FidelityConnects: Building a concentrated U.S. equity portfolio for long-term growth

[00:02:46] Pamela Ritchie: Hello, and welcome to Fidelity Connects. I'm Pamela Ritchie. Much ink has been spilled discussing the end of U.S. exceptionalism but do the winnings of that so-called trade really end over a period of just a month or two? Today we're going to dive into the weeds of what works and what doesn't in a concentrated U.S. focused fund. Happy to say joining us live from Boston today is portfolio manager, Steve DuFour. Welcome, Steve. Great to see you again. How are you?

[00:03:16] Steve DuFour: Very well. Thanks for having me, Pamela.

[00:03:17] Pamela Ritchie: Little warm there.

[00:03:19] Steve DuFour: Quite hot, quite hot.

[00:03:21] Pamela Ritchie: Yes, the Eastern seaboard is, yeah, we're feeling the heat but that's okay. It's summer so we can't complain about the heat. Let's go into this discussion of U.S.  exceptionalism. Your fund, obviously, is U.S. focused, it's a concentrated fund, just remind us how the fund is set up again. You talk a lot about the fairway and then you have some core stocks. How many stocks have you got?

[00:03:42] Steve DuFour: The goal is 36 and I think I may have 37 right now. I try to own 36 stocks with strong relative earnings trading at attractive prices.

[00:03:56] Pamela Ritchie: Fantastic. This term, U.S. exceptionalism, do you feel from your perspective, we're asking lots of people but has it actually been just a little overdone, the sort of idea that this U. S. exceptionalist trade is a bit over? I mean, it seems like it's gotten to the point where the Uber driver is talking about it so that's not good.

[00:04:17] Steve DuFour: That's a good point. I don't know the answer to whether it's over but the way I look at it ... and I run the U. S. Focused Stock Fund but I also have been working on the Fidelity Worldwide Fund since 2007. For the last 18 years I've been looking with my co-partner portfolio manager for great ideas around the world. I don't really ever do anything. We talk about themes, we talk about anything. I don't do anything at the top level, I really just get down to stocks. As I look at the U.S. stock market there's still kind of three, four, maybe five sectors where kind of the U S. still has an advantage and it really doesn't change when we change presidents, it doesn't really change year-to-date. A lot of these things are kind of 3 to 10-year investment cycles in order to have a viable product.

[00:05:20] The areas where the U.S. continues to lead, and maybe don't lead as fast, they may have been one lap ahead and then they may only be a half a lap ahead so that could be a little bit of bloom coming off the roads, but in technology, particularly AI, in health care, particularly in the development of drugs, in communication services a little bit like Google and Meta, and then parts of the financial services whether it's the introduction of new ways to use crypto, stablecoins, alternative investments like private equity, private credit, M&A activities. There's some areas where we're very strong but having said that, there's areas that are stronger outside the U.S. but they've always been stronger outside of the U S. Luxury brands in Europe, materials, energy, you can find a lot better names outside the U.S. I think it's a catchy phrase but I still think there's areas within the U.S. that are very, very strong.

[00:06:25] Pamela Ritchie: STell us a little bit about the fund. I think all of us have been a little bit holding on for dear life over the last volatile several months. Tell us a bit about the fund.

[00:06:38] Steve DuFour: The fund is a concentrated growth fund but it's not ... as I said earlier it's strong relative earnings at attractive prices. I pay roughly two more P/E points than the S&P 500 average is trading at to get what I believe is going to be substantially better growth — earnings, I follow earnings, earnings, earnings, earnings —  earnings growth over the next one, two, three years. That has been the process since 2007 as I've been running the U.S. version of this product and since 2011 the Canadian version of this product. Year-to-date the fund has had a tough start to the year. We haven't changed our process. What we got hit with at the beginning of this year was ... as I say, strong relative earnings at attractive prices so you went into this year and we thought that earnings were going to grow about 12%. So you sit there looking for names that are going to grow more than 12% with decent valuation.

