FidelityConnects: Denise Chisholm: Sector watch – August 7, 2025

[00:03:42] Pamela Ritchie: Hello, and welcome to Fidelity Connects. I'm Pamela Ritchie. It appears we are close to learning who will be appointed as a new member of the FOMC. This is after the Federal Reserve held interest rates steady at their latest meeting in July. Most surveyed economists now believe that a cut will come in September after a dismal July jobs report. However, if the July jobs number is more of a data blip, of which there have been many this year, then perhaps equity investors could be looking at a Fed cut on top of the tax cuts that are profiled in the One Big Beautiful Bill Act. That, ultimately, could build potential wind in the sales of valuation expansion. Joining us with her thesis for what an interest rate cut in the months to come might mean for stocks is Fidelity Head of Quantitative Market Strategy, Denise Chisholm. Welcome, Denise. How are you?

[00:04:38] Denise Chisholm: I am very well, how are you, Pamela?

[00:04:40] Pamela Ritchie: I'm very well, I'm very well. Delighted to see you here. We'll ask everyone to send their questions in for Denise over the next half hour or so, next 30 minutes or so. Let's begin with we know about the cut, I think everyone's digested that one, now it's the brouhaha in the non-farm payrolls discussion, the survey itself a dismal jobs report, I mean, really electric actions taken afterwards. Do you want to just take us inside what we were watching there on Friday?

[00:05:13] Denise Chisholm: I'll take us inside the data. I wrote a note on this internally and it's going to end up being flipped to LinkedIn, I think, next week on the revisions and the magnitude of revisions if you rebase it. I think everybody knows the headline number was 258,000 revised negatively over the last two months, which is a giant revision nominally, and even giant when you rebase it relative to payrolls when you look back historically. I mean that in the sense that we have never seen that type of downward revision outside recessions since 1968. We have seen it before in this magnitude but usually it's around a massive shock, meaning like COVID or the financial crisis. Generally speaking, we understand that that is likely to happen because the response rate of the first survey is fairly low, 58% or so, and it's drifted lower over time, which I do think complicates the nature of the estimate in non-farm payrolls, because it is an estimate. Then that jumps later but it jumps to the people that didn't report the first time are usually the strugglers. They're disproportionately small businesses. You end up seeing, after a shock you have this massive downward revision. Again, you don't typically see this outside of recessions.

[00:06:32] Now, the interesting part about if you dive into the non-farm payrolls is that they have made a lot of statistical advancements over the years despite the fact that the response rate has drifted lower. and it's been more around smoothing the data. We talked before this webcast around the fact that negative payroll numbers, I don't want to say that they were the norm but they happened more often even in economic recoveries so there was a volatility associated with that data. There was a real purposeful thought process to make that data a little less volatile so that then you could understand what the trend rate was, meaning if you step back there was a trade-off of the quote accuracy that is going to be inherently volatile and something a little less accurate and timely to something that was going to be more smooth.

[00:07:27] This is a problem for the Federal Reserve, this Federal Reserve specifically, because of their stated data dependency. Look, I've been looking at data for a long time, there's not really right or wrong answers with data, it's more about the interpretation and understanding what you're seeing. As much as these downward revisions are problematic what it shows you is that when underlying trend rates change quickly the payroll report is not going to capture it, and it's going to look like late data. This is not falling on deaf ears. The BLS knows this, as does the Federal Reserve.

[00:08:06] Pamela Ritchie: The smoothing, let's just go back to that for a second, not falling on deaf ears because they were the ones actually enacting or making sure that there was a smoothing effort there. In Canada there are wild swings monthly in the jobs report and many will ask maybe we should have a smoothing, or more smoothing and so on so familiarity with that. What if you just remove it? Why not? Would that make it a perfect survey or close to perfect?

