December 15, 2022 | 8 Minute Read
John Waldron: When the pandemic started, the CEO and CFO community was shocked at the immediate demand destruction. No one had planned for demand destruction of 80-100% to happen almost overnight. The market-based community, however, was kind of assuming and expecting that there'd be some central bank response and we would end up getting through this with more liquidity. The CEOs were much more pessimistic at that point, and the market participants, to me, were more optimistic. That dynamic has since shifted—today, I would say market participants are more pessimistic while CEOs and CFOs are more balanced, believing that some demand destruction and margin compression will occur, but it will be a soft landing or a short recession as opposed to something that's more dramatic.
One thing we’re watching carefully is the consumer. The US economy is still consumer-driven, and consumer behavior gives you a lens into the demand across income strata. I'm getting incrementally concerned about the lower levels of the distribution and how they're behaving—stretching out payments, substituting in the context of their basket, feeling much more of a pinch on inflation. We're also watching the advertising market, where I think you're starting to see the beginning signs of weakness—I used to work quite a bit with media businesses, and I've always thought that was a pretty good early indicator of how the corporate world resets their budgets.
Waldron: Larger companies have become nimbler, including multinationals. They have more engineering capabilities, and they’re investing more in technology, software, and automation. Financial planning is better. People are using data more effectively. And I think the pandemic showed that companies can change the paradigm—they realized that they could have people at home and still run the company, but it also showed that they can make decisions more quickly and deal with complexity faster.
I think most companies realized that they got caught flat-footed in the pandemic. And they're under pressure from their boards to be more thoughtful about having more resiliency in supply. I think it’s moving from efficiency—like just-in-time production—to more resiliency and durability. Put another way, it’s about having an insurance policy.
Waldron: There's a countervailing dynamic here: while I believe companies will want to reduce capital spend in 2023, many companies are trying to figure out how to build more resiliency in their supply chain—and that is fundamentally inflationary and requires more spend. Shifting the supply chain from China to Vietnam or Mexico represents incremental spend because they’re not going to pull out of China; they are just going to build more resiliency on top of China. So, the incremental dollar may not go to China, but they're not likely reducing their China spend. They're just putting their incremental dollar somewhere else. Or they're going to spend a little more in China and a little more in Mexico, and they are going to grow the whole pie. That's the decision making that's going on right now.
In my view, the adjustment in headcount will be the big thing to watch, more so than capital spend. I think there was this massive growth in headcount in many companies, and a lot of that was in engineering. Now I think the big debate will be where does hiring go in the early part of 2023? We’ve already started to see some layoffs. The Federal Reserve (Fed) will be watching that employment picture and how it plays out in the first couple quarters of 2023, because that's going to help them gauge how much room they have to try to bring inflation down without unduly damaging the employment picture.
Waldron: I think there will be a trend towards less globalization, driven by geopolitics. The pandemic fostered many things, one of which is a rise in nationalist behavior and mindset as each country had their own healthcare response. It didn’t feel like a globally coordinated response, and perhaps the mindset is less desiring of the coordination. However, technology and the interconnectedness of supply chains make it difficult for globalization to be completely reversed. So, I think it's a gradual disconnection of points where you feel more exposed, but it's not like you're disconnecting all the way back to your home country.
Waldron: The pandemic is unlike anything else we've faced in our lifetimes. We had a significant demand shock and then saw the central banks try to resuscitate demand by putting enormous amounts of liquidity in the system. And because we had such a decline and then such an increase in liquidity, we must navigate through those imbalances, all while we have an economic contraction.
The UK’s recent liquidity issues stemming from liability-driven investing structures is concerning. It shows that when you have these imbalances and you have leverage, even with safe securities, things can go awry. And there was a little bleed through into the US markets because of what happened in the pension markets in the UK.
Government debt is also a destabilizing factor. The real economy was shocked with the pandemic, and the governments came to help. All that financing was essentially moved from the private market to the public market, resulting in extra leverage on public balance sheets. That's all fine when you have low interest rates, but now we have higher interest rates. The US has the global reserve currency, energy security, food security, and other advantages, but if you look at it through the lens of a large leveraged buyout, it went from financing at 2% to now financing at 5 or 6%. That's a big difference, and a very nonproductive cost in the US economy. For other countries that don't have the same advantages as the US, there is greater concern about those imbalances with that cost of capital shift and the currency mismatch.
Waldron: We're big believers that liquidity is ultimately what matters. Asset prices and other things are important, but you have to maintain liquidity above all else to provide ballast. We tend to focus on having more liquidity, being more careful in the ways we are funded, and talking to our clients about their funding.
It was easy for companies to fund themselves in a lower-for-longer environment where there was an abundance of liquidity. Today, the cost of that funding is increasingly expensive. We tend not to want to have longer-dated duration risk and make sure we can get ourselves closer to home more quickly with less disruption in the markets.
Waldron: We’re very focused on what we call “sustainable finance,” which includes both climate transition and inclusive growth efforts. In 2020 we put forward a target to deploy $750 billion across investing, financing and advisory activities by 2030 and bring our commercial expertise to help our clients accelerate climate transition and advance inclusive growth.
On the climate transition side specifically, our role is to be a financier, an investor, and an advisor—usually all three at the same time. For a renewable energy project in Latin America that has some interesting new technology to create more climate transition capability, we will advise, we will finance, and we will typically invest so that we can find a way to be the most holistic provider of that capability. And we will likely do that with a development bank or some other governmental institution in a “blended finance” manner where it's a public-private partnership. The public sector might allow for the project to be financed more intelligently, and then Goldman Sachs can find ways to marshal the capital.
Beyond that, as it relates to the climate transition, the way I think about it is simple: what's the EBITDA of transition? How do you create the metrics that the market can rally behind? How do you think about decarbonization technology? How do you think about the way we're going to get capital to work? I’m optimistic about the work we’re doing in this space—the rest of the market might start to look and say, “I'd like to rally a bit more behind those ideas.”
Waldron: I’d flip that question around. I think the thing that I'm wrestling with as the COO of our firm is digital transformation, increased automation, and the critical importance of human capital. Increasingly, we need leaders that understand operations and engineering as much as they understand markets. When I meet with clients, I would like to know from them how they are navigating this transition.
If you're running the global markets business of the future, you probably need an engineering background, or at least one of those people running a chunk of it needs an engineering background. That probably wasn't the case ten years ago. But it’s complicated to figure out where to put those dollars, how fast this transformation is happening, and what we’re missing that we're not investing in. You don’t want to get to a place where you're all about engineering and you're not about people.
When I go home at night and think about my biggest challenge, it's actually not risk managing the firm because we've got an enormous number of talented people focused on that. It's really more this question of how to optimally execute the digital transformation and people aspect of things, and how to get that right.
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