FidelityConnects: Denise Chisholm: Sector watch – June 25, 2026

00:01.001 --> 00:06.573

<b>Subtitles are AI Generated</b>

 

00:07.107 --> 00:09.809

Hello, and welcome to Fidelity Connects. I'm Pamela Ritchie.

 

00:09.809 --> 00:14.080

The inflation squeeze is real but it may be setting the stage for a stronger

 

00:14.080 --> 00:18.184

equity backdrop. Despite sticky prices weak real

 

00:18.184 --> 00:22.422

income growth is capping demand making a sustained inflation

 

00:22.422 --> 00:26.493

reacceleration pretty unlikely and quietly extending the bull

 

00:26.493 --> 00:30.497

market cycle. Why hasn't inflation spiralled like in

 

00:30.497 --> 00:35.168

the 1970s and could today's hit to purchasing power actually improve

 

00:35.168 --> 00:37.370

forward equity returns?

 

00:37.370 --> 00:41.307

Joining us here today to unpack this counterintuitive setup for

 

00:41.307 --> 00:44.644

another edition of Sector Watch is Fidelity Director of Quantitative Market

 

00:44.644 --> 00:46.513

Strategy, Denise Chisholm.

 

00:46.513 --> 00:49.282

A warm welcome to you, Denise. How are you today?

 

00:49.282 --> 00:51.351

Thank you. I'm very well. How are you?

 

00:51.351 --> 00:55.555

Very well, thank you. Delighted to have you here and we are seeing things like

 

00:55.555 --> 01:00.326

inflation discussions swirl, certainly. It is an era of new talks about inflation.

 

01:00.326 --> 01:05.331

I wonder if we can ask you just about the moving parts of inflation

 

01:05.331 --> 01:08.234

right now as you see it from your view.

 

01:08.234 --> 01:12.305

There do seem to be some re-evaluations of what inflation is right

 

01:12.305 --> 01:14.641

now, for instance.

 

01:14.641 --> 01:18.578

As it relates to the US consumer there's no differential in terms of

 

01:18.578 --> 01:22.282

what core inflation is versus what energy inflation is.

 

01:22.282 --> 01:25.018

It's all the same experience of higher prices.

 

01:25.018 --> 01:28.555

As it relates to the Federal Reserve, they can't control a lot of those prices.

 

01:28.555 --> 01:32.692

If there's a supply shock in energy they don't want to necessarily

 

01:32.692 --> 01:36.663

raise interest rates to quell any demand

 

01:36.663 --> 01:39.132

that's really the result of a supply shock.

 

01:39.132 --> 01:43.803

That's why I think that they struggle with exactly how to measure inflation.

 

01:43.803 --> 01:47.574

I think one of the interesting parts of this cycle is that we know that supply

 

01:47.574 --> 01:51.010

shocks can happen. We're just seeing it in energy, they've certainly happened

 

01:51.010 --> 01:52.679

in food, historically speaking.

 

01:52.679 --> 01:56.583

There's actually an argument to be that one's happening in shelter right now.

 

01:56.583 --> 02:00.653

If you had mortgage rates go up a lot a lot of people can't move homes so you

 

02:00.653 --> 02:04.724

have much less turnover than you've ever had historically in housing.

 

02:04.724 --> 02:08.895

That makes it very difficult to have an accurate pricing discussion over what

 

02:08.895 --> 02:13.066

rents really are and what they might be at some point in the future.

 

02:13.066 --> 02:16.136

When you look at inflation, the CPI is a great measure, we can talk about the

 

02:16.136 --> 02:19.906

PTE that just came out, when you look at it ex-housing, core inflation

 

02:19.906 --> 02:23.510

ex-housing, you're really in the low twos.

 

02:23.510 --> 02:27.447

Which is not to say that it's at target but you've been between 2.3

 

02:27.447 --> 02:30.683

and, let's call it, 2.6 for the better part of the last year.

 

02:30.683 --> 02:34.888

Remember, the sweet spot for the equity market is actually between 3 and 4

 

02:34.888 --> 02:38.958

so you don't need to get to target for the equity market not to have a problem

 

02:38.958 --> 02:42.762

with inflation. That doesn't necessarily mean any of this is comfortable for

 

02:42.762 --> 02:46.199

the US consumer because they consume all of inflation.

 

02:46.199 --> 02:50.236

That oil price shock that just went up, that we just saw,

 

02:50.236 --> 02:54.440

actually led to just the second time in history that you cited real

 

02:54.440 --> 02:59.245

incomes being negative without people losing their job.