[00:08:31] Denise Chisholm: There is no perfect survey. I think you illustrated the two sort of extremes, which is to say the smooth data, for the most part when you're in a trending economy, is the way to go, but when you have a changeable event it's very late. Now, if you sort of go with the more volatile data, which we can talk about ADP as more like that now, when you look at the more volatile data then you're left with assessing, well, what is the underlying trend? Those are the two extremes. There's not going to be any right answer. I think that you have to look at the holistic nature of all of the jobs metrics. Again, I don't think that this is lost on the Fed. We have the household survey, we have the payroll survey, we have initial claims, we have the JOLTS report. They do have a big congregated picture of what the job market looks like such that the non-farm payroll shift month to month is just one of those. Now again, that was a massive downward revision. I think that that will be something the Federal Reserve takes into account, and it may very well be something that now shifts the statistical process over time so maybe that 58% response rate needs to be higher so that we don't see this magnitude.

[00:09:44] There are a bunch of shifts that can be done but, ironically, there are a bunch of shifts that already have been done in the private markets. One of the big complaints about ADP whenever it came out was that ADP, obviously, one of the biggest payroll surveyors in the private markets, releases its own figure. I can't remember how many years ago they redid their own estimate and statistics around that estimate to be more like that GDP now, to give you more of that timeliness. What's the downside? Well, it's more volatile. What have market participants said? Well, it's not accurate, it doesn't represent payrolls. And now after the payroll revisions payrolls looked a whole lot like ADP.

[00:10:27] Pamela Ritchie: That's so interesting. You'll hear sort of these throwaway phrases like never trade ADP, not to say that anybody at  Fidelity has traded a data point, but it's sort of that catchphrase because it can be all over the place, you wouldn't want to trade it. Does that mean people do ... well, we know they do trade jobs reports. I mean, often good investors will not trade data points at all, however, maybe it was seen as a more stable data point that some did go ... I'm just sort of wondering the thinking behind smoothing it, who's that good for?

[00:11:00] Denise Chisholm: I think it's good for the Federal Reserve. They want a transparent, or they want to smooth the look instead of this volatile look in terms of what is the underlying run rate. Again, back to the you have to not just know the data but the interpretation of the data given the statistical method. As it relates to the market I think that in some ways we've already talked about the fact that this is all in the rear-view mirror. I mean, it's ironic when you can talk about, okay, does firing the chief displace incentives? Well, administrations don't always get what they want. There is the optionality that maybe the data actually improves, and that's a good thing for policymakers going forward, but interestingly enough, like we just talked about, the private markets might have already solved it in that more like job now component in terms of ADP.

[00:11:49] Even if you look at these negative payrolls and say, well, this is a problem for investors, when we've seen negative payroll's like this in the past what has that meant? It has, ironically, meant buy stocks. Why has it meant buy stocks? Because the stock market usually has already reflected what is now reflected in government data, meaning that you're not fooling anyone with the different types of data. The stock market, historically speaking, based on the data that I see, already understands the true picture. In some ways, you can point back to that, that was the bear market, or the almost bear market that we saw in April. This downward revision isn't a surprise to the market as much as it might be a surprise in the Eco Surprise Index on Bloomberg. Again, even when you say, okay, what are the problems in the job market? Maybe we don't understand the underlying run rate, is that a problem going forward? I think you have to struggle back with what have stocks already discounted because history suggests that payrolls are a lagging indicator. You run a real risk of using this in your investment process when stocks have already fully priced it in.

[00:13:01] Pamela Ritchie: This firing has happened and a lot of headlines were made out of it. What do you think sort of in terms of the way data is presented and brought to bear for market participants, and also for the Fed, what will change here? It sounds like something will change.

[00:13:21] Denise Chisholm: It certainly might. Back to the, you know, none of this is falling on deaf ears of either the BLS or the Fed, there's been plenty of white papers done about the pros and cons of the statistical approaches. I don't think that there's ... there is intrinsic knowledge at the BLS of how you could shift the methodology. Will that happen instantaneously? Probably not. Nothing happens instantaneously in the U.S. government. Does it need to happen instantaneously? Probably not because, like I said, in the sort of throes of a government problem of what is the underlying data the private markets have largely ... I don't want to say they've solved it but they have other data points from other vendors that also provide that, as does the Federal Reserve.

