FidelityConnects: Denise Chisholm: Sector watch – July 24, 2025

[00:04:12] Pamela Ritchie: Hello, and welcome to Fidelity Connects. I'm Pamela Ritchie. As markets adjust to higher valuations and shifting economic signals one thing is clear. Capital expenditures are becoming a more meaningful part of the market narrative. With policy tailwinds like the one big, beautiful build, so-called, fueling what some are calling a capex comeback investors are watching closely to see where the next opportunities will emerge from tech and financials to energy and consumer discretionary. While many are focused, certainly, on what the Fed might do next Fidelity's Denise Chisholm, Director of Quantitative Market Strategy, is looking beyond the headlines and helping us understand what's driving capital spending, how inflation is playing out and which sectors are best positioned in today's environment. Welcome, Denise. Great to see you.

[00:05:04] Denise Chisholm: Hi, it's great to be here, Pamela.

[00:05:06] Pamela Ritchie: Delighted to have you here. We'll invite everyone to ask questions for Denise over the next half hour, send them in to us, we'll put those to her. I wonder if we might start with, we know the so-called one, big,  beautiful bill has tax cuts. As a broad statement, why do tax cuts lead to capex? Why don't they lead to better share buybacks or giving people money back in different ways? Why does it specifically lead to that type of investment?

[00:05:38] Denise Chisholm: I will say that I'm not quite sure of the why but you can see it statistically in the data. You can study history with lower effective tax rates or lower statutory tax rates, you have the same sort of impetus, especially extra sessions with effective tax rates, where if corporate taxes go up corporations spend less per their unit of sales. If you give corporations tax cash back through lower taxes what you will find is corporations spend more in terms of capex per unit of sales. It's a very symmetrical signal, and I think it's an important one because what you usually find is ... I'm not necessarily sure there's cause and effect but there is a really strong corollary of when you see corporate spending, again. normalized for their sales base, pick up it tends to coordinate with a really strong durable earnings cycle. It's almost like it's the math behind that virtuous cycle we're all struggling to find in the economy which is, to the extent that corporations fund and see growth it usually pulls forward more growth. That starts a virtuous cycle which continues in terms of the durability of both the economic cycle and the earnings cycle.

[00:06:53] Pamela Ritchie: When we think about this bill in particular it goes to better situations for depreciation of assets, for instance, there are all kinds of details within there that make having equipment, having whatever you're going to spend in terms of capex in a better place to be put onto balance sheets, essentially. What particularly in this bill, do you think, is either an extra catalyst or is adding to it in some new way, or is it just it's a tax cut that leads to capex.

[00:07:21] Denise Chisholm: I think two things. One, the magnitude. Effectively, it is a 700 basis point cut. That is not insignificant at all. Two, most importantly about tax cuts here, Econ 101 probably taught you, is whether or not they're temporary or permanent. This is permanent. You've got a permanent tax cut that pulls forward R&D expensing and all of what you talked about in terms of [indecipherable] depreciation that was rolling off under the prior administration all pulled forward this year and is permanent without any sunsets that we saw in the last clause with personal income taxes. Those things, again, when we think about does uncertainty weigh on business spending, well, this is one aspect that impacts business spending a lot that is now quite certain. That's one of the reasons I think the intricacies behind this bill but, again, I do think that we're not hearing it enough in terms of what it means to corporate spending, to corporate profits. I know that there's not a lot on the personal side, and there's definitely not when you run through the math, but it's very significant, at least by the way I look at history, in terms of what it needs to corporate profits and, therefore, what it mean to the stock market.

[00:08:34] Pamela Ritchie: What it means to the stock market and also, potentially, sort of the economy of it all if you have companies that are raking in better profits lots of other things go well, including jobs. I'm sort of curious because there's a lot of discussion of efficiencies being made through AI, through technological enhancements and so on, but at the same time you would think that companies who are more flush will spend more also on human capital.

