Goldman's Kostin Says Investors Should Focus on How Companies Use AI

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00:00Well, let's talk right now with David Koston. He is the chief U.S. equity strategist at Goldman

00:04Sachs. And David, I want to get first your take on the potential of a government shutdown.

00:11You know, this jolts data made all the more important by the fact that we may not get the

00:15jobless, the NFP number on Friday. How much does that matter to you?

00:20Well, the expectation is there may be a short term shutdown. I think the more fundamental

00:26story behind the equity market is eventually the data will come out. And the idea of what's

00:31a fundamental thrust to economic activity is the economy is still growing. The likelihood of a

00:37recession is low. If we look at the earnings, underlying earnings, expectations, around 7 percent

00:42earnings growth for this year and 7 percent for next year. Matt, what people are really going to

00:46start focusing on is what are the third quarter results, because that's not going to experience

00:50a shutdown. Corporations will report their results. Expectation right now is very low bar, around 6

00:56percent year over year earnings growth. The median stock, in fact, around 8 percent.

01:00So that's still pretty low because last quarter, the average for the last several years has been

01:05around 400 basis points faster earnings growth than expected. If that pattern was to continue,

01:11Matt, it'd be around 11 percent earnings growth for the overall market. So that's the more

01:14important variable from a corporate fundamental perspective. Obviously, the valuation of the stock

01:20market is pretty high, around 23 times earnings. So that's a concern, probably constraint on the

01:24magnitude of appreciation. We look at the trajectory of the overall earnings growth for next year,

01:30around 7 percent. It's pretty much matching our view on the S&P 500 index level climbing to around

01:357,200, 7,200 a target in about 12 months time. I think that is the more fundamental discussion

01:42points with with portfolio managers right now. David, you mentioned the median company is expected

01:47to grow earnings by 8 percent. And, you know, I wonder when when I look at double digit growth

01:54expectations, which is what it would be if they beat by 400 basis points. Right. Is that the Mag 7 or

02:01the Great 8 or the top 10 AI stocks that are driving that growth or is the S&P 493 catching up?

02:10No, I think it's an important point that the expectation for growth in terms of earnings growth

02:17for the largest companies in the market, call the sobriquet what you like. But the idea of

02:22well into the double digit forecast is what is what the baseline expectation is, something in the mid

02:27teens. And that's likely to be a reason is certainly has been a reason why those stocks have done so well.

02:34The expectation that they'll continue to grow more rapidly. These companies expect to go more

02:39rapidly in sales than the rest of the market is why these companies traded a meaningful premium.

02:44They trade about 10 point greater PE multiple than the rest of the market. So you're paying a higher

02:49multiple, but you're also getting, you know, what's expectations of much better growth, higher margins

02:54and sort of the fundamental story behind behind AI. I think the issue that investors will be focusing

03:00on is if the broader universe of companies can identify some concrete examples of how they are

03:09using AI and the various forms of technology to enhance their revenues or alternatively improve

03:16their margins or lower their costs. Right now, it's been pretty underwhelming in terms of the case

03:21studies, the examples that we find. We find most companies are really been focusing on the cost

03:26savings side of it, not so much on the increased revenues as a result of adopting AI or embracing AI.

03:32So I think some evidence around that and the idea of the ability of AI to be enhancing the growth of

03:39companies would be something that we're certainly going to focus on for the for the third quarter

03:43results when they come out over the next month or so. If you take a longer view, David, are you

03:48worried at all about a bubble? You've had a long and storied career. You've been at Goldman Sachs since

03:53before the dot com bubble was inflated and burst. So do you see parallels here? Because when we start

04:01to get these announcements of one AI company investing double digit or even triple digit hundreds of

04:08billions of dollars into another AI company, it's a little worrisome for the market.

04:14I think the point you made, Matt, is an important one. Yes, there are some parallels. I think the parallels

04:19relate to vendor financing. The idea of vendor financing was a was a real story behind some,

04:26not all companies, but some of the companies in the late 1990s. It accelerated their revenue growth.