[00:14:07]  I think that you could see a shift in the statistical algorithm to maybe be more volatile but also more accurate, Remember, there's a trade-off around there. Do you want accurate or do you want volatile? You sort of can't have a smoothed approach be accurate at all times. There is just a statistical trade-off as it relates to looking at that data. Maybe we've swung too far in the wrong direction and maybe we need to swing back. I think that might be likely over the next couple of years. I don't think a whole lot is going to change over the next three months. Back to the does it need to, I think there are a whole lot of other pictures of the job market that not only the Fed has but, obviously, market participants have already had.

[00:14:52] Pamela Ritchie: Okay, so the stock market, as you say, often can be a better place to look for all kinds of things. It distills things for market participants. That's what it is. Take us to what traditionally it's meant when we see this kind of shock to the stock markets themselves, and in this particular case we're looking at, well, it looks like we're looking at companies that are not really hiring. That doesn't mean that they've gone the firing direction either. What do we need to read into the labour market right now?

[00:15:23] Denise Chisholm: It is an interesting sort of set of data. I think if we step back and say, what are you afraid of as an investor? You're afraid of a recession, right? What's that? A contraction in the job market. Have we seen that yet? Not really. Not clear. I mean, we might have in terms of if it's the beginning of a massive downward revision but corporate profits are usually the leading indicator in the job market. They're stable and now, potentially, accelerating which might mean that in the grand scheme of things this actually might be the soft spot of the pause that refreshes. In the statistics in terms of we were seeing, I'm making up numbers like trend numbers of 150,000 non-farm payrolls each month saying that that was our underlying trend, if that's relative to a population and part of the population growth was driven by immigration and now you're seeing a downshift in that immigration, well, then the underlying growth rate that you should expect in payrolls might be more like 50. That might be the actual growth rate. So it looks like a massive downshift but relative to the population, which is how you should rescale it from a growth rate perspective, it's actually not that meaningful.

[00:16:32] Should you be surprised as an investor if you see this downshift in growth but it not being bearish for the market? As Chair Powell sort of said in his comments, what you're seeing is a rebase in terms of a decrease in the demand for labour at the same time as a decrease in the supply for labour. It's not clear that this needs to lead to a massive spike in the unemployment rate, which means that maybe this is less clear that it's a recessionary forecast. Again, stepping back, what does it mean to the stock market? If it's not a very clear recessionary trend this is very bullish for stocks historically. Again, back to the it's not just that when they get revised down this much the data point says for the next 12 months that stocks go up, it's the very clear pattern that you see in the data.

[00:17:24] The bigger the downward revision, the more likely stocks are to be higher. Why? Because more often than not in the past stocks were already lower to reflect it. It gets back to this weird sort of almost perverse conclusion which is stocks see the data before the Fed does, in the sense that it sees. To the extent that you use stocks as the forecasting mechanism for what payrolls are going to be what April was saying is, oh, payrolls are taking a downshift down and what stocks are saying now is that might be the pause that refreshes, meaning that there might be growth to come. When I put the statistical picture together from what the job report says and from what we're seeing in the historical data as it relates to revisions, I actually think that this is a bullish trajectory, not a bearish one.

[00:18:20] Pamela Ritchie: That is fascinating to think that it's already been discounted and we've moved on, the stock market has moved on and might continue to do just that. Does it also mean that wages will be either high or high enough to keep spending going and therefore avert a recession from that perspective?

[00:18:38] Denise Chisholm: High enough is probably the right answer. We're seeing a sharp decelerating trend in wage growth. I mean, in some ways people have said, well, you know, if we have a shock in terms of the supply of labour will that cause sticky wage inflation? My answer to that when investors ask me that, or when market participants ask me, is to say, I hope so. Right now the downtrend in wage growth needs to see, needs to be forestalled. You need to see supply be culled to have wage growth really level out at levels that you want to see it level out at. I think that that's where we are now. Again, when you look at the overall economy there isn't a whole lot that you could point to that is strong.