[00:07:55] We had what I believe was a great portfolio, and I still believe it was a good portfolio, but then you get hit with threat of tariffs, DOGE, taxes, the fear of higher inflation from the tariffs, and the Federal Reserve not wanting to grow interest rates even though we're in kind of an industrial recession in part of the economy, particularly in housing and other parts like that. It was a perfect storm. The market started to say, are we going to have 12% earnings growth this year or are we going to have 2? That's why the market was going like this. At one point it went like that because people got strong belief that the earnings growth rate for this year was heading more towards 2 than it was to 12, so things that were a higher price got hurt.

[00:08:49] In addition, we had a number of individual names ... I told you I try to own 36 stocks. This was a unique period year-to-date where 5 of my 36 did not perform, 2 of the 5 replaced their CEOs, that's how bad they performed, to or from lower spending because of the threat of tariffs and lower consumer spending. One was a competitor, decided to lower prices to compete against them, which happens. The other one, part of their business was selling into the construction agg and trucking areas and that area has been hurt the last 12 to 18 months.

[00:09:38] Pamela Ritchie: With that and with truly exogenous shocks in a lot of ways, the way this stuff came through and hit the markets by surprise, what do you do? You go back to the fundamentals, roll up your sleeves and you sort of dive back in. What have you been doing in reaction to some of those changes?

[00:09:58] Steve DuFour: The first thing you do is you scrub your 36 dots. Let's make a list of all the problems. We now have new variables. I didn't even throw in the fact that China came out with a very good AI model called DeepSeek.

[00:10:13] Pamela Ritchie: That was a moment, yes.

[00:10:16] Steve DuFour: That was the moment. That brought into question the amount of capexes needed to do AI. Do we need as many chips? Do we need as many data centres? Do we need as much cooling, electronics? You throw DeepSeek, you throw foreign currency, you throw interest rates, you throw inflation, you throw tariffs, throw tax rates and where your IP is located, you make the whole list of every problem and you go back to — DOGE government contracting — and you go through the portfolio and say, all right, where are we? What is the effect of earnings if it happens? What is a problem? We actually owned a shoe manufacturer who manufactures all of their shoes in areas that are very high tariffs. You go to each of your problems and decide, all right, how confident are we in our earnings projections, what is our ability to predict anymore?

[00:11:11] We try and delude ourselves into believing that we can predict the earnings two to three years out. If we even can't convince ourselves, delude ourselves into that anymore we've got to go into another name because you've got love your stocks. You can't say, you know what, I'm not sure and stuff like that because we own very large positions in 36 stocks. You do that, and that's the fear. So you do fear and then you go to greed. The greed is you create a list of stocks that you've always wanted to own in your life. As I told you, I pay 2, 3 points of P/E points higher than the market for better growth. That doesn't get you the best in class in a number of industries because you usually have to pay a lot more than that to get there.

[00:11:59] As I explained to a number people, I've been talking to people about the fund's performance year-to-date over the last few weeks or few months, I explained that strong relative earnings and attractive prices get you a beach house basically two blocks from the water. If you go on the second floor of the house into the bathroom and look out the window you can see the ocean, but there's houses that are one block in front of us that are on the ocean, they're usually too expensive, and during this time where things get discombobulated you've got to take the advantage if something comes into your price zone and move closer to the water. That is what we did. We did fear and then we did greed. During this period, we've probably added 6, 7 names, new names, in our 36 which have upgraded the portfolio. There's a lot of fear. You internalize the fear and then you accept it and then use it as an opportunity.

[00:13:08] Pamela Ritchie: Can I ask, are those names, you often talk about your fairway where you'll have maybe smaller positions and then you'll have some larger ones, did they all come from that?

[00:13:20] Steve DuFour: Some of these are still a little bit outside the fairway. I usually tell people that we have 85 to 90% of the fund right down the middle, this is what we're doing, but I leave myself a bucket for opportunistic names where you kind of have to look out, maybe not the third year of earnings, maybe the fourth year of earrings, because these are just very strong franchises in very long runway businesses. They didn't come all the way down into our fairway but they came very close and I realized that there's something we definitely want to own over the next two, three, four, five years.

[00:13:59] Pamela Ritchie: Fantastic. Are you quite actually excited about those ones? I mean, have you moved on from some of the ones you obviously had to exit at that point, or they could come back and at some point look interesting again, or this is a new direction?

