Goldman's Hatzius and Kostin on Markets and Macro in 2025

27:44So that was clearly very low relative to certainly what we expected. Now, I think the market's price may be a little bit higher than is appropriate in our view. So there's a lot of things happening on the back of your question and the idea of investment strategies around inflation. What's the source of the inflation that may occur? And we can think about U.S. companies that are selling abroad compared with U.S. companies that are selling domestically. If you're concerned about tariffs and what that might be from a price level point of view, the risk of retaliatory tariffs is certainly there. And so owning companies whose customer base is in the United States, while, of course, along the supply chain, they may have increased the prices, the idea of those type of stocks generally doing better is part of our view.

28:31You can think about wage inflation as well. We have companies where labor costs are relatively low. And when I talk about labor costs, I think of the wage, not just wages, salaries, and bonuses, and stock-based compensation, and healthcare benefits, which, of course, in the U.S. are borne by the corporate sector. And there are companies where that's quite low, relatively low labor-intensive companies, as compared with high labor-cost companies. And I think that's an area, again, we're looking for strategies, investment strategies, around these different macro themes that Jan has described and we talk about in our teams at Goldman Sachs.

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30:42Brokerage services for US listed registered securities, options and bonds in a self-directed account are offered by public Investing Inc. Member FINRA and SIPC. Crypto trading provided by Backed Crypto Solutions, LLC. Complete disclosures available at public.com slash disclosure. One thing I'm wondering as we enter another Trump administration, you know, Joe and I and other journalists, we have it kind of easy where we either see the headlines at night before we go to bed or if we're sane people, we see them in the morning when we wake up. And all we have to do is write them up, basically, what Trump is saying.

31:13When you wake up and see the headlines in the morning. How like reactive is your work to some of the stuff coming out of Donald Trump's mouth? And I guess the social account. Yeah. And I guess the consensus right now is you should take Trump seriously, but perhaps not literally. And I guess my question is like, when does that change? Well, it certainly changes once you have actual government policies that can be implemented during the transition, of course, that's not the case. So in terms of changing our forecast, the hurdle now would be quite a bit higher than once we actually were back in the second Trump administration.

31:56In terms of providing a comment on some of these announcements or tariff threats, yeah, there's a lot of demand for that. And so we did write a comment on yesterday's announcements around the Canada, China, Mexico tariffs, but ultimately said some of this is very consistent with what we had been assuming, namely the China tariffs, and maybe even a little bit lower than what ultimately is likely to materialize. But then on Mexico and Canada, we would take this with more of a grain of salt because there will be a whole process around that renegotiation. And ultimately, we did have some similar tariff threats in the first Trump administration on Canada and Mexico, which ultimately didn't materialize because NAFTA effectively just became USMCA, but not with a huge number of changes.

32:49Think about it in terms of horizon arbitrage. There is lots of price noise that happens every day. And then there's investment themes that may be less connected with the administration, whether it's Donald Trump, Joe Biden, what have you. The idea of artificial intelligence, AI that everyone talks about, well, that's really less affected by some of the government policies. It may be, depending on the policies that get implemented. but the idea of more productivity growth or idea of more efficiency or the infrastructure build out relating to AI, those are some of the themes that are probably independent of the administration.

33:27These are the things that are happening in the technology world. And that's a discussion point that I look at with portfolio managers who may have an investment horizon that may be three to five years out. What stocks should they own? How should they position their portfolio as compared with maybe some who are focusing on the day-to-day announcements of tariffs, which may be implemented, may not be, that may be variable. One thing I would just say is that on tariffs, this is to a large extent up to the president and up to the White House. So it does deserve more attention than some other policy pronouncements, which require Congress to hash out a reconciliation bill and ultimate tax legislation.

34:09So it is important to focus on the things when there are announcements that are effectively under the control of the White House. The Treasury Secretary nominee has, according to reports, been pitching Trump on this idea. Three three threes, improved growth via deregulation, smaller deficits, and more barrels of oil. Let's set aside the oil for a second. Do you see any prospect of a meaningful change in the spending trajectory? And do you see any meaningful opportunity for further pickup in trend growth from more favorable regulatory environment? So I think these are aspirational goals. They're both pretty ambitious.