[00:09:01] Denise Chisholm: It's interesting, I hear a lot of people say, well, we've seen earnings come through and earnings are strong but really at the end of the day this is all about what it comes down to in terms of the job recovery and are they going to hire. I will tell you, if you step back one of the biggest significant forward looks in terms of hiring is corporate profits, meaning that if corporate America makes more money, and we're talking about all the reasons why earnings growth is likely durable, they will likely hire more people. Again, that gets back to sort of this durable cycle in terms of the economy via job growth and corporate profits in terms of spending begets growth which begets more spending. I do think that some people that I've heard in terms of talking about what the key things to watch are, are watching the wrong things, in terms of jobs is really the backward looking indicator, we always call payrolls a lagging indicator, where corporate profits are actually the early look on what we think the economy will look like in the future.

[00:10:00] Pamela Ritchie: In terms of earnings, what we've seen thus far in this earnings season is actually good. There was a lot of fears that it might not be because it was Q2 and it was right after Liberation Day and goodness me, what did that mean? Things have been pretty good. We've actually got some guidance back. It seems like CEOs were a bit on pause there, understandably, perhaps, and they're looking through a lot, it seems. That's what I've noticed. I'm wondering what you're noticing in sort of the earnings guidance piece.

[00:10:29] Denise Chisholm: You can definitely say that earnings are better than, in some ways, what we thought going in but certainly better than we thought at the lows post-Liberation Day. I always think that that's the math that we need to struggle with because you could step back and say, okay, earnings are okay but they're not fantastic. You didn't need fantastic, you needed it not to be as bad as it was discounted at the lows. Remember, a 20% decline in stocks is equivalent to a 15% contraction in earnings growth. We're not seeing a 15% contraction in earnings growth. In some ways that math had to be rationalized by the V-shaped recovery that we've just seen. So yes, I think earnings has been broadly better than expected. The more interesting part is less on earnings and more on stock valuations.

[00:11:17] A lot of what we're seeing in the durability of earnings and what we just talked about in terms of the capex cycle, a lot of the impetus on that in terms what it means to the stock market is through multiple expansion. You might be thinking, well, Denise, aren't we already priced for perfection after the bounceback especially? What you find is to the extent that the market thinks earnings growth is durable, and I just laid out the math why I think that that's a really strong argument from a historical perspective, the market is still going to pull that forward into valuation expansion. Remember, the market's going to not wait for it, it's actually going to anticipate those durable earnings. I do think, again, I think we're going to have to struggle with investors of all the higher for longer mantras that we see in terms of the Fed or inflation or deficit spending. I think the higher for longer that we really need to get our heads around is valuation. I think multiples are going to stay higher for longer because of all these catalysts we're seeing.

[00:12:15] Pamela Ritchie: All these catalysts and, I guess, offsets for what appear to be sort of the bump in the night bad news that's out there as well. There seems to be a number of offsets. What is inflation at this point for you? I mean, we've seen CPI  directionally, is it still lower?

[00:12:32] Denise Chisholm: Yes. Directionally I think you're seeing broadly it's lower and lower and lower. Every month that goes by in some ways the overall inflation trend is still decelerating. Will we have bumps off that trend? Certainly, especially in the areas impacted by tariffs, but those are only in goods areas. Some of those are seeing offsets already. Then there are services. All of that, again, when you step back it's important to consider as an investor what the overall trend is and why maybe this time it's actually right to talk about it in terms of transitory because it's not clear to me that higher prices on certain goods are going to change the overall rate of inflection.

[00:13:17] Again, if you sort of go back to if tariffs don't impact the consumer all at once and it gets dragged out over time then that acceleration we're all waiting for in terms of prices might be off a lower base. That base, that underlying run rate of inflation, that's what's important to the market. If it's not going to be something like 4, 4.5 in terms of the inflation trend then I'll tell you when you look historically somewhere between 2.5 and 3.5% is still the sweet spot for equity market returns. As much as you might see an acceleration that hasn't been a problem for the market. Again, always provided that there is growth with that acceleration of inflation. I think we just laid out the parameters for why that actually might occur. As much as everybody is very worried about inflation and very anxious about it I do think that the underlying trend really caps the ability for inflation to be a problem for the stock market.

[00:14:17] Pamela Ritchie: We just saw the announcement of a trade deal with Japan. We don't have a lot of details about it, but it does seem to be a version of paying for access to the U.S. market, and a lump sum and that money will be distributed, it appears, as American leaders and sectors would like it to be distributed. It should also add to capex, that type of deal?