[00:19:21] You would definitely say that we're not in a recession as of yet but I think you would struggle to say which parts other than maybe technology investment spending are strong. The U.S. consumer right now has ... people would say that they've pulled back, I would say it's off of a very surge in terms of the fourth quarter ahead of tariffs. It's not clear what is normalized consumption. Right now real income growth, partly because energy prices are staying low, partly because the economy is still growing, is a positive indicator. Is it extremely positive? Not really. It's been volatile this year. What you see is that underlying trend is very different from what the consumer experienced in 2022, which was a real downtrend in terms of real income. We haven't seen that yet. Back to your point, it looks like it's good enough.

[00:20:18] Pamela Ritchie: Good enough, and then we go to the discussion of sort of the earnings that you've been seeing but then also the valuations. Earnings have been steady enough. I mean, this was the quarter that everyone was pretty worried about. That said, I'm sort of curious about the relations between earnings and valuations because it seems like valuations just keep pushing higher with earnings that are absolutely fine. Is it because they got so cut off at the knees in April that we see valuations expanding?

[00:20:51] Denise Chisholm: That's exactly right. I think that there are a lot of investors who would say stocks are already expensive so you shouldn't bet on valuation expansion. I'm not going to say that. The reason I'm going to not say it is because stocks get more expensive not just because of irrational exuberance from investors but stocks get more expensive when durable earnings growth is visible. The more visible durable earnings growth, the more likely stocks are going to discount in advance and it doesn't matter in terms of the starting point of expensive levels. You can see this in all of my work, meaning that when you're starting at top quartile valuation levels and you get a tax cut, you get the Fed cut, you get earnings to be strong, all of this, or you get a capex cycle, all of these sort of durable signals,  and we're seeing a trifecta of them, gets discounted back regardless of the fact that you're starting point is already expensive.

[00:21:43] I do think that stocks are likely to even get more expensive relative to what we've seen and I don't think that that's going to be a cap to forward returns, because I think what stocks are saying in that valuation expansion is just that mid-cycle earnings are going to be higher than any of you think. We've got a tax cut for corporate America, basically, 700 basis points. We may have a Federal Reserve cut, maybe 50 to 75 basis points, that usually expands multiples, and we're in the midst of a capex recovery which usually makes earnings growth more durable. If we think about valuation as more not in any one given year is it very reflective of what stocks will do but in terms of an esoteric almost R-star for valuation what is that mid-cycle and what multiples should we put on that mid-cycle earnings? It might end up being, given these massive tailwinds, and I would call them massive, that mid-cycle earnings are just higher than you think, which means stocks are not as expensive as you think, which means that valuation is not going to be a headwind. So earnings growth is good, I think it's likely to stay good, I think it's likely to get better, and I think that stocks are going to stay expensive, and that means that the return of the secular bull market is intact.

[00:22:58] Pamela Ritchie: That is amazing. There are a lot of questions coming in right now about tariffs, which we haven't mentioned yet but you have mentioned in every other discussion. I'll put a couple of these to you. With tariffs being imposed on the American population, on companies, why are we not considering possible recession in the market?

[00:23:17] Denise Chisholm: Size. It's a great question and I think that history really can be a guide. I understand the fact that people want to use tariff rates as sort of a barometer for global trade, which they think changes the nature of the global economy. That's a really hard proof statement that I can't find in the data. What you should be thinking, I think, of tariffs as a tax increase. We don't know where the tax lands but we know it is a tax. People will pay more for goods, whether it's the U.S. consumer, U.S. consumer doesn't want to pay it, it comes out of corporate profit margins. Some of it might be absorbed through currency. Some of it might be observed by the foreign producer. We have to make guesses in terms of where that's all going to land.