[00:14:15] Steve DuFour: In the end there's 504 stocks in the S&P 500 and I basically play with 175 of them. There's probably 200, 300 names we're just never going to own. It's just not a business ... they don't have enough revenue growth, they don't have enough earnings, they have poor balance sheets, something is wrong with them that we're just not going to do it. A lot of these names come and go based on what variables are in the market, interest rates, growth rates, inflation rates, you name it, technology cycles and stuff like that. I'm very, very excited about the portfolio because if you follow strong relative earnings.

[00:15:17] As I've told you over the years, you and I have been speaking for years, I don't go out and say, wow, that's a great new theme, I want to put some money in that theme. I follow the earnings and then figure out what theme I now own. We never got into buying marijuana stocks, never got into fake meat. We looked at hydrogen. Things come and go. 3D printing came, went, stuff that comes and goes. We follow the earnings. As we are upgrading the portfolio into stronger earnings growth we are getting very good themes. A lot of it continues to be in and around AI. There's various different ways to play AI but the themes are very strong.

[00:16:08] Pamela Ritchie: Tell us a little bit about that because we had the hyperscalers which led the way and the money, obviously, but then their valuations ticked down and then a lot of them have come right back up again. This is the AI investment. Then you sort of got the so-called, I forget what you called them, the pick and shovel, basically, the data centres, the places where you're going to get the power and everything else to make it all work. Are you invested in all those areas of that?

[00:16:35] Steve DuFour: Yes. We were a lot more ... a year ago, year and a half ago, we were a lot more in picks and shovels. Now we're more in operators and we're trying to get a little bit into implementers, it's hard to do implementers, and then the ultimate goal is to be in products as well as companies that are doing a very good job of implementing the products. It's a process that I'm implementing probably over the next three, five years. Right now, still pick and shovels, more operators. The operators over the last year or so were being used primarily to create large language models. You've seen all the different ones from Gemini to Grok to ChatGPT. There's a whole bunch of these LLMs now, DeepSeek. What's happening now is people are actually using them and as they're using them the data centres are lighting up and they're basically an ATM machine.

[00:17:40] As you're going into your ChatGPT and saying, what is the best way to fix an unclogged drain, what is the blah, blah, blah, asking questions, whatever you're asking in the thing it's lighting up the data centre and then there's cost. They're making money on every query. Basically, they're calling them tokens. How many tokens did you use to ask the question? How many tokens did it take to produce the answer? Basically, these data centres are going to become token factories. That's a good business. We eventually want to own the product that people really use [crosstalk]...

[00:18:27] Pamela Ritchie: Which is calling the plumber and then however many tokens that cost to unplug the drain.

[00:18:37] Steve DuFour: Yes. Correct.

[00:18:37] Pamela Ritchie: We've got to get to that point. I don't know, the answer to that question for me is always to call someone else but other people have a different approach to that. Steve, tell us, ultimately, the tokens that you're talking about there sort of lead me to the question of ... lots of discussion of stablecoins, lots of ideas about money just sort of being data transferring around. We do it already in many different ways but getting things kind of priced for that and stablecoins, it looks like, are going play a much greater role. That's one piece of policy that seems to have some investment dollars around it, is it one that you're interested in?

[00:19:12] Steve DuFour: Very much so. We've been following cryptocurrencies, well, stablecoins are kind of a cryptocurrency, cryptocurrencies for many years and looking for ways that are investable. We own a brokerage firm that 65% of all their customers own some type of cryptocurrency in their accounts and they're very active traders of cryptocurrencies. We own a cryptocurrency exchange which is a great business because with the currencies fluctuating you want to own the trading of it versus the actual currency in a fund like this. We've been following stablecoins and looking for ways to invest. We also own a trust bank which does the trust. They introduced ETFs here in the U.S. less than a year ago for Bitcoin and they do the custody for 95% of all the Bitcoin ETFs. It's a growth area and I think that stablecoins are just getting going.