 

02:59.245 --> 03:03.349

That's what's unique this cycle. The '70s and '80s literally had a

 

03:03.349 --> 03:07.654

wage price spiral. To the extent that you kept your job more

 

03:07.654 --> 03:10.623

or less you kept pace with inflation.

 

03:10.623 --> 03:14.427

The way you sort of see the chart is that real income certainly declined in the

 

03:14.427 --> 03:18.464

1970s but that's really a function of about 15% of the population

 

03:18.464 --> 03:21.834

actually lost their jobs up into that peak unemployment rate.

 

03:21.834 --> 03:25.939

This is a very unique setup in the sense that everybody is keeping their

 

03:25.939 --> 03:30.009

jobs, meaning the unemployment rate is low and not really advancing very much,

 

03:30.009 --> 03:34.113

and all of US consumers, really for the first time, are

 

03:34.113 --> 03:35.882

losing purchasing power.

 

03:35.882 --> 03:39.852

I mean, that is fascinating. As you say, in a, for instance, a recessionary

 

03:39.852 --> 03:44.157

environment you would expect that pricing power to go and people

 

03:44.157 --> 03:46.960

to close up their purses and make sure that they're not in their wallets and

 

03:46.960 --> 03:49.429

make sure they're not spending. But this is not a recession.

 

03:49.429 --> 03:53.333

You just take one look at the stock market and know that we're in wild times in

 

03:53.333 --> 03:57.403

certain areas and yet the wages sit where they

 

03:57.403 --> 04:00.073

sit and are a bit static.

 

04:00.073 --> 04:04.110

Yes, which is exactly why consumer sentiment is the lowest that it's ever been.

 

04:04.110 --> 04:07.046

The US consumer did what they're supposed to do, which is show up for work

 

04:07.046 --> 04:10.316

every day, and for the first time, really, in history they lost purchasing

 

04:10.316 --> 04:14.020

power. This leads to a very kind of counterintuitive view on inflation.

 

04:14.020 --> 04:18.057

It's very difficult, because of this difference it's very difficult

 

04:18.057 --> 04:20.526

for inflation to be sustainable.

 

04:20.526 --> 04:23.596

If you want to see the chart, you can go to my charts of the week on LinkedIn,

 

04:23.596 --> 04:25.298

there is a very clear relationship.

 

04:25.298 --> 04:29.269

The worse real incomes are the lower the odds that inflation

 

04:29.269 --> 04:33.339

in any measure can accelerate, such that when you're in the

 

04:33.339 --> 04:37.343

bottom decile, which is exactly where we sit right now, you only have 15%

 

04:37.343 --> 04:41.347

odds of inflation, either core or headline, actually

 

04:41.347 --> 04:43.182

accelerating over the next year.

 

04:43.182 --> 04:47.287

Even in that 15%, which I would say statistically you probably shouldn't

 

04:47.287 --> 04:50.556

bet on, is really a de minimis acceleration.

 

04:50.556 --> 04:54.060

It shows you that at the end of the day, I think there's lots of ways to define

 

04:54.060 --> 04:57.664

it, but really it is too much money chasing too few goods.

 

04:57.664 --> 05:01.267

To the extent that you don't have too much money, which is exactly the

 

05:01.267 --> 05:04.837

situation we're in, we just don't have enough money for the US consumer, it's

 

05:04.837 --> 05:09.042

very difficult for any supply shock to be either a), passed

 

05:09.042 --> 05:13.146

through or b), any kind of pricing power to end

 

05:13.146 --> 05:17.150

up being sticky enough to increase the odds that it's

 

05:17.150 --> 05:19.686

a runaway trajectory of inflation.

 

05:19.686 --> 05:23.389

That's the part that I always push back on, which is not to say that like ...

 

05:23.389 --> 05:27.493

I'm just looking at the market-based PCE, core PCE Chain Price

 

05:27.493 --> 05:31.431

Index, it's 3.3 on an annualized

 

05:31.431 --> 05:34.467

basis over the last three months. You would say, okay, that's higher than

 

05:34.467 --> 05:38.571

target. They certainly want it lower, that's true, but again, we're back to

 

05:38.571 --> 05:40.807

that sweet spot for the equity market, at least historically.

 

05:40.807 --> 05:44.844

You have to be above 4 1/2% and rising to be

 

05:44.844 --> 05:47.213

truly problematic.

 

05:47.213 --> 05:50.016

Yes, inflation is at a run rate higher than it has been historically.

 

05:50.016 --> 05:54.087

That's certainly an issue for the US consumer but that also

 

05:54.087 --> 05:57.123

makes the whole thing very self-limiting.

 

05:57.123 --> 06:01.194

I think that that upside concern, that I do think still plagues

 

06:01.194 --> 06:05.498

the market, I think is just a much lower probability than

 

06:05.498 --> 06:07.867

investors expect.

