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GOLDMAN SACHS: Companies are staring down a battle with higher rates - here are 5 ways they can win
GOLDMAN SACHS: Companies are staring down a battle with higher rates - here are 5 ways they can win
Joe CiolliMar 9, 2018, 16:36 IST
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Goldman Sachs has some ideas for how companies can offset higher rates by pursuing internal growth.
The firm sees 4% as a crucial threshold for the US 10-year Treasury yield.
If US companies are going to withstand the pressure of Federal Reserve monetary tightening, they're going to have to grow.
So says Goldman Sachs, which sees 4% as a crucial threshold for the US 10-year Treasury yield. If rates exceed 4%, the firm estimates companies will have to generate 200 basis points of medium-term growth to neutralize the negative effect on valuations.
"A boost to medium-term growth expectations or a decline in the equity risk premium (ERP) could offset the negative valuation impact of rising bond yields," a group of Goldman strategists led by David Kostin, the firm's chief US equity strategist, wrote in a client note.
Goldman Sachs
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It's important to note that Goldman is making recommendations in the event of a sudden, unexpected rate increase. The firm's 2018 forecast for the 10-year is just 3.25%, and it's been argued in recent weeks that at least some areas of the market will do just fine on a relative basis, regardless of how high rates go.
With that in mind, here are the five ways Goldman says companies can preempt rate-hike madness and stand tall in the face of rate hikes:
This includes the growth of capital expenditures (capex), as well as research and development (R&D).
Goldman notes companies that "invest for growth" have historically outperformed during periods of rising interest rates. In addition, growth investment as a percentage of cash flow from operations has declined close to its lowest level in 30 years, suggesting there's room for a rebound.
2. M&A
Goldman is referring to the type of merger and acquisition (M&A) activity that "improves existing revenue streams or offers access to new markets."
And the firm says conditions are ripe for M&A right now, with the ratio of cash-to-assets for S&P 500 companies sitting at a record high. Goldman also notes tax reform will bring a flood of cash into the US from overseas — money that companies should put to work.
3. Expansion to new geographic markets
Goldman is particularly keen on emerging markets (EM), which account for just 14% of S&P 500 sales, thereby representing a massive area of opportunity.
The firm highlights its proprietary current activity indicator (CAI), which it notes is roughly 2 percentage points higher than the US version.
"EM is early in the cycle, and therefore presents an opportunity for incremental growth," said Kostin.
4. Sustainable margin improvements
Goldman says these changes should include investment in technological innovation — like artificial intelligence or automation.
The firm notes this strategy is particularly important, since inflation will be rising as the Fed hikes rates, which could put additional pressure on margins.