[00:14:42] Denise Chisholm: In theory, yes. I think that we're all probably right as investors to be skeptical about how that will play out over time. I don't think that you need that to bet on a capex cycle. I think that's sort of the important message, which is that might be nice to have but I'm not necessarily sure that that's in the risk-reward math that I'm looking at in terms of the durability of earnings and the capex cycle that I think, ultimately, makes technology a winner. It's interesting, and it's an interesting offset to the better trade deal instead of 25% sectoral tariffs on autos maybe it's only 15, it shows that the administration is willing to negotiate. It also shows that tariffs are flexible and they may even be more flexible over time to the extent that these other deals get done. It's back to the, what's important to the market, at least the way I look at it, is are we past peak uncertainty as it relates to tariffs. The more clarity you get on these deals the more flexible they are, and the less they are relative to what we thought was a baseline the better it is for the market. The market can continue to climb the wall of worry.

[00:15:48] Pamela Ritchie: Does more capex, more durable earnings mean that a recession is less and less likely?

[00:15:55] Denise Chisholm: I think that's certainly a corollary. Again, back to the what does it mean historically speaking, it means that usually when corporations spend  they're spending because they see growth, and because they're spending that usually creates growth. That's that virtuous cycle that we're all thinking about as it relates to not only corporate profit but like I just said in terms of the job recovery, and then the economy. To the extent that you look at capex cycles historically, one of the big ones was the '90s where it ran not only at a higher rate than we are right now but at a much longer rate than we're seeing right now. That was almost an entire decade of what you would call a capex recovery. Remember, we didn't have a recession between 1990 and the dot-com bust in 2000. From an economy perspective I think you could almost argue that the 2000 recession, again, from the economy, not a stock market, was a pretty light recession. Really, when you look back we didn't even see consumption actually contract.

[00:16:56] Pamela Ritchie: That's really, really interesting. Is it likely that the cheapness of oil, relatively speaking, is helping an AI capex story as well? I mean, capex often is building stuff that requires energy to do so, and there are lots of different energy sources these days but certainly the idea that oil is staying below levels that we've seen in a long, long time, and sort of sustainably, it appears, that also helps. It's got to be a tailwind.

[00:17:26] Denise Chisholm: Absolutely. It's absolutely a tailwind and you can sort of measure it statistically. Again, we were all afraid coming into this year that tariffs are a tax and that tax was going to be borne out of corporate profits in terms of the consumer not wanting to spend their additional hard-earned cash on higher goods prices, well, then that's, obviously, going to end up in corporate profit margins. To the extent that there is a tailwind on the other side what you're finding is the legislation that was just passed and the reduction in energy prices more than dwarfs on the corporate side, not on the personal side, but on the corporate side more than dwarfs the headwind associated with tariffs.

[00:18:03] Yes, I mean, I think lower energy prices are a big impact, and you can see it statistically. The lower energy prices are, not only in terms of the higher consumer spending is but in terms of the more durable corporate profits are. We've got a whole bunch of catalysts that we're really sort of talking about but not really doing the math around. When you put together the legislative impact, the continuation of the capex recovery, the lower energy prices, and maybe even the Fed cutting interest rates, you really have a lot of legs to the stool of making earnings growth much more durable. Again, if that's visible to the stock market in history it's very likely that you see valuation expansion ahead of those durable earnings growth, and we're sitting here in six months saying, stocks are up a lot, earnings growth has been okay, but wow, they're way more expensive. I think we should get ready for that as investors because I think that that might be the next couple of years in terms of the theme of higher for longer.

[00:19:02] Pamela Ritchie: That's so interesting. So higher for longer valuations and therefore no one's too late, actually, or possibly.

[00:19:08] Denise Chisholm: That's correct.

[00:19:09] Pamela Ritchie: A couple of questions coming in here, let's put this one to you, Denise. Is there a time lag between when a tax cut is introduced and when we typically see capital investment rise?

[00:19:20] Denise Chisholm: It's a year, it's a year lag. You usually see on the tax cut itself you get a bump in CEO confidence and then you get capex moving the next year and then that durability into that year forward. That gets back to the weird part about multiples because you say, well, it's not going to happen till next year but, again, because it's very visible from the historical perspective stocks are going to pull forward so you're going to get a couple points from multiple expansion even though you don't see that capex right now and you don't see the relationship to earnings growth either. So yes, it is sort of stocks are leading so you won't see the impact on the economy probably for a year.