 

06:07.867 --> 06:11.838

Add to the discussion of the consumer and wages holding

 

06:11.838 --> 06:15.842

back inflation getting out of control because it just can't spend into it

 

06:15.842 --> 06:17.877

for all those reasons you just stated.

 

06:17.877 --> 06:21.914

You had mentioned, I can't remember how many months ago, oil was up, you

 

06:21.914 --> 06:25.952

sort of said maybe don't chase it if you're already there, fine, but it will

 

06:25.985 --> 06:29.756

drop like a rock. There are commentators today saying that they're looking for

 

06:29.756 --> 06:33.159

potentially $40 oil over the course of the next little while.

 

06:33.159 --> 06:35.094

I mean, that's kind of shocking.

 

06:35.094 --> 06:37.430

Could that possibly be the case?

 

06:37.430 --> 06:40.299

Oh, sure.

 

06:40.299 --> 06:43.336

When I look at the math, we talked through the math before, I think people look

 

06:43.336 --> 06:46.873

at inventories as a predictor of price, kind of like they want to look at the

 

06:46.873 --> 06:50.009

unemployment rate as a predictor of wages, but statistically it doesn't really

 

06:50.009 --> 06:54.046

work. Partly because prices are based on the market and the

 

06:54.046 --> 06:58.117

market is kind of smarter than the actual inventory level right now.

 

06:58.117 --> 07:01.154

I think that the inventory math went something like, look, even if you solve

 

07:01.154 --> 07:05.458

the Straits it's going to take them time to get through all of what piled

 

07:05.458 --> 07:09.362

up, some places are shut in and it's gonna take them a little while to get

 

07:09.362 --> 07:13.199

through into full production that you had been prior.

 

07:13.199 --> 07:16.269

Inventories are gonna stay lower, that means prices are gonna be higher.

 

07:16.269 --> 07:19.939

If you look statistically inventories don't predict price half the time.

 

07:19.939 --> 07:22.308

What predicts it better? Excess capacity.

 

07:22.308 --> 07:26.345

The more excess capacity it is, like OPEC has been

 

07:26.345 --> 07:30.316

cutting for the better part of the last four years, there was already

 

07:30.316 --> 07:34.454

too much supply. The shales were much more productive into a

 

07:34.454 --> 07:37.190

strong demand environment. There's no problem with demand.

 

07:37.190 --> 07:39.192

There's just a lot of supply.

 

07:39.192 --> 07:43.329

I think one of the reasons why oil wasn't anything above 120 is

 

07:43.329 --> 07:47.934

because there was already a lot of supply on the water stored in tankers.

 

07:47.934 --> 07:51.971

Maybe it shows you, look, off of the biggest supply shock in history

 

07:51.971 --> 07:56.576

maybe it tells you oil was a triple off what should have been the price of 40.

 

07:56.576 --> 08:00.646

If we actually sort of let those barrels actually come

 

08:00.646 --> 08:03.149

to market.

 

08:03.149 --> 08:07.453

I think what the market is telling you is we're already in an excessive supply

 

08:07.453 --> 08:11.657

situation before we got into this mess and right now if the mess is

 

08:11.657 --> 08:15.595

resolved, ooh, what if it resolves with more supply in a different way?

 

08:15.595 --> 08:20.533

What if they're building pipelines to make sure that the Strait isn't

 

08:20.533 --> 08:22.268

restrictive in terms of the capacity?

 

08:22.268 --> 08:24.036

We're already seeing it from the UAE.

 

08:24.036 --> 08:27.740

They already said that we thought it was going to be 2027 but it looks like

 

08:27.740 --> 08:32.645

it's going to later this year. There's going to be a wealth of options to

 

08:32.645 --> 08:35.748

get production, to get oil to the market.

 

08:35.748 --> 08:40.019

So no, I don't think it would be a surprise to see oil be lower for

 

08:40.019 --> 08:45.157

longer despite the shock.

 

08:45.157 --> 08:48.494

Take us back to consumer, their wages are what they are but they no longer

 

08:48.494 --> 08:52.598

potentially have what they are struggling with at the pumps, can

 

08:52.598 --> 08:56.736

other parts of the inflationary story then take off and then

 

08:56.736 --> 08:57.737

be an issue?

 

08:58.337 --> 09:02.174

There are some areas of the market that have pricing power.

 

09:02.174 --> 09:05.411

Technology is a great example of being able to price its product.

 

09:05.444 --> 09:08.814

There are some areas of the market that have absolutely no pricing power, which

 

09:08.814 --> 09:11.884

I would say anything consumer-based, consumer discretionary, consumer staples.

