 3>we're all familiar with, and so it's challenging to look

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<v Speaker 3>at the market. That's that component, and you can look

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<v Speaker 3>at the rest of the balance of the market. So

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<v Speaker 3>you think about those big stocks, they trade at thirty

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<v Speaker 3>one times earnings.

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<v Speaker 4>That's a two point seven percent or so earning yield.

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<v Speaker 3>It's a negative risk premium versus ten year treasuries. So

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<v Speaker 3>that's a concern about valuation. And then you have the

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<v Speaker 3>concentration item that I overlaid. Rest of the market has

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<v Speaker 3>a positive risk premium versus bonds, and so that's one

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<v Speaker 3>of the attractive components of why there's a broad end

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<v Speaker 3>of the market and why we anticipate that to persist.

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<v Speaker 5>David, I have an election night question for you.

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<v Speaker 4>When you, you.

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<v Speaker 5>Know, get home, put on your slippers, grab a scotch

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<v Speaker 5>and your pipe or whatever, and you settle down in

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<v Speaker 5>that lazy boy right click on Bloomberg TV.

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<v Speaker 4>What are the.

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<v Speaker 5>What are the indexes or the assets or what are

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<v Speaker 5>you going to be watching on election night as we

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<v Speaker 5>hopefully get a clearer picture of who's going to occupy.

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<v Speaker 4>The White House in the next four years.

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<v Speaker 3>Well, the election is obviously quite close in terms of

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<v Speaker 3>the polls and things like that. So I think there's

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<v Speaker 3>a couple of things that we look at. First, is

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<v Speaker 3>there a split Congress versus the presidency that would suggest

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<v Speaker 3>there's certain executive actions that can be taken, whether that's

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<v Speaker 3>respect to tariffs, whether it's respect to certain regulation aspects

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<v Speaker 3>that the presidency he or she could implement.

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<v Speaker 4>Whereas if there's a sweep on.

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<v Speaker 3>The Democrat or the Republican side either direction, there are

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<v Speaker 3>potential legislative aspects. So, Matt, that's sort of the first

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<v Speaker 3>question I want to think about. The second as we

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<v Speaker 3>think about, well, what are the impacts of potential tariffs,

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<v Speaker 3>what would they be? Well, US companies that are selling

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<v Speaker 3>domestically are likely to outperform US companies that export more

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<v Speaker 3>to the rest of the world because there could be

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<v Speaker 3>retaliatory tariffs. So that's one strategy that we might look at.

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<v Speaker 3>We might look at companies that have that sort of

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<v Speaker 3>an executive authority that you might want to think about.

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<v Speaker 3>And then we talk about that with portfolio managers, and

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<v Speaker 3>there's baskets that we have we trade on Bloomberg with

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<v Speaker 3>clients based on those two characteristics.

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<v Speaker 1>All right, so it sounds like you have a lot

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<v Speaker 1>to keep an eye on we all do, and we

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<v Speaker 1>really appreciate you taking the time today to walk through

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<v Speaker 1>that call heard around the world that is gold min Sachs,

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<v Speaker 1>chief US equity strategist