Goldman Sachs analyst on what Fed rate cuts mean for Big Tech

Goldman Sachs managing director Kash Rangan sits down with Brian Sozzi and Madison Mills at the Goldman Sachs 2024 Communacopia & Technology Conference to discuss the top themes in tech and the sector's overall outlook.

Rangan argues that there are three important things for software companies at this juncture: interest rates, the election, and generative AI. He notes that the Federal Reserve will likely initiate a 25-basis-point cut at its September meeting, and will likely total between 325 and 350 basis points by the end of its easing cycle. Easing rates will bring down the cost of capital for businesses, and will serve as a "tailwind for existing customers to expand their deployments."

"With every economic cycle, as we come out of an economic cycle, coincidentally, there's always a new tech cycle that also goes with it," Rangan tells Yahoo Finance. He explains that after the 2008 recession, tech companies came out with cloud products, which eventually became "the catalyzing force for the tech industry."

He notes that for real growth, there needs to be innovation alongside economic improvement: "It's not as easy as saying lower rates are good. I mean, they're kind of the first lift. It's the primer. The next thing, it has to be followed by real innovation."

Rangan adds that after the 2024 presidential election in November, there will be less uncertainty: "It's not important to nail what the new policies are going to be, but it's more important to have less uncertainty and more certainty about what those policies are," he says, which indicates companies may move forward with projects it put on the backburner during peak uncertainty.

Finally, Rangan believes generative AI will be a long-term theme for the tech sector. "I am very bullish how it unfolds eventually in the long term. But if you're looking for proof points today, there's a scattering of proof points, but not enough to get conviction that this is going to be a thing in '25 or '26."

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This post was written by Melanie Riehl

Video transcript

We are here at the Goldman Sachs 2024 Comicopia and Technology conference.

I'm Madison Mills here with Brian S our executive editor.

We are thrilled to be joined by Cash Ran and he is the managing director over at Goldman Sachs Cash.

You got quite the coverage list.

All the software names, the hyper scale we love to talk about, but I want to start on this tech sell off that we are the middle of right now, the market recovering a little bit today.

But what are you hearing from executives here at this conference?

And how does that impact your bullishness on some of these A I?

So I'd like to always say the three things that are important with software companies at this point in time rates, elections, generative A I so rates we had that our chief economist make his prediction that we're going to get a 25 basis point cut, maybe 50 basis point cut.

But you cannot possibly underestimate the degree of confidence that tech executives would have because it means something to their end customers.

The signal that the fed sends that look the cost of capital for your business is projected to come down.

So Jan is now saying that over the next several quarters or so, the rates are going to come down to 325 350 basis points.

That's a very different regime.

So tech investments in tech spending overall where there is a cost of financing element that is adding to that sensitivity, we start to feel alleviated.

So you're seeing CFOS at this conference say distinctly when asked the question, what do lower rates mean for your business?

Oh, the worst thing you could hear was it's definitely not a negative, but the best thing it is going to be a tailwind for existing customers to expand their deployment.

So it all starts to add up and compound small little steps start to compound rate reductions.

Give you a little bit of expansion in your current book of business.

We call this N net expansion rates.

It's been stable for the industry.

It came down significantly over the last three years since things peaked in 2021 right?

We're starting to see some stability and of what the CS are saying that rate cuts are going to be positive for expansion rates, that expansion rate starts to move up, which is, it has never moved up in the last three years.

All it's done is just keep going down.

That's a positive, right?

The other thing that's also important is post elections, uh less uncertainty.

It's not, it's not important to nail what the new policies are going to be.

It's more important to have less uncertainty and more certainty about what those policies are.

My belief is that once we get through November, we're going to have uh if it's not the outcome that you want as a business person, you're going to pull in your spending into Q four.

If it is the outcome that you want, you're going to feel good and say, you know what these capital project that I with withheld will start to get approved.

And then j that more of a long tail thing.

I am very bullish how it unfolds eventually in the long term.

But the proof points, if you are looking at proof points today, there, there, there's a scattering of proof points but not enough to get conditioned that this is going to be a thing in 25 or 26.

So when I talked to Jan this morning, he made a lot of good points and he said he sees a series of rate cuts.

So if we get a series of rate cuts, a lot of these tech stocks that have been selling off now, are they back off to the races?

More multiple expansion earnings re accelerate and we're looking at some of these stocks, maybe, maybe they're up 2030 40% from where they are now.

I wish it would make my job so simple.

In fact, I quit when I was in ya on stage today that, oh, so your rates are gonna come down.

So, it means multiples are gonna go up and I'm gonna have to upgrade my price targets.

No, no, no, no, not that fast.

With every tech cycle there is a, I'm sorry, with, with every economic cycle as we come out of an economic cycle.

Coincidentally, there's always a new tech cycle that also goes with it.

And if you're on the right side of tech and if you got the goods, the sales force into, you know, Mark was in 2009, 2010.

Distinctly remember the economy is coming out of the correction, right?

And cloud was in its infancy and lifting out of the recession and cloud was in its infancy and cloud became the catalyzing force for the tech industry.

You have to have, you have to have cloud otherwise you're gonna be left behind, right?

And so similarly, it's not as easy as saying lower rates are good.

I mean, they are kind of the first lift.

It's the primer, the next thing it has to be followed by real innovation.

If your net expansion rates go from 170 to 190 they stall, it's no good.

It needs to go up.

We need to get the industry back from 11% growth rate to 20 30%.

So that new innovation needs to happen, you need to be the first capitalist on gen I your products need to come out, you need to be able to improve your retention Upsell when you compound that innovation with lower rates, magic happens.

Does that mean you think that Microsoft is the A I winner?

Because they sort of do have first mover advantage.

I think this game is about capital unfortunately, or fortunately for the hypercar so you need to deploy unlike prior cycles.

Uh the cloud was capital intensive by the way, people forget that there was a lot of criticism of companies like Microsoft and Adobe.

What are you doing?

You're taking your 80% gross margin business and making it 70% gross margin.

What the hell do you do?

Right.

And if they had not, if they had listened to investors and they had not spent the capital that they spent, we would not be talking about an $80 billion cloud business, whatever it is.

So, so these are visionary managements that uh that uh decided to spend and this capital cycle is even more intensive of a capital cycle than the cloud was right back in the cloud today.

It's a trillion dollars give or take a little bit less than that.

We were substituting on prem with cloud, basically substituting compute with computer.

That's all we did.

Now, we're augmenting human capital, human capital, I don't know, 2030 trillion that installed days of human capital is far more valuable.

That's cognition, capital than compute capital.

So this cycle if done well, it is going to be huge.

And if you are Satya Adela, if you're one of these tech ceos hyper, you're like, OK, I was lucky to get the cloud cycle, right?

Man, this cycle is not a trillion dollar cycle.

This is like multiples of trillions of dollars.

I hate to get on it if I don't, if I'm not the first mover, I'm crushed as you know, you don't want to be even the third in the tech industry.

It's either one or a strong number two.