 

09:11.884 --> 09:15.888

Very difficult to pass through, very little marginal propensity

 

09:15.888 --> 09:18.791

to consume, very high sensitivity to price.

 

09:18.791 --> 09:21.594

You even saw that with the tariffs. I think that there were a lot of companies

 

09:21.594 --> 09:25.598

in the packaged goods area that tried to pass through pricing and just said,

 

09:25.598 --> 09:29.235

well, I think the US consumer can take it, it's a strong economy.

 

09:29.235 --> 09:32.104

The US consumers said, nope, I'm going to go to another competitor, there's

 

09:32.104 --> 09:34.507

either too much on the market, or I'm just gonna buy less.

 

09:34.507 --> 09:37.643

I'm still gonna buy my iPhone but I'm gonna still buy less of whatever it is

 

09:37.643 --> 09:41.781

that you produce. We saw a whole bunch of companies in the consumer space roll

 

09:41.781 --> 09:45.751

back their price increases because quantity demand ticked too much.

 

09:45.751 --> 09:49.655

The margins were under pressure anyway, and they actually resolved it by

 

09:49.655 --> 09:53.025

cutting price and the US consumer actually came back.

 

09:53.025 --> 09:57.196

It's just an example of how in a lot of areas that you cannot pass

 

09:57.196 --> 09:58.664

through price.

 

09:58.664 --> 10:01.067

The interesting thing is at the aggregate level ...

 

10:01.067 --> 10:05.504

the income limits everything so there is gonna be winners and losers beside

 

10:05.504 --> 10:09.475

that and it's just a matter of what is the marginal propensity for the

 

10:09.475 --> 10:13.579

US consumer to consume more in technology, less in consumer staples and any

 

10:13.579 --> 10:19.885

sort of goods, I would say goods area, more in services, less in goods.

 

10:19.885 --> 10:23.856

In response to those winners and losers, at the aggregate level, ultimately,

 

10:23.856 --> 10:26.092

if you don't have more money it doesn't really matter.

 

10:26.092 --> 10:28.661

You're going to spend more in this area but you're going to spend equally less

 

10:28.661 --> 10:31.163

in this area. I think that's the unique part.

 

10:31.163 --> 10:35.434

Yes, there will be winners and losers but at the aggregated level

 

10:35.434 --> 10:39.839

I think it's going to be tough to see inflation sustained anywhere above

 

10:39.839 --> 10:40.840

3 1/2%.

 

10:41.307 --> 10:43.843

There's the beauty of the market, the way it sorts these things out.

 

10:43.843 --> 10:48.014

It is incredible. Let's come back to the discussion of housing

 

10:48.014 --> 10:50.282

and where its role in the discussion.

 

10:50.282 --> 10:53.819

Really, we're going back to The Fed and the discussion there, their various

 

10:53.819 --> 10:57.890

task force. You brought to our attention some time ago now that

 

10:57.890 --> 11:02.128

if housing is really the big issue or one of the big, big issues,

 

11:02.128 --> 11:06.532

and The Fed can't really fix that with rates that it

 

11:06.532 --> 11:09.969

becomes more of a fiscal discussion, which leads to kind of a broader

 

11:09.969 --> 11:13.973

discussion of the fiscal and the Fed and how they're gonna work together.

 

11:13.973 --> 11:18.210

When you get numbers like this, PCE in, taking a look at where housing

 

11:18.210 --> 11:22.448

could come out, what does that bring you back to in the discussion of fiscal

 

11:22.448 --> 11:25.251

and the Fed on housing?

 

11:25.251 --> 11:28.921

I think that there's a lot to be debated still about housing when you think

 

11:28.921 --> 11:31.090

about who's the ultimate mortgage buyer.

 

11:31.090 --> 11:34.193

I do think that the balance sheet of the Fed that, obviously, Chair Warsh is

 

11:34.193 --> 11:38.330

trying to tackle at some point distorted the mortgage market.

 

11:38.330 --> 11:42.368

You still do have much higher mortgage spreads than you

 

11:42.368 --> 11:45.871

should have at any point where we are in the cycle.

 

11:45.871 --> 11:49.809

Even if you say it's been a poor cycle mortgage spreads have never really been

 

11:49.809 --> 11:53.045

this elevated for this long and it's in part because of what the Federal

 

11:53.045 --> 11:56.215

Reserve purchased during the pandemic.

 

11:56.215 --> 11:59.418

That's a little bit of a problem overall the affordability.

 

11:59.418 --> 12:03.355

It's not just the overall rate, it is the balance

 

12:03.355 --> 12:07.026

sheet in terms of what you own and the QT that you have done relative to that

 

12:07.026 --> 12:08.728

mortgage-backed portfolio.