[00:20:29] We just had the IPO of the first company, Circle, which was less than two weeks old. We'll see where these stablecoins evolve into. Some people think it'll stay in the background for transactions, some people think they'll go all the way to the cash register. It's easy to debate right now, we just don't know the answer of how far they will ... they definitely will be involved for foreign remittance, particularly from countries with high inflation rates. It's very good for that business. I don't if you're going to go to Walmart and pay with your stablecoin wallet but it's not out of the realm of opportunities.

[00:21:17] Pamela Ritchie: A couple of different pieces of investment that have had to, in one case, react to policy, which was tariffs, which universally most companies have had react somehow to that. This is another interesting area of the market that has been brought forth by, as you said, the Genius Act. There's new legislation, rules and regulations around things. There's more to come, it appears, on the regulatory deregulation, basically, story, also tax cuts side of things. Are pieces of policy something that you follow very carefully? You're looking at companies, I know, bottoms-up but to what extent are you paying attention to these big, I mean, they could be called themes, couldn't they?

[00:21:58] Steve DuFour: You're spot on. Not to get into the weeds but we have the House putting stuff in a bill and we have the Senate putting things in a big bill and then they've got to come together and come up with a big, beautiful bill. As each of them take things in and put things out, whether it's subsidies for electric vehicles, whether it's funding of solar and wind — I don't really own companies that are implementing solar and wind but I do own companies that make chips that are used in those processes and electronics in those process and stuff like that. If EVs are going to slow because of less subsidies or stuff like this I've got to watch and listen.

[00:22:46] As we talked about tariffs, on, off, on and off, these bills, if you listen to them each day, it's hard to trade off of that because the bid ask between the House and the Senate is so wide, particularly in areas for health care funding and stuff like that. We don't own but we have companies that sell products into the health care system so if the funding is going down ... there's a whole host, you can spend your whole day. We're only on June 24th but year-to-date it's been a record number of things that have changed, or potentially changed, that need to be ... but that's my job, to make sure the portfolio can weather those changes.

[00:23:38] Pamela Ritchie: It's fascinating. Is health care still of interest with you? As you say, there are movements. I know it's an area that in the past you've been invested in, quite interested in. You've always taught me and everyone watching things.

[00:23:48] Steve DuFour: I'm always looking for a good new product. Right now we own three health care stocks. One is robotic surgery, one does [indecipherable] for helping, well, just a whole bunch of things but the fastest growing product is [indecipherable] and then we still own one company in the GLP-1 sector. Those are the three areas that I think have durable growth. The other areas are under pressure for a number of reasons, particularly for how they do their taxes. We've got to watch taxes and then taxes and then taxes. A lot of the companies in the sector move their intellectual property to lower tax countries like Ireland and then sold their products into the U.S. in transfer prices at very high prices creating, in some cases, some are very greedy, tax losses and so they're cutting ... as you talk about following the government policies they're looking to cut some of these loopholes where people are moving tax dollars around the world.

[00:25:03] Forget about what product you make, forget about margins you make, forget about advertising, blah, blah, blah, if your taxes are going from zero to 24% that takes up a lot of your earnings and probably 2, 2 1/2 years of earnings growth. The long and short of the whole thing, there's lot of mines in the mine field this year and you've got to step carefully because right when you think you've found something that's safe something is changing. That's why you've just got to watch these names day to day.

[00:25:41] Pamela Ritchie: Nimble. Yeah, got to say nimble and you have a concentrated portfolio so you're making choices, you know, a smaller selection. There's some great questions coming in. Some you addressed earlier on but people are interested so we'll kind of swing back to a couple of these. Can you comment on your stock selection of the Mag Seven names? For instance, why less weighting to some, if any, more to others. Can just kind of go through? They do do different things but they get lumped together, don't they?

[00:26:11] Steve DuFour: Yeah. This is where we get a little tricky because they like me to stay in my top 10. Let's think of AI. Almost all of them are AI-driven. Look at AI and you play out the scenario, and I reserve the right to change, but you want to have very good distribution, you have a good product with great distribution and a defendable against competition. As I look at my large position, which is Meta, they have great distribution through their various properties which touch 2.3 billion people on the planet, all who have purchasing power, and they've been doing advertising to them. As they add new products they have the ability to take a new product which they're developing and put it on their system, as well as go into new services like search, Google search, and stuff like that.