34:53I mean, both a 3 % of GDP federal deficit. That's not what we're expecting. That's not what the Congressional Budget Office is expecting. I mean, we think it's going to be closer to 6 % probably. Maybe we can bring that down. Bringing it down to 3 % would be certainly very desirable. I think we'll ultimately need to bring it back down to something like 3 % and to bring the primary deficit, the ex-interest federal budget deficit, back down to somewhere around zero, depending on where growth and real interest rates ultimately balance out. But that's going to be a process that's going to require an enormous amount of effort.

35:36And that would take real political effort to cut into very sensitive areas of spending, right? That's right. Because such a large chunk of government spending is basically entitlement programs, defense, and debt service. That doesn't leave a lot of discretionary non-defense spending that's maybe a little bit easier to cut than some of those other categories. 15 % or so of total federal spending is non-defense discretionary, so a relatively small share. And that then leaves the tax side. And obviously, there's no desire to deliver a sizable tax cut, certainly not with this administration. So it's going to be very difficult.

36:18On the growth side, we're on the optimistic side of at least the economist consensus. If you take the Federal Reserve, the median longer term GDP growth rate is 1.8%. We're at 2.1%. Maybe that can be lifted somewhat. Getting to three, again, would be very difficult, especially given the demographics. If you have the labor force grow at only a pretty slow pace, not a lot of natural population growth because of low birth rates and probably much lower immigration. So even if you're a productivity optimist, and I would say I'm on the more optimistic side as far as productivity is concerned, getting to three will be difficult.

37:03Let's talk about immigration because as you pointed out, tariffs are largely under the purview of the president. Maybe immigration is a little bit different. What's been the impact of immigration on the economy from the past, you know, three or four years or so? And how do you see that unfolding going forward, given that we don't really know what's coming? We could have mass deportations or we could have something, you know, around the edges or maybe nothing happens. So it's been very important in boosting growth and nevertheless less bringing down inflation. So it's obviously a very controversial topic from a political perspective.

37:43But if you just look at the economics, if you bring more people into the workforce, especially at a time of very serious labor supply constraints, and in particular, very serious labor supply constraints at the bottom end of skill distribution in 2021-22, in areas like bars and restaurants, you know, and other areas like that, construction, having that large influx of people has boosted growth and probably at the margin also helped to bring down inflation, at least has helped to bring down wage inflation in some of these areas to levels that are more sustainable. Now, there is already a deceleration in the immigrant inflow.

38:26if you look at it on a month-on-month kind of annual rate perspective, in late 2023, we were running above 3 million at an annual rate. We're now probably a little bit between 1.5 and 2 million. And that is likely to come down further even before you see an additional tightening of restrictions on people coming in and increased deportations. We'll see how large the deportations are ultimately going to be. If you go back to, say, the Obama administration, we were averaging something like 400 ,000 per year. I think it's probably going to be higher than that. But whether it's going to be dramatically higher than that, that I think is still less clear.

39:17Yes, it is up to the executive branch, it's up to the president. But unlike with tariffs, there are going to be a lot more logistical issues around deportations and moving immigration to much lower levels or into negative territory than with tariffs. With tariffs, it's administratively relatively easy. So if I'm thinking about supply, the sort of growth negatives, tariffs on the one side and then immigration on the other, I'm more worried about tariffs than I am about immigration. David, you mentioned, you know, you talked to clients in one of the dominant conversations. Scott Besant gets named Treasury Secretary nominee.

39:57Maybe his 3 % deficit to GDP goal is very aspirational. Maybe some of his growth ambitions are aspirational. But it strikes me that, like, ultimately, he does not strike me as some sort of, like, major shakeup, we're going to totally rethink how the economy works guy. He sort of has a traditional macro background, seems to have very good understanding. When you talk to clients, how far does that go? You know, in terms of thinking, being able to think long term and avoiding the noise of the day to day headlines, the fact that Scott Besant is likely going to be the Treasury Secretary, the fact that according to reports that just hit the headlines, someone fairly mainstream like Kevin Hassett is going to be running NEC.