 

12:08.728 --> 12:12.098

I think that there's something to be said to think about a natural buyer of

 

12:12.098 --> 12:14.834

that. That's the Fannie and Freddie discussion.

 

12:14.834 --> 12:19.138

That provides an ability at least, I mean, we'll see how it all plays out,

 

12:19.138 --> 12:22.541

there's some people to take the other side of this argument, that provide the

 

12:22.541 --> 12:26.912

ability at least to actually quell mortgage spreads and bring something more

 

12:26.912 --> 12:31.717

normalized to a mortgage rate relative to the 10-year Treasury overall.

 

12:31.717 --> 12:35.855

If you could end up in a situation where the Fed might not have to do much from

 

12:35.855 --> 12:40.059

a policy perspective, from a policy rate perspective, but do more from a

 

12:40.059 --> 12:43.062

balance sheet perspective to solve that housing market.

 

12:43.062 --> 12:46.866

I think that the whole thing is very interesting when you step back and say,

 

12:46.866 --> 12:50.803

okay, we're talking about inflation and we're debating whether

 

12:50.803 --> 12:54.673

or not that they should hike or cut, part of the debate is around the level

 

12:54.673 --> 12:58.944

that they're already at. Maybe if the Fed was at zero

 

12:58.944 --> 13:02.948

and inflation was at 4 or 3 1/2 you would say, well, clearly they

 

13:02.948 --> 13:06.986

need to raise rates. If the fed was at 5 and inflation

 

13:06.986 --> 13:09.722

was at 3, well, you would say that the Fed clearly needs to lower rates, which

 

13:09.722 --> 13:12.391

is where we've been at different points of the cycle.

 

13:12.391 --> 13:15.628

We're sort of in that muddy middle.

 

13:15.628 --> 13:19.765

That gets to a very key discussion of what people call R-star, meaning

 

13:19.765 --> 13:23.702

that there should be some relationship between their normalized interest

 

13:23.702 --> 13:25.905

rates and the real level of growth.

 

13:25.905 --> 13:28.607

If the economy is growing at 3 then that's okay.

 

13:28.607 --> 13:31.844

If the economy's growing at 2 maybe it's too tight.

 

13:31.844 --> 13:35.080

Now, the interesting thing when you debate that measure of R- star, and there's

 

13:35.080 --> 13:38.951

a lot of debate about it, what I think that the Federal Reserve controls is all

 

13:38.951 --> 13:43.522

the interest rate sensitive areas of the market.

 

13:43.522 --> 13:47.526

Does growth filter in in terms of earnings growth in the AI trade and CapEx?

 

13:47.526 --> 13:51.463

Yes, but that's less control by the Fed when you think about restriction and

 

13:51.463 --> 13:53.365

accommodation and monetary policy.

 

13:53.365 --> 13:56.101

The interesting part to me is when people say, oh, no, they're too

 

13:56.101 --> 14:00.239

accommodative right now, look at the areas they can control.

 

14:00.239 --> 14:02.708

Residential investment is recessionary, it's in contracting.

 

14:02.708 --> 14:06.745

There's decent argument to

 

14:06.745 --> 14:10.382

say that you're more restrictive than you think on the things that you can

 

14:10.382 --> 14:13.152

control like housing.

 

14:13.152 --> 14:17.122

I think that you could definitely make different arguments at this

 

14:17.122 --> 14:20.693

point. I don't think that the data is so clear.

 

14:20.693 --> 14:24.864

Things that you can control, that is sort of the debate about how

 

14:24.864 --> 14:28.868

the Fed, as you say, not the experience of others experiencing inflation but

 

14:28.868 --> 14:32.905

how the Fed calculates it based on what they can do

 

14:32.905 --> 14:36.008

about it, if they can do something with rates one way or the other or their

 

14:36.008 --> 14:37.843

blunt instruments.

 

14:37.843 --> 14:42.882

There could actually be a redefinition, we think, of how they calculate it.

 

14:42.882 --> 14:46.919

No, they're definitely good. Of the five committees that I think that Chair

 

14:46.919 --> 14:51.023

Warsh put out, one of them is Inflation committee and that's about how

 

14:51.023 --> 14:55.294

to calculate inflation. There are market-based measures, there's PCE, there's

 

14:55.294 --> 14:59.431

CPI, there's market-based measures, and then there's what is the

 

14:59.431 --> 15:04.336

parts that we can control. Shelter

 

15:04.336 --> 15:08.340

component, especially when you think about the way that they calculate

 

15:08.340 --> 15:12.578

shelter, rent overall, it hasn't really changed in the last 20

 

15:12.578 --> 15:16.615

years. Maybe it needs to be more price sensitive relative to other

 

15:16.615 --> 15:19.718

market-based measures that we look at, like Zillow rents or something else,

 

15:19.718 --> 15:23.122

that actually more marks to market quickly.