[00:19:58] Pamela Ritchie: You mentioned at the beginning that these tax cuts, the ones that we're talking about within this one big, beautiful bill, so-called, are permanent but there's a question here. Maybe just circling back to that, how important is long term policy certainty in making tax cuts effective for driving investment decisions?

[00:20:18] Denise Chisholm: Well, in some ways I think that the longer term policy is certainly coordinated with business investment decisions. When you think about short term policies, I would say short term, what we study historically is anything between two and four years. A lot of the tax cuts on the consumer side are about four years, they sunset in 2030. That's a significantly different calculus as it associates with returns and the durability of earnings and that discounted cash flows back to what we think about as corporate profits. Anything longer than a 10-year time horizon, I think you can think of as almost permanent. There are a lot of uncertainties around different aspects of government policy from a tax perspective. This is one that's more or less certain in terms of the permanence of the cut. I can't underscore that enough because it is an important offset to all the other uncertainty we're seeing in terms of what tariffs will ultimately mean.

[00:21:18] Pamela Ritchie: The certainty is an offset to uncertainty. It makes a lot of sense, though. Tell us about where we were within capex, I don't know, for the last couple of years. It began slowly, actually, coming out of the pandemic. It was a pretty slow burn and now it's being picked up for all these catalyst reasons. What stage was the pendulum swinging in even a couple of years ago?

[00:21:45] Denise Chisholm: I should say, let's define our terms. When I say capex recovery I'm not talking about investment spending or the I in the C + I + G equation of GDP. I am literally talking about adding up all the capital expenditures of the public companies in the Russell 3000 and looking back in history, normalizing that base as a percentage of sales and then looking at how that oscillates or iterates over time. If you want to see the chart you can go into my charts of the week. What you can see is that, off that low in 2022, which was one of the lowest capex to sales we've ever seen historically, we have been in a slow slogging recovery. I would say that we are in year three-ish of a capex recovery off of a secular low in corporations not really spending a lot. The question is, is this sort of a dead cat bounce in capex, or is this capex recover likely to continue and get stronger? That's where it gets back to the catalyst.

[00:22:45] The catalyst in the legislation, when you run out the math, does look like that it's likely a durable capex recovery driven by the 700 basis point cut in capex, driven by this 700 basis point cut in corporate taxes that likely makes this durable. The interesting thing about the capex recovery this cycle versus any other cycle is the diffusion really isn't there, or at least not what it was in the '90s. As much as it's definitely not just tech, it's definitely not just AI, but you're not necessarily seeing capex recover across the board. I think we have to be open-minded though that for the next three years it might be the impetus is more across the board. Not only is it a durable capex cycle that drives durable earnings growth but it gets more diffuse as well, which you'll see more drivers for the overall economy. I think where we are in terms of that secular low in 2022 and the impetus we've seen in terms of the legislative impact, I think suggests that this might have much more legs than just a bounceback off of a low.

[00:23:56] Pamela Ritchie: I mean, one thing that we haven't even brought into this discussion is, for diffusion to happen to what extent are lowering rates part of that story? The capex story for the last couple of years has been the hyperscalers, essentially, just pouring money into AI, and they had money to burn, literally. No one was borrowing for that, that was just all money that they had on hand that they were pouring into their own capex stories. But as you say, more diffusion, where do the rates story come in for this?

[00:24:29] Denise Chisholm: It's an interesting rate story because the Fed's been on hold for, what, more or less six months. When you look back in history, I'm actually writing a note on that this week, when you say, what's the Fed's next move, half the time it's a hike, half the time it's a cut. There's no specific pattern. It, obviously, depends on the macro circumstances. Even when the Fed cuts, remember, it's always the why that matters much more than what they do. If they're cutting because they have to because you're going into a recession and people are losing their jobs, then that's never bullish for the equity market. But if they are cutting because they can, because they can renormalize rates, then that makes a big difference to the equity market. You usually see it, much like we talked about, pulled forward in terms of you get the multiple expansion before you get the durable earnings growth.