[00:24:01] But let's make some guesses and then let's see if it's big enough to tip into a recession when you compare it with the historical things that have tipped us into a recession like massive Fed rate hikes or usually oil prices. We have good comparisons, and what you'll find is, let's say we land on 15% tariffs-ish, $3.2 trillion of imports, let's say that that's $500 billion of tariff revenue or a tax hit, let's say it's all shared by U.S. consumers or U.S. corporations, half and half, that's a $250 billion hit to the U.S. consumer. Sounds like a lot. It's a 1% headwind, also sounds like a lot. When you look in history 1% headwinds have not been enough to tip us into recession. Why? Because there are usually other tailwinds that you're not measuring. What could be the tailwind this time? Lower energy prices. That's, what, three-something in terms of per cent of income. It's down 30% over the last year. That's a 1% tailwind. Completely offsets the 1% headwind.

[00:25:11] Is this fun? Does it mean you're going to have a strong consumer? No, it does not. But it does mean that it's likely not a recessionary event, meaning that we muddle through. If we muddle through, which might not mean good growth, but if we muddle through juxtaposed with a stock market that discounted a recession at the low, 15% contraction in earnings growth, you still have a potential catch-up trade. Back to 2022, what happens when you price in a recession that doesn't happen? It's not just a 20% snapback. It's 75% over the next two years. That's your potential upside risk if you get that math wrong. That's why when I do the math on what tariffs might mean to the U.S. consumer it's just not big enough to be a tipping point for a recession. And if that doesn't happen and stocks discounted that happening, you end up climbing the wall of worry again.

[00:26:02] Pamela Ritchie: Do you think there's anything to, I mean, it was such a shock, as we all know, in April, and that shock has then mostly come back into kind of a second half more optimistic look. I mean, we're only part way through  so we don't know but it's just interesting. A lot of market participants did say, you know, take the pain early on and then it'll ease up later on. Is that kind of where we are?

[00:26:29] Denise Chisholm: That's true, it might be. It might actually be exactly that. There is, hey, their policies were misaligned, the tariffs are coming before the tax cuts, that's going to be a problem for the market. It was indeed a problem for the markets and now it's actually levelling off, which might mean, again, sort of if you look back and you just looked at your statement at the beginning of the year and the end of the year, you might be like, no, there's nothing to see here, it was all fine. But it doesn't look fine when you look month to month.

[00:26:56] Pamela Ritchie: Right, which brings us back to the jobs. Okay, here's another question. This is on the jobs report. Does the discussion around statistics imply that perhaps media makes too big of a deal of data releases and their impact? You said maybe the Fed benefits from a smoothing. I mean, maybe we all do, I don't know, adding noise to the signal, perhaps. Is too much made of these individual data releases? What do you think?

[00:27:19] Denise Chisholm: I think so. Every time you ask me to talk about payrolls I'm like, please don't make you talk about payrolls, because payrolls are just the most heavily revised series because of the month to month change. Even if we think we know the answer of it's 75 this time, that's well within the range of it could be 5, it could 150. We have no idea when these data are released. You only know in deep retrospect after the 3-year benchmark revision what jobs ultimately were. One of the reasons why I don't like looking at it in terms of does it mean that I should do something different from an investment conclusion. At the end of the day, Denise Chisholm is not an economist. I'm not buying units of GDP. I'm using economic data to see if it is signal or if it is noise as it relates to the stock market. What I keep coming up with when you look at the data every way and twice on Sunday is that payrolls are a lagging indicator. They don't help you when you are thinking about should I buy, should I sell, should I hold. For me, yes, I think that the headlines, we make too much of a heavily revised series.

[00:28:21] Pamela Ritchie: Okay, fascinating. Wanted to take just take a couple of minutes to ask you about about the dollar. Along with everything that happened in April slid the U.S. dollar, and, proportionately, we saw currencies around the world lifted due to that, including the Canadian loonie as well. Was that overdone?