 

15:23.122 --> 15:27.192

The whole definition of inflation I think could change in the

 

15:27.192 --> 15:31.163

appropriate way. It's not to say that, oh, we're going to magically redefine

 

15:31.163 --> 15:33.032

inflation and then there is none.

 

15:33.032 --> 15:36.035

The US consumer will obviously experience all the inflation.

 

15:36.035 --> 15:38.737

You can see it all in the real income numbers.

 

15:38.737 --> 15:42.875

Are there ways for the Federal Reserve to recalculate inflation such that they

 

15:42.875 --> 15:45.444

understand what measures they can control?

 

15:45.444 --> 15:48.781

In a weird situation I've heard a really strong argument.

 

15:48.781 --> 15:51.283

I haven't really done the numbers and we don't know how these things will play

 

15:51.283 --> 15:55.321

out but I'm always open minded. I think that to the extent that the

 

15:55.321 --> 15:59.425

housing issue is more supply driven than demand driven,

 

15:59.425 --> 16:02.962

meaning that there's very little supply. You can look at housing starts.

 

16:02.962 --> 16:06.298

They're de minimis. I think that you might be able to make the argument that

 

16:06.298 --> 16:10.602

you could solve supply a little by dropping the policy rate to allow

 

16:10.602 --> 16:14.540

homebuilders to actually have lower interest construction loans to

 

16:14.540 --> 16:16.742

be able to build.

 

16:16.742 --> 16:19.878

Which is not a hike, which is not a hike.

 

16:19.878 --> 16:23.816

Right. I mean, there's the irony of monetary policy in terms of

 

16:23.816 --> 16:26.752

what it can and can't do.

 

16:26.752 --> 16:30.823

Even within the concept of the dual mandate I think there's a lot

 

16:30.823 --> 16:34.360

to struggle with in terms of how you define it and how you define it in terms

 

16:34.360 --> 16:35.361

of data.

 

16:35.661 --> 16:39.798

That's fascinating. We'll come back to the sectors in a second.

 

16:39.798 --> 16:43.469

We were speaking to one of your colleagues in Europe a little while ago and

 

16:43.469 --> 16:47.039

mentioning a bit about the AI trade, how it's filtering through to companies,

 

16:47.039 --> 16:51.176

and ultimately that its power and

 

16:51.176 --> 16:55.214

its productivity and sort of utility may be more of a

 

16:55.214 --> 16:59.218

business-to-business story rather than a business-to-consumer

 

16:59.218 --> 17:03.422

story, which, arguably, tech over the last 10 years has been

 

17:03.422 --> 17:07.326

quite consumer focused, if you take it from social media, the hardware and so

 

17:07.326 --> 17:11.363

on, that this might be much more impacting a company because they can use and

 

17:11.363 --> 17:15.734

deploy AI to help them produce and do what they do.

 

17:15.734 --> 17:19.905

I'm just curious how inflation might be a little bit different there, how it

 

17:19.905 --> 17:24.243

might be important to calculate it a little differently there if you're

 

17:24.243 --> 17:28.714

looking at an industrial revolution that may not

 

17:28.714 --> 17:31.417

impact the consumer quite as directly.

 

17:31.417 --> 17:35.554

I don't know what you think about that but does it change how inflation is

 

17:35.554 --> 17:39.124

looked at, for instance?

 

17:39.124 --> 17:41.693

Well, it wouldn't change how inflation is looked at but it will change how

 

17:41.693 --> 17:45.964

productivity is. We can grow faster with the same

 

17:45.964 --> 17:49.034

amount of workers, essentially.

 

17:49.034 --> 17:53.005

I think from that perspective

 

17:53.005 --> 17:57.543

you can grow faster at the same level of inflation,

 

17:57.543 --> 18:01.814

that's sort of the important math as it relates to the Federal Reserve.

 

18:01.814 --> 18:05.551

The interesting part is that is also self-limiting.

 

18:05.551 --> 18:08.487

The one thing that I will say, when you think about the cost structures,

 

18:08.487 --> 18:12.691

especially B2B, you're already seeing this pushback in terms

 

18:12.691 --> 18:16.862

of tokens and token costs. Trees don't grow to the sky and

 

18:16.895 --> 18:20.866

the US businesses are saying, well, my budget is not unlimited

 

18:20.866 --> 18:25.003

as it relates to AI. The good news about technology, what

 

18:25.003 --> 18:28.740

it does is make something that's very expensive and rare and it makes it

 

18:28.740 --> 18:30.542

abundant and cheap.