[00:25:15] In some ways, back to that question we had in terms of, well, if tax policy changes today when do you usually see the capex impact, it's very similar for the Fed. If the Fed moves today you likely see no real impact on capex until a year from now. You'll likely see the durability get reflected in higher valuations as well. It's yet another catalyst, right? We're like piling on the catalysts in terms of what the secular bull market might mean and just how expensive stocks might stay over the next 18 months.

[00:25:47] Pamela Ritchie: Because there is still going to be a debt issue in the United States, every country is going through a debt issues, they all spent too much, the developed economies, during COVID or, at least, I don't know, too much is probably too definitive but a lot of spending. The deficit position of countries, the debt position of countries, does that slow things? Is that fine? It's just on the side for what we're talking about right now for an equity market that seems to be having a capex cycle, it can deal with debt on the sides, is that where it's putting it?

[00:26:20] Denise Chisholm: It's not clear relationship in the data as it relates to the U.S. whether or not deficits as a percentage of GDP, or overall debt as a percentage of GDP, has a relationship with overall economic growth. I do understand the logic argument that at some point there's a tipping point. The problem is when you relate those tipping points to historical data it usually comes out with a debt crisis. That's the tipping point. You get a debt crisis when no one wants to fund your economy, so the debt crisis ends up in a currency crisis. The problem with assuming that we will get there at some point in the U.S., maybe we will, maybe we won't, is because of the relative debt dynamics, to your point. It's not just that the U.S. spent a lot of money, and it was a lot, 25% of GDP over the course of the pandemic dumped onto an economy so not insignificant, which is why we saw inflation. But it's not clear to me that the debt dynamics are much better in Japan, much better in Europe from a secular perspective, and, certainly, not much better in China.

[00:27:24] It gets back to that, look, the U.S. currency might depreciate because its starting point is expensive but it's not clear to me that that ends up in a currency crisis. If there is no tipping point because relative debt matters a whole lot more than absolute debt, and there's no relationship between deficit spending and GDP growth, and oh, by the way, there's not a lot of relationship between GDP growth and corporate profit growth, then there's a whole lot of links in that mathematical chain that can go wrong in terms of your interpretation of debt as it relates to a headwind for stocks.

[00:27:58] That's the sort of seller beware argument about debt, and oh, by the way, total debt for the U.S., if I pile up consumer, financial, government, and corporate, has, basically, been at the same levels for the last 20 years. In a lot of ways we're only talking about a debt transfer to the government. I'm not sure that that's the most impactful as it relates to equities. It's not clear to me that higher debt means that you want to sell your equity portfolio.

[00:28:27] Pamela Ritchie: Oh my gosh, you so have to do a note on that one. I love that, that's so interesting. Just ticking off the August ones. I did want to ask you about the changing nature of the incentives, essentially, for companies at this point. Trade is a big piece of that. Obviously, tax cuts will be a new type of incentive for them to make different decisions but there is sort of a playing field of incentives that are changing. I'm just wondering, how big is this?

[00:28:53] Denise Chisholm: It is a big change in terms of incentives in terms of the ability for corporations to spend and boost industrial production in the U.S. That's significant. In some ways corporate America does what you incentivize them to do. Now, look, there's a big gap in terms of how much it costs to produce things in the U.S. versus how much it costs to produce things — take the iPhone as an example — so that gap is probably too wide for, let's call it, 15% in terms of average tariffs to close but on the margin that incentive, on the margin improves the ability for industrial production to grow in the United States. Industrial production has, for the better part of, I think, the last six years, been roughly flat. It would be really interesting and a different cycle if we actually saw manufacturing come out of recession, industrial production finally inflect, along with capital spending on technology and services actually accelerate. It sort of gives more legs to the stool and adds to the ability for this economic expansion and earnings growth to be durable.

[00:30:04] Pamela Ritchie: That is so fascinating. In this call for a capex, but also just a build out of all kinds of things, there seems to be a reckoning with what we're educating the workforce for, just kind of hearing anecdotally, need more electricians, need more of these different types of things. You wonder if there's a bit of a shift there as well. This has nothing to do with your research but I'm just curious what you think. Do we need to educate workers for a new economy, essentially, pretty rapidly and make schools do that?