40:39Is this the kind of thing that just makes investors, do they get comfortable when they hear these headlines? What are those chats like? I would say that is a pretty good characterization of how portfolio managers are thinking about it right now, based on his background. A number of people, myself included, known him for some period of time as a portfolio manager. And he's viewed, again, perception as sort of more mainstream. Of course, a lot of the policies will depend on the president. And so it would be up to the treasury secretary and the other cabinet members to carry out those policies. And that remains, as Jan indicated, some uncertainty around what those ultimately will be.

41:15So one of the reasons we'd like to talk to you is because you go out and talk to other people too, your clients, portfolio managers, as you just mentioned. What are some of the more interesting questions that you are getting this year? And what's maybe different to this time in 2023? Well, it's much more around policy and much less around the underlying path of the economy. I mean, I think that we're again going through beyond the policies which we've discussed a little bit of the concern around higher inflation. It's certainly true that the last couple of prints have been a little bit higher.

41:53We talked about it earlier. I'm not super concerned about it, but it wouldn't be shocking if we saw the next few months a little bit of upward pressure. First quarter has been a sort of seasonally higher sequential inflation period, I think partly because seasonal adjustment is difficult, especially post-pandemic, and there is some residual seasonality, which we may see again. So there are definitely questions around inflation. There are questions around the longer-term neutral funds rate, our star, To what extent has it risen relative to the pre-pandemic period? Our view is that it probably never was quite as low as many people thought in 2018, 2019.

42:42We were never that sold on the secular stagnation story. And it might not be quite as high as many observers now think. I mean, we're still in the low to mid threes in nominal terms, low to mid ones in real terms. but there's certainly a lot of discussion around that. There's a lot of discussion around Europe and the impact potentially of higher tariffs, or maybe just the trade policy uncertainty in advance of any actual tariff increases on Europe. What is that doing to an economy that's already pretty soft? And it's an area where we're actually well below consensus. We have a 0.8 % forecast for euro area growth in 2025, which is four or five tenths below the Bloomberg consensus or the ECB.

43:34And a lot of that is around trade policy uncertainty, which seems to have a particularly negative impact in Europe. So definitely another big topic of conversation. David, do you want to take a stab at the same question? Sure. There's a variety of things that portfolio managers are focused on right now. And the first is something you referenced earlier, Joe, which is the idea of the largest stocks in the market are now representing more than a third of the S &P 500 equity capitalization. So the question is, how does one position in that? You look at the mutual fund community, for example, 75 % of mutual funds are lagging their benchmark.

44:09It's not a criticism, it's just the data so far. And those companies, what's been consistent about those funds has been they've been underweight these positions in the largest stocks. And so the idea of perhaps having an index weight for the largest companies and then choosing to generate alpha or seek alpha in the rest of the market is probably the better strategy. That's number one. That was something that the 25 % of the mutual funds that are outperforming have tended to do. That's number one. Number two, relating to Jan's observation, it's a perpetual question of, well, what about these global markets?

44:43Europe, Asia, China, Japan, is this their opportunity to outperform the US? The relevant valuation metrics are really, really eye-catching, which is that the multiple, forward PE multiple for the US equity markets now roughly 23 times, and it's about 13 times for Europe and Japan and China is even lower than that. And so that question is, well, for a decade, It's still been the US. Is this the time? Is the valuation gap so significant that the opportunity set at the lower end of the valuation scale? Does that represent good opportunities? I'd say those are two major questions. The third question that is highly debated is on AI.

45:25And the idea is of the huge capital investments that some of the hyperscalers and other companies making these investments, what will the ROI, return on investment, be of the AI that they're making? And so that is a question that's ebbed and flowed over the course of the year. A lot of the companies who are involved in the infrastructure buildout have done particularly well. Those PE multiples have expanded and the share prices have done better than the growth rate in the underlying growth of earnings. And so our focus has been on companies in the third phase, as we think about it, the third phase of AI infrastructure buildout.

46:00First phase is NVIDIA, its own kind of unique story. The second phase is the infrastructure. And the third phase is the companies we think of whose revenues will be enhanced by AI and a lot of the software companies. And their price return this year have basically matched the earnings growth trajectory. And so the opportunity does exist there in some cases for a multiple expansion. So that would be an area of focus. So those are some of the topics that are debated with fund managers right now. Tracy, first of all, it feels like international outperformance is always one year away or two years away.

