What a Fed Rate Hike Could Mean for US Stocks

0:00 Speaker 1 This is the markets. I'm Chris Hussey and today is Friday, September 11th. Before we start, I want to acknowledge that it's 25 years since the 9/11 attacks. As our Chairman and CEO, David Solomon said in remarks, our firm joins the community in honoring the lives lost that day, as well as the first responders, recovery workers and survivors and everyone who suffered from 911 related illnesses. 0:28 I'm also joined today on the Goldman Sachs trading floor by John Sugar. John is Head of Cross asset sales within Thick and Equities. John, thanks so much for joining us on the markets. 0:40 Speaker 2 Thank you for having me Chris. Great to be. 0:42 Speaker 1 Here. Well, first time. Long time for you, I know. Tell us a little bit about cross asset sales that could encompass anything. What? What? What exactly is it? 0:48 Speaker 2 What we like to do is be like our clients, which is ultra flexible as to where the opportunity set is. That's really what drives it. The team is about 25 people, specialists across equities, derivatives execution, credit rates and FX. And so really what we're able to help people do is capture these inflection points in markets, whether that's going from a growth equity cycle to a credit cycle or whether that is looking at asymmetric hedges. 1:15 And you've seen the utility of that ever since the subprime crisis to different rate hiking cycles or credit protection where we look for asymmetric hedges. And we'll talk a little bit more about that later on. 1:26 Speaker 1 Yeah. Well, it sounds like the having the inflection guy here is perfect because we just got the CPI report. The FOMC meets next week, looks like we might be in for an inflection. What do you make of the CPI report and the reaction that the markets had so far? 1:41 Speaker 2 So I think that the market reaction is telling you that they're going to hike next week. We have something like 84% odds price to that and for 50 bits before your end. That's not to say that inflation has not followed some of what the people who want to hold say, which is you haven't seen shelter inflation continue to go and goods inflation moderated. 2:02 It was really driven by things like communication services. That being said, with it being so hot and the Fed having said they're data dependent, the market is telling them that in some ways it's actually more dangerous not to hike because you might lose control of the back end in that case. 2:19 And that's one of the bigger risks to the market. 2:21 Speaker 1 Yeah, it's a great point because the Fed controls the front end through their Fed funds rate, but the back end is controlled by the markets and the markets can do anything they want there. Let's talk a little bit about equities for a second here because this Alto is back to school week and we we've had a series of things that always happens in the back of the school and people come back and they're trading heavily. 2:39 The market though is kind of flat lined since early August. What do you make of the rally that we've had and where do you see it going from? 2:46 Speaker 2 Here. So we've had some near term challenges. Momentum's had an extraordinarily tough last two months. When you look at technical levels here, you have both CTA and systematic flows against you in the near term. That being said, we just finished our Communicopia conference. One of the biggest themes in the market right now is AI. 3:04 The company is coming out of there could not have been more bullish And to the people who say the market is expensive, we're trading at a 19 PE. That's the 10 year average. We've had S&P earnings growth of something like 30% on the second quarter. So if you look at that, you basically have a market where all, all of the heavy lifting has actually been done on the earning side. 3:25 And when you think about the drivers going forward, there's terrific opportunities within various AI consumer sectors, which are off highs to really say that well, over the next few weeks, we may have a lot more speed bumps. But if you and I are sitting here at your end or we're sitting here next year, we're talking about an S&P that's probably well over 8000. 3:45 Speaker 1 OK, John, let's examine deglobalization because your customers can invest anywhere in anything all at once funds and there have been a lot of geopolitical risks. We're seeing it in the oil tape. What are your customers saying about those geopolitical risks today? 4:01 Speaker 2 So one of the most interesting things has been the things that really impacted the market negatively. When you think about Liberation Day as the original tariff announcement, those have become less relevant to price action as we go forward. And it's a trend that we've really seen since COVID, which is the duration of opportunity to take advantage of dislocations to the market is getting less and less and the moves to correct to the upside are much more violent. 4:27 Now when you think about geopolitical risk out there, there's certainly things which are near term. You mentioned oil. If you look at Brent right now, you're trading around one O 4, but you look at one year, you're buying Brent with A7 handle on it. So this is still viewed as a more near term problem. 4:43 That doesn't mean you can't have local disruptions on the product side, whether it's gasoline, diesel, heating oil probably looks incrementally worse for Europe than the US, but that can certainly be something that comes up. All that should be relatively short duration in terms of impact, but can certainly drive local price action. 5:01 When we think more broadly their geopolitical impacts on both the positive and negative side. Obviously there's a good reason why you might want to look at a country like Brazil, and we've seen investors increasingly look to buy upside there as they're going into an election. 5:18 Speaker 1 Brazil, when the market zigs, you zag. I love it. OK. You're a risk guy. Let's talk a little bit more broadly about risks here because I know you have a view. What are the risks out there that you're watching and how do you want to hedge them? 5:32 Speaker 2 So as we think about what the largest risk on the board is, it really outside of some of the true tales which are global geopolitical risk exploding is really in the back end of the ray curve. And that is because one, there's natural impulse for this to be higher. 5:48 You have global fiscal deficits. This is not just AUS problem, this is everywhere. You have a ton of AI issuing. So hyperscalers doing about 800 billion of CapEx this year. Our analysts estimate something around 1.2 trillion next year. 6:03 So there's a lot of natural supply which is competing for money. Now if you get a really sharp move in rates because equities can tolerate higher rates, it's really just the pace of change that has the biggest impact. So the way we like to hedge that is really in two ways, either buying outright payers or payer spreads on the back end, the 30 year part of the swap curve or looking at and doing something like ACMS cap, which is the shape of the curve between front and back end. 6:31 And we think that there's good returns out there. Now. We always love 10X type trades on reasonable strikes, you can probably still make 5 to 6 X your premium, and so that's what we're talking to investors about now. 6:43 Speaker 1 5 to 6 XI thought everything was 10X but OK, you know, you you say equities can tolerate higher rates, but do they tolerate higher rates? Because as long as the rates are going higher because of inflation, equities are indexed to inflation, so they're nominal assets, so they go up. 6:59 What happens if the higher rates are tied to something more like a debasement rate? 7:03 Speaker 2 So if they're tied to a true tail risk debasement trade, that would obviously be negative in the short term for equities. If you get true hyperinflation and you can go back to Zimbabwe or anything you want, that could be really good for equities because they are nominal asset. 7:18 That being said, I I think the reason people are thinking about all this is 1. Economic growth remains good. The fact is that hiking 25 or 50 basis points doesn't change the need for the strongest balance sheet companies in the world to be invested investing heavily in CapEx, given how transformative a technology AI is going to be. 7:39 And the consumer outside of the low end still is OK. And so you compare that to the fact that most consumer stocks are trading 30% plus off their 52 week highs. There just seems a real disconnect here. And so as you think about equities going forward, people got very surprised by things like biotech performing so well and biotech another thing that typically has a lot of core relation negatively to higher end rates being higher. 8:09 Well, I think consumer and their pockets of that we like their pockets of that we don't like could be the thing that surprises into your end. By the way, another plug for our conferences. We've got our consumer conference next week, so we're going to know a lot more after that. 8:22 Speaker 1 OK, you gave us a great hedge trade, but give us one more. What's the trade? 8:26 Speaker 2 So I think that there's a lot that can be done here. Number one, within consumer, there's both lungs and things that were more cautious on on the long side, the experiential type names, whether it's cruise, whether it's events, things that people really want to do and spend money on, especially at the high end that continues to see a lot of growth. 8:43 On the flip side, there have been companies releasing agents for consumers. Well, guess what, if you don't have to spend 2 hours to switch your their own plan to a cheaper plan, that's probably something that could be really impactful. And so we're a little bit more cautious on some of the impacts there. We mentioned AI briefly. 8:59 A lot of the CapEx picks and shovels are trading well below market multiples. A lot of the semis type names trading well below market multiples. You're seeing capital return in some of those places and other interesting things. We think this is a temporary air pocket and those have good runway ahead of them. 9:17 Speaker 1 Terrific. Sum us up for this here. What are you watching for next week, in the weeks ahead that we should be keeping our eyes on? 9:24 Speaker 2 So clearly watching the Fed next week, I think that's something where the press conference is going to be a lot more impactful than the actual if they do hike, hike. If they don't hike, that's actually very interesting and may have impact of its own. Outside of that, I think that any clarification on kind of the big picture questions from corporates as you go through the rest of the year on the efficacy of AI in terms of increasing revenue will get people really, really excited. 9:51 Again. Outside of that, watching the Giants on Sunday, hoping that's not another tough season to be a Giants fan. 9:58 Speaker 1 Jets, Jets, Jets, Jets, John Sugar, you're a wealth of information. Thanks so much for joining us. 10:04 Speaker 2 Thanks, Chris. 10:05 Speaker 1 That does it for this week's episode of the MARKETS. I'm Chris Hussey. Thanks for listening. 10:14 Speaker 3 The opinions and views expressed herein are as of the date of publication, subject to change without notice, and may not necessarily reflect the institutional views of Goldman Sachs or its affiliates. The material provided is intended for informational purposes only and does not constitute investment advice, A recommendation from any Goldman Sachs entity to take any particular action or an offer or solicitation to purchase or sell any securities or financial products. 10:34 This material may contain forward-looking statements. Past performance is not indicative of future results. 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