[00:30:34] Denise Chisholm: There definitely could be. What you're seeing is despite the fact that there's a lot of narrative around the labour supply is potentially capped, you are seeing more and more people in prime age employment actually coming back to the workforce, which is significant . To the extent that more people want jobs then more corporations will actually be looking for employees. I do think that there's an argument to be made around that diversity of the different jobs that might be inflecting higher. That is one thing that we've seen,  as much as payrolls have been fine, not great, certainly, not bad, certainly, but they also haven't been diffuse. Much of the hiring has been in health care and government. It would be consistent with a capex recovery, with a durable earnings recovery, to have many more jobs pop up and get that diffusion index something closer to 55 to 60% of all of the employment sort of categories that we track actually advancing.

[00:31:37] Pamela Ritchie: That's so interesting. Let's go through your sectors. You said a lot of the hiring is in health care, which is, actually, a laggard sector for you, I think, but they're bulking up, ultimately. Tell us about your top three, bottom three sectors.

[00:31:52] Denise Chisholm: Top three are still technology, technology, technology, but I'll add in financials and consumer discretionary. Within financials I really find brokers and capital markets to be the most intriguing combination of good valuation with really strong fundamentals. Again, that durable earnings recovery is very consistent with that, which is not to say that I don't like banks but it is to say the banks, which we've talked about for the last 18 months, have moved just outside that key zone in terms of valuation support, which, again, doesn't mean they have to underperform but it just changes the risk-reward enough that I think that there are other areas of financials that are better. I know consumer discretionary hasn't worked yet, and it definitely is a sector that bears the brunt of the tariff impact because that is exactly where consumers are the most sensitive, that is exactly what corporate America will be able to pass on that the price increases, but it still has that strong valuation support. I do think consumer discretionary now looks a little like financials looked 18 months, which is to say that I know the news is not good but the valuation is such that I think you could be paid to wait by sitting with that in your portfolio. So in the top three it's technology, and I'll add in semiconductors to sort of my top industry, and then financials, and then consumer discretionary.

[00:33:13] On the bottom, let's talk defence. I think health care still screens like a value trap to me. It's partly around this fact that what you can measure from the peak in operating margins in the 2000s, what you can see is every time it's been this cheap you haven't wanted to own it. Why? Because the market's smart enough to know that the earnings cycle isn't as over as you would think in terms of operating margins are still likely to slow from here. That creates this problematic value trap where you say, it's got to all be priced in, right? If the secular decline is still to come, then the answer is no.

[00:33:53] Pamela Ritchie: Fascinating. Maybe a one word answer for this one because we'll run out of time. All of the tax changes, ultimately, how it looks like tariffs are landing for corporations in the U.S., does it all sort of bid for a more back to U.S. exceptionalism versus global markets for you right now? I mean, are all things pointing back to, perhaps, U.S. markets over global?

[00:34:19] Denise Chisholm: Yes.

[00:34:21] Pamela Ritchie: I sort of caught that but there we go. Denise Chisholm, thank you for joining us. Always learn an awful lot and it's almost like a master class. Thanks for joining.

[00:34:33] Denise Chisholm: Always great to be here.

[00:34:34] Pamela Ritchie: That's Denise Chisholm joining us today from the Boston area. Coming up on Fidelity Connects tomorrow, Fidelity equity research analyst, Cameron Ho, joins us. Cameron focuses on U.S. retail and apparel, particularly. He's going to let us know which consumer trends he's tracking and, ultimately, how ongoing trade and tariff developments are impacting this sector.

[00:34:54] On Monday, Director of Global Macro, Jurrien Timmer joins us to dive into the latest macro themes on his radar. He'll also bring those amazing charts and graphs to help point you in a few right directions for the week of trade ahead. Thanks for joining us here.

[00:35:10] We've got Tuesday next week, portfolio manager both U.S. and global focused funds, Chris Lee, he's going to be joining us for his mid-year review. He'll give you an update on Fidelity Advanced U.S. Equity Fund and what's next for the second half of this year. That webcast with Chris will be available in live French audio interpretation, just so you know. Have a great rest of your day. I'm Pamela Ritchie.