46:33We're always waiting for EM. We're always waiting for EM and Japan and Europe. One day they're going to have their day. But also not to reference another shop's performance, but I always love looking at the B of AML hedge fund survey. And one of the things they ask is what's the most crowded trade? And it's always big tech. And it's always big tech that wins. And I think about how I'm glad I am that I'm not a portfolio manager and how sick to my stomach it would have to be that the big source of alpha I just have to ride the most crowded trade. Anyway, I'm glad I don't have that job where I have to just do the same trade as everyone else to outperform.

47:05We're all glad, Joe. Well, actually, speaking of jobs, Joe and I came up with a contrarian trade idea based on AI, which is buy Europe as a beneficiary of productivity enhancing technology. Pharma, chemical. Because their productivity is really low. Would that work? You guys should see the expression on David's face right now. He looks like he just bit into a lemon. No one likes our contrarian idea. It could work. I think maybe you should think about it in terms of M &A activity, the idea of the companies in the United States, much higher profit margins. And the idea, I guess, Tracy, your hypothesis is perhaps their margin expansion would be potentially enhanced by the adoption of AI.

47:53There you go. That one question is on the source of the potential margin enhancement. Is that labor driven and you have more efficiency, therefore fewer jobs? Is that sort of orthogonal to what the objectives are, as a lot of the European governments? And so I think there's some debate around that. Could it be a trade? I'm not a buyer. Goldman isn't going to set up that index just yet. Do you have AI macro thoughts? And to my mind, there's potentially two ways it could go down. One is just the macro impact of all the capital spending. Does it move the dial at all in any sort of categories that are important on the top level?

48:29But I guess more importantly, looking a few years out, when you think about productivity, when you think about labor growth, are we at the stage yet where you can make interesting predictions about the impact of this stuff? So on the near-term impact, we generally have not viewed that as all that large. I mean, these are huge numbers in a very small part of the economy, but in terms of boosting, you know, near-term growth, it's very difficult to get anything more than, you know, a very small sort of tenth of a percentage point or something like that. And in terms of the broader impact on potential growth, I think we're also still probably several years away.

49:11But then we're actually pretty optimistic when it comes to sort of late 2020s, early 2030s. And a little over a year ago, we raised our long-term potential growth estimate for the U.S. by four-tenths of a percentage point. We were at 1.8 % for the sort of years around 2030. We're now 2.2%, which is, no, that's a pretty sizable boost. And it's really driven by the fact that AI can replace a lot of the tasks, not necessarily the jobs, but the tasks within certain jobs that are being done at sort of low and mid levels of white collar work at the moment. And that is ultimately going to be productivity enhancing.

50:00Of course, it does mean some labor market upheaval, although we would emphasize that the labor market impact is going to occur over a period of time, and there will also be new jobs that will be created. So historically, when you go back, it's actually not that easy to find instances of technological unemployment that were visible in the overall economy. Typically, when you have large increases in productivity growth, those are actually typically low unemployment periods rather than high unemployment periods, even though at the individual job level or industry level, you might see quite a lot of job destruction.

50:42But overall, we're optimistic over the longer term, but in the short term, it's probably still going to be more limited. I can't wait to be a prompt engineer generating AI written podcast, Joe. That's our future. We kind of already are. We're already data providers. Yeah, that's true. David, I just have one more question, which is whose idea was it to write the equity outlook through the lens of lessons learned from the art of the deal? Well, last year we referenced Taylor Swift and we said the subtitle of the report was, all you need to do is stay invested. And that was the strategy for calendar 2024.

51:20In reference to your first question of this podcast, you asked, does everyone look back and see what we wrote? You do, hopefully. We certainly do and think about it as a report card. What was the impetus for The Art of the Deal and why we titled that or subtitled that for our 2025 outlook. Part of it is the M &A environment and the idea that our forecast is for a 25 % increase in M &A in calendar year 2025. That's part driven by our forecast of the use of cash of corporate America. S &P 500 companies will spend about$4 trillion of cash next year. And a good portion of that, we have a 20 % gain or increase in the cash devoted to M &A activity.