 

18:30.576 --> 18:33.579

Moore's Law will continue along the spectrum.

 

18:33.579 --> 18:37.583

I would just always caution people not to use anything static in terms of

 

18:37.583 --> 18:41.587

what the cost is, what the CapEx is, what the utility cost is.

 

18:41.587 --> 18:46.125

All of those things, if history is a guide, are likely to go down, which

 

18:46.125 --> 18:50.295

will make it more accessible over time for businesses to

 

18:50.295 --> 18:53.098

use, which will add to productivity.

 

18:53.098 --> 18:57.136

I do think that this is going to be a very, very slow process that happens

 

18:57.136 --> 19:01.140

over 10 to 20 years, not that happens over the next 1

 

19:01.140 --> 19:04.076

to 2 years.

 

19:04.076 --> 19:07.045

In which case inflation is something potentially to be fought for a while in

 

19:07.045 --> 19:08.080

there by the fact--

 

19:08.113 --> 19:08.447

Correct.

 

19:08.447 --> 19:11.049

--they'll have to make some ...

 

19:11.049 --> 19:14.686

it's not a one-year hold, hold there, we'll wait it out.

 

19:14.686 --> 19:18.290

There's some work to be done, potentially anyway.

 

19:18.290 --> 19:20.626

I think. That's Denise Chisholm's opinion anyway.

 

19:20.626 --> 19:24.796

Do we know where, do you know, not we, do you know where we are in the cycle?

 

19:24.796 --> 19:28.133

Seems to be hard to read these days.

 

19:28.133 --> 19:32.137

I think we're early. I say that because median earnings just finally got

 

19:32.137 --> 19:34.273

past their prior peaks.

 

19:34.273 --> 19:37.643

Median earnings peaked in 2019, 2018, 2019.

 

19:37.643 --> 19:39.645

It was actually before the pandemic.

 

19:39.645 --> 19:42.881

We, obviously, saw profits contract for everybody, median and cap-weighted

 

19:42.881 --> 19:46.952

alike. The recovery in terms of median earnings never got past

 

19:46.952 --> 19:51.156

the prior peak. That just shows you how poor the recovery

 

19:51.156 --> 19:54.393

has been. There's only been two other instances where it was that long, I think

 

19:54.426 --> 19:58.497

1967 and 1973, and then during the financial crisis

 

19:58.497 --> 20:01.800

where the average company, or the median company, not income-weighted, not

 

20:01.800 --> 20:06.238

cap-weighted, not tech-heavy, just your average US business actually

 

20:06.238 --> 20:09.408

took that long to get back to prior peaks.

 

20:09.408 --> 20:13.879

Once you did the rest of the cycle lasted four years on average,

 

20:13.879 --> 20:19.151

with some sort of diffusion around like three to six as well.

 

20:19.151 --> 20:23.121

For the most part I think that we are, for the average company,

 

20:23.121 --> 20:27.125

very early in part because it's just been a terrible

 

20:27.125 --> 20:29.494

cycle in a non-terrible way.

 

20:29.494 --> 20:33.932

What I mean by that is 2022 could have been a lot worse.

 

20:33.932 --> 20:34.499

It could have been a true disaster.

 

20:34.499 --> 20:37.402

It was pretty bad, actually, but...

 

20:37.402 --> 20:39.605

But the unemployment rate did not go up.

 

20:39.605 --> 20:42.674

That's what I'm sort of ... when you look through history, yes, it was bad.

 

20:42.674 --> 20:45.110

Everybody lost real income.

 

20:45.110 --> 20:47.879

The S&P went down 30% peak to trough.

 

20:47.879 --> 20:50.849

Profits actually contracted by about 7% which was a lot.

 

20:50.849 --> 20:52.684

Inflation was, obviously, 9%.

 

20:52.684 --> 20:56.355

Things were bad. When you look through a history and what bad means, at least

 

20:56.355 --> 21:00.359

to me statistically, somewhere between 8% and 15%

 

21:00.359 --> 21:03.128

of the American population loses their jobs.

 

21:03.128 --> 21:05.864

That's what bad has been historically.

 

21:05.864 --> 21:06.865

That didn't happen.

 

21:07.766 --> 21:12.070

It wasn't that bad relative to what could have been.

 

21:12.070 --> 21:14.006

Corporate America kept us all employed.

 

21:14.006 --> 21:18.110

Now, again, we all shared the real income loss for the first

 

21:18.110 --> 21:22.314

time in history as well but that has made this recovery terrible

 

21:22.314 --> 21:25.317

because there wasn't anything to recover off of.