[00:28:41] Denise Chisholm: I think so, and that's actually going to be my note this week that probably in two weeks will get flipped to LinkedIn. I actually have to look because the chart's right up there for me. It's interesting. What we've seen in terms of dollar depreciation, and by dollar depreciation  I mean it on a trade-weighted basis. We've definitely seen a bottom decile move but we've seen that before in history. The question is, okay, looking at history, does that tell us what should happen next, and what happens next is, again, dependent on whether or not you think that the U.S. will go into a recession. If you're with me on the base case that I think we're in muddle through capacity where corporate profits are the leading indicator, the tax cut, the capex cycle, and potentially Fed cuts is our tailwinds that may allow us to muddle though and remain in growth for the U.S. economy, you get 85% chance, historically speaking, of the dollar re-appreciating.

[00:29:32] You layer on top of this that it's very rare in the data to have non-comms, the non-comm report, or the speculators, be massively short the dollar in favour of both the yen and the euro at the exact same time. Those two things are very predictive. It's almost like this, everybody out, and that everybody out always creates an opportunity for a bounceback on the other side. Now look, this doesn't make me a giant dollar bull. I don't think that that's a secular tailwind for the dollar over the course of the next decade. I think that, ultimately, in three to five years we look back on dollar and see something much like we've seen in interest rates. There's a whole lot of volatility and at the end of the day it went nowhere. Rates are kind of the same as they've been in 2022, with a whole lot of 30% and 40% moves in the middle. I think that that might be what we see in terms of the dollar. There's been moves down, there's going to be moves up. I think over the course of the next five years the dollar will just be flat, which means that you need to think about other things than currency as it relates to your international investments. Currency is not likely, in my opinion, not likely going to the long term driver.

[00:30:48] Pamela Ritchie: Since we spoke to you last have your sector choices at the top and at the bottom, have they changed? You had tech, financials, I think also discretionary. Are they still the same?

[00:30:58] Denise Chisholm: Still top three, absolutely. No change.

[00:31:02] Pamela Ritchie: And bottom three, health care, is health care getting further to the bottom?

[00:31:05] Denise Chisholm: Probably further to the bottom, yes. Ironically, as they get cheaper they get further to the bottom because statistically they look like a value trap. So the cheaper they get, the more likely I am to want to short the sector, ironically. It's usually because the market understands that there's a problem in terms of margin degradation. There has been a problem. Margins have been relatively stable over the last couple of years and I think what the market is saying is that that's not likely to continue, is that relative margins are likely to take another step function down relative to the rest of the market, which could create more pressure on health care. Health care, energy would still be a sector that I would be underweight, and then I would pick on consumer staples after that.

[00:31:48] Pamela Ritchie: Fascinating. We are so grateful for you sorting us through some of the data discussions. It sounds like there's going to be a lot more circulating that we'll have to put to you but thanks for straightening us out for today.

[00:32:00] Denise Chisholm: Always fun to talk about it.

[00:32:02] Pamela Ritchie: Denise Chisholm joining us today from Boston here on Fidelity Connects. Coming up over the next couple of days, tomorrow we check in with portfolio manager, Aneta Wynimko. She gives us an update on global consumer trends and where she's seeing opportunities in this space. It's quite fascinating how she sees some of the trends and demand stories shifting possibly in favour of the future for the consumer story.

[00:32:26] On Monday, Vice President of Product, Andrew Clee, he joins us to share his latest views on markets, the ETF landscape and what product innovations are coming down the pike at Fidelity Canada.

[00:32:38] On Tuesday of next week we dive into the global equities playbook. This is with portfolio manager, Patrice Quirion. He will be sharing what emerging opportunities he's keeping an eye on globally and, ultimately, what advisors want to do to stay the course during some of these uncertain global times across the marketplace.

[00:32:56] Just an update for you, there's a new episode of the Upside Ticker Talk. This is Étienne Joncas-Bouchard. It's available on YouTube, Spotify or Apple Podcasts. The newest episode is an interview with Fidelity's Director of ETFs, Andrei Bruno, about the evolution of ETF's and their popularity with Canadian investors, hugely popular with Canadian Investors. They'll get into that for sure. You can check that out. Thanks for watching us here today. I'm Pamela Ritchie.