52:02So that was one of the impetus that thought about the art of the deal. And then it is remarkable. And for all the listeners of the Outlaws podcast, I would suggest you go back and read the report, read the book. The Art of the Deal was written or ghostwritten perhaps by Donald Trump 37 years ago. And many of the characterizations of the transactions in his whole thought process was pretty interesting. So we went back, revisited that, my first edition copy for when I was way back in the day. and that was the impetus for why we thought about that as an organizing structure for our Outlook report.

52:36You have a first edition? Or are you used to? 1987. Wow. Oh, wow. I'm going to have to go read it. I should read it. I will read it. Yeah, I haven't read it either. Isn't there a sequel as well? Oh, there's many, many books. You think he stopped at one? We did reference there's The Art of the Comeback that he wrote 10 years later, 1997, and a whole sequence of books that he's written. Oh, my gosh. Okay. David and Jan. Thank you so much for coming on OddLots. This was a true treat to have you both. And maybe, I don't know, let's make it an annual tradition. We'll do it again next year. Thank you, Joel.

53:09Thank you for inviting us. Thank you so much. That was great. Thank you.

53:25Tracy, that was a real treat. That was really fun having David and Jan on together. I know. I wonder if they've ever done an external appearance together like that before. Or an external media appearance. Yeah, that's what I mean. I guess we could have asked them. I'm sure they've spoken to clients together. Yeah, but that was really cool. You know, just one random thing that stuck out for me that I hadn't realized. I knew, or I had a good idea in my mind that the reason big tech companies have done so well is because they're earnings juggernauts, right? Right. There's other things that go on, flows, et cetera.

53:57But like they make so much money and they're so large. And yet they still put up like 30 percent numbers. It's insane. But I had not realized, like, A, quite how wide that gap has been over the last two years between their earnings growth and everyone, the other 493 stocks. And B, that the consensus is for a major shrinking in that gap going into 2025. Yeah, that's right. Well, the other thing I was thinking was the differentiation between different Trump policies. as well and like maybe dividing them up by how much is under the purview of the president versus like what things need congressional improvement and where there are those sort of political limits and guideposts in place i guess like that seems a reasonable way to view some of these risks i still think there's a lot of stuff up in the air yeah and you know it seems to me and we sort of joked in the beginning that like the GDP usually grows like two and a half, 3 % and stocks usually go up.

54:54And that's true. And it seems like even with the sort of some of the unorthodox or heterodox economic views of the incoming Trump administration, the impacts right now expected to be marginal, right? So even tariffs aren't expected, if they go through as expected, aren't expected to have a radical change to say the inflation trajectory or whatever, And et cetera. You know, it seems like what people are anxious about, what you're talking about, maybe some clients are talking about is the idea of like genuine policy uncertainty. And that means not a debate about 10 percent versus 20 percent tariffs, which is, you know, you shave some percents off GDP, you shave some earnings off and life goes on versus like the seeming potential for some genuinely radical rethink of how we do business with the rest of the world.

55:42Yeah, totally. And I think that's a plausible thing. That's the big one, right? It seems plausible, yeah. Yeah. Well, in the meantime, sign up for our 2025 Investment Outlook titled, GDP Normally Increases 2 % to 3 % and Stocks Normally Go Up. That's who we're going to title our newsletter on Monday when this comes out. Let's do it. All right. Shall we leave it there? Let's leave it there. This has been another episode of the All Thoughts Podcast. I'm Traci Alloway. You can follow me at Traci Alloway. And I'm Joe Weisenthal. You can follow me at The Stalwart. Follow our producers, Carmen Rodriguez at CarmenArmand, Dashiell Bennett at Dashbot, and Kale Brooks at Kale Brooks.

56:20Thank you to our producer, Moses Andam. For more OddLots content, go to Bloomberg.com slash OddLots. We have transcripts, a blog, and a daily newsletter. And you can chat about all of these topics, including macro, including markets, 24-7 in our Discord, discord.gg slash OddLots. And if you enjoy OddLots, if you like it when we bring you not just one, but two Goldman strategists, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, in addition to getting that daily newsletter, you can also listen to all of our episodes absolutely ad-free.

56:56All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

57:10Thank you.

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