 

21:25.317 --> 21:29.288

Usually recoveries are defined by unemployment going from 11% to something

 

21:29.288 --> 21:31.490

like 6%.

 

21:31.490 --> 21:35.627

It doesn't feel great to have 6% unemployed versus our 4% but

 

21:35.627 --> 21:39.331

that 11 to 6 is usually pretty good for the US economy.

 

21:39.331 --> 21:41.800

We're not experiencing that either.

 

21:41.800 --> 21:45.804

For me, what this does statistically, again, back to the data and what it

 

21:45.804 --> 21:48.140

usually means, there's symmetry.

 

21:48.140 --> 21:52.110

The longer the contraction or the stagnation in profits

 

21:52.110 --> 21:54.413

the longer potentially recovery.

 

21:54.413 --> 21:58.383

The reason behind that is just because of what you know as investors, the

 

21:58.383 --> 22:02.454

real problem for both the economy and the stock market is euphoria,

 

22:02.454 --> 22:05.123

is excess, is boom times.

 

22:05.123 --> 22:08.393

Sure, could you pick out some parts that are boom times?

 

22:08.393 --> 22:12.497

Yeah, absolutely. There are some four baggers in terms of stocks

 

22:12.497 --> 22:16.568

over the last four years but it's very hard to find that on a systematic

 

22:16.568 --> 22:20.772

basis. I just saw a chart, interesting, I didn't confirm the chart but it was

 

22:20.772 --> 22:24.910

the number of stocks that had gone up by fourfold in the last,

 

22:24.910 --> 22:29.047

let's call it six months, you can see that we're nowhere relative to

 

22:29.047 --> 22:34.019

prior bubbles, even in the '90s and the '00s and even in 2022.

 

22:34.019 --> 22:38.190

It's really interesting. Yes, you could point to individual issues

 

22:38.190 --> 22:42.361

but back to like, geez, wouldn't it be odd to be in a really strong recovery

 

22:42.361 --> 22:44.296

with housing actually contracting?

 

22:44.296 --> 22:48.233

There's not this whole undercurrent of

 

22:48.233 --> 22:52.237

growth. There is some growth but there's also a whole lot of areas that

 

22:52.237 --> 22:55.474

haven't contracted a lot, that haven't grown a lot either.

 

22:55.474 --> 22:59.611

From that perspective it's just difficult to build up the excesses that usually

 

22:59.611 --> 23:03.815

determine the end of both an economic and secular bull market cycle.

 

23:03.815 --> 23:07.953

If we're at the beginning and starting and early how are you looking

 

23:07.953 --> 23:11.890

at sectors? I think tech is always and still at the top but tell us a bit more

 

23:11.890 --> 23:15.560

about how else you're ordering the sectors.

 

23:15.560 --> 23:18.029

It is. I mean, technology is still interesting to me.

 

23:18.029 --> 23:22.401

The debate now is not really on valuation because the stocks are actually cheap

 

23:22.401 --> 23:25.670

because earnings growth is too strong, is strong.

 

23:25.670 --> 23:28.573

The debate is about is it an earnings bubble.

 

23:28.573 --> 23:32.511

Right now, based on what I see in the data, again, it sort of looks

 

23:32.511 --> 23:35.213

very durable from a leading indicator perspective.

 

23:35.213 --> 23:37.849

I think semiconductors are the real way to think about the cycle.

 

23:37.849 --> 23:41.052

Semiconductors are cheap. Well, Denise, they're supposed to be cheap because

 

23:41.052 --> 23:42.821

it's got to be the top of the cycle.

 

23:42.821 --> 23:45.624

What if you're wrong? What if it is different this time?

 

23:45.624 --> 23:48.894

I can say you can measure it differently because 2-year earnings have never

 

23:48.894 --> 23:50.896

stacked this good relative to history.

 

23:50.896 --> 23:55.133

What if the cycle lasts three years longer than you think it does and then

 

23:55.133 --> 23:59.337

that valuation leads to 77% odds of outperformance.

 

23:59.337 --> 24:03.775

Semiconductors, it's been one of the most volatile areas of technology.

 

24:03.775 --> 24:06.344

What happens over the next three months, who knows?

 

24:06.344 --> 24:08.113

I will not take a bet on that.

 

24:08.113 --> 24:11.383

When you look at what has gone on in terms of earnings, your starting point on

 

24:11.383 --> 24:15.420

valuation, and then just overall what even price momentum that we've seen

 

24:15.420 --> 24:20.025

actually predicts on a 1-year basis, it all looks like leadership to me.

 

24:20.025 --> 24:24.563

Uncomfortable, very volatile leadership but still looks like to me.

 

24:24.563 --> 24:26.998

I don't really