[00:27:26] That is a company that has mew products going into great distribution. That one is a [indecipherable]. Amazon, two businesses but they have a great web services business which allows them to be in the forefront of distributing as well as implementing new products. That's two for two. Nvidia, until things change, is the best way to implement AI processing power quickly. Everyone says they're going to eventually be a competitor and blah, blah, blah, and they're right. If you go out long enough there's going to be a very strong competitor someday. Right now they're making billions and billions of dollars at 85% margins so that is a name I don't think you can bet against. You have to watch it because it is a chip industry. There's three for three.

[00:28:23] Outside of the top 10 you need to look at some of those names about what they're doing and talking about. Some are talking about future products that may or may not evolve into big things. Others have decent distribution but no products. Others are the strongest leader in a product, the best product that was ever created on the planet with 99% margins, but now has infinite new competition. Let's think about whether you want to own a company which margins look like they can go one way and you have infinite competition. I'm not talking about all of them but that's the way I would frame it. I'm looking for product and distribution and I'm trying to avoid companies whose existing product is coming under duress.

[00:29:22] Pamela Ritchie: That's super helpful. I want to try and get two questions in. This is the penultimate one because it's a U.S. focused fund, of course, but you do have the ability to go outside the U.S. This is, essentially, a question on taking a look at your allocation outside of the U.S. What can you do, what have you done, just give us a quick update on that and then I've got another one for you.

[00:29:43] Steve DuFour: The fund could be 10% outside the U.S. I would say the majority of that is in the great country of Canada.

[00:29:56] Pamela Ritchie: Yay! Okay, anyway, sorry, I didn't mean to do that. Is it really? That's interesting.

[00:30:02] Steve DuFour: Yes.

[00:30:02] Pamela Ritchie: Is that a commodities play broadly?

[00:30:06] Steve DuFour: One of them is commodities play which I can talk about because we've talked about it before.

[00:30:09] Pamela Ritchie: We don't have time.

[00:30:11] Steve DuFour: It's a royalty trust company.

[00:30:16] Pamela Ritchie: Got it. Yeah, perfect. Let's just kind of swing back to this idea of having you walk us through the U.S. exceptionalism story because I think it gets a lot of press, as we said at the beginning. At the end of the day they're just incredible companies and you have a very focused laser focus on some of these within your fund. Just kind of wrap us up with the story of where this fund belongs, perhaps for Canadians that are taking a look or are already invested.

[00:30:45] Steve DuFour: If you believe that AI, e-commerce, electrification, innovative health care products are some of the fastest growing areas, which I do, those opportunities, as well as some new innovative payment systems, the best way to invest in those are in companies that are in the United States. I'm not saying that means U.S. exceptionalism, I'm just saying I just need 36 stocks and so as I look around the world I see the best growth and attractive prices in areas that currently are in the U.S. That's why I'm still very bullish on the U.S.

[00:31:31] Pamela Ritchie: It's great to see you and catch up with you, Steve DuFour. You've been busy, you're always busy, but it's great just to have a moment to hear what you've up to. All the very best for the summer.

[00:31:42] Steve DuFour: You too, Pamela. Thank you.

[00:31:43] Pamela Ritchie: Steve DuFour joining us from Boston today, a hazy, warm Boston, same as it is in the eastern side of this country. Thank you for joining us today. Here's what's coming up over the course of the next little while. Tomorrow's show will be highlighting trends shaping Canadian households in terms of wealth distribution. Senior Managing Director at Investor Economics, Carlos Cardone, fascinating graphs and storylines that he will bring you on where wealth is headed as an overall industry.

[00:32:11] On Thursday Fidelity Director of Quantitative Market Strategy, Denise Chisholm, will take a look at the different sectors, ultimately, where the oil story belongs in the overall economic story. She'll hit on stagflation, whether it will, whether it won't, some of the factors that you will probably want to bring to bear within your own decisions.

[00:32:31] To end out the week on Friday, Fidelity equity research analyst, Andrew Hall. He joins us to share his perspectives on the Canadian consumer, current trends shaping consumer staples, utilities, telecom. We'll dig deep into those to close out the week. Thanks for joining us. We'll see you soon. I'm Pamela Ritchie.