04:31And when the actual customers could not necessarily come through on those payments, that was a

04:37notable discount. But another way to be thinking about it is in the in the words of the book that

04:45George Soros wrote on the alchemy of finance and the way that companies are the idea. Most finance

04:52people think about the price of a company price of a stock represents the discounted future of

04:58expectations of the of the business. And what Soros's observation was that, in fact, the price

05:03action of the shares itself was integral in thinking about the valuation and the momentum of the companies.

05:10He reduced the idea of the alchemy of finance to the ideas theory of reflexivity and the idea that as a

05:16company acquired something else, the multiple would go up, the growth rate would rise, the multiple would go

05:20higher, et cetera, et cetera. And that reflexive nature would be that would spiral up in us for a period of time.

05:26And at some point, then that would start to spiral down. And I think that idea of vendor financing,

05:30alchemy finance, those are some those are some sources of concern that that we think about. But broadly speaking,

05:36the economy continues to grow. The idea of earnings are still rising. And the idea that that share

05:41prices are likely to go higher, I think, is a is a more fundamental issue. Some of the areas probably

05:46is in the private market area. We don't get great clarity or line of sight into what's happening

05:52in that area. I think in the public market, some of the largest companies, their margins are super high.

05:57They're growing, obviously, quite rapidly. They got a lot of cash flow. They're basically able to fund

06:01a lot of the capex. I think the the source of concerns that from my perspective would be some of the areas within

06:06the private markets. If you think about positioning, which is the other kind of angle, which is right now the

06:11position data we look at across hedge funds, mutual funds, foreign investors, that would suggest that investors

06:18are sort of neutrally positioned, maybe slightly under under risk, if you will. And so that would be a source of

06:24additional interest demand for shares. And I think those are the the areas. And of course, the big area focus now is on the

06:30the IPOs and the the M&A activity. The IPO market is very robust this year. And and the M&A activity

06:36obviously up quite quite a lot. We're expecting another 15 percent rise in M&A activity as we look

06:42into next year. Yeah. I mean, we saw great news from Jeffries out this morning. You mentioned

06:47that we've seen twenty four billion dollars of IPOs, I think forty six that are over twenty five million.

06:55So it's it's been a fantastic year thus far. Does that momentum continue? Do you think, you know,

07:00M&A is back? IPOs are back for this market. Now, I think the way you want to think about

07:06it is a couple of ways. Number one, we have an IPO barometer, which measures the how conducive

07:11is the market to receiving IPOs. We're now rating or the barometer is reading around 140, 140. Put some

07:19context around that. 100 is sort of the average conduciveness receptivity of the market for IPOs.

07:25100. We're 140. The peak in 2021, February 2021, was just over 200. And the low, the nadir was around

07:33seven in November of 2022. So it gives some sense. We are well into the positive territory around the

07:3888th percentile versus history. It's point one. Point two, if you look at the performance of those

07:43IPOs you referenced, 70 percent of them actually had positive results since they went public. Number

07:49one. Number two, the average performance is up on the first day, up 30 percent. The typical

07:54performance, Matt, over time is around 15 percent. So it's kind of twice as positive results as is

07:59typically the case. That's sort of the IPO market. And then you look over into the into the M&A market.

08:04Obviously, lots of activity here. It's been up about 30 percent or so year over year basis. And one of the

08:11the investment, you know, this investment program, think about what how does one invest as a portfolio

08:16manager, think about investing what has not participated in the rally. We point to some

08:20of the alternative asset managers which have underperformed or lagged our measures of macro

08:28forecasting, what we would think would would be those shares performance. They've lagged. We think

08:32that's an interesting opportunity. My colleagues in who cover the stocks would look at Carlyle,

08:37would look at KKR, look at TPG as examples of companies where there is growth, reasonable valuation

08:42in this M&A activity. If the M&A activity environment continues in the IPO market,

08:46those are some of the beneficiaries that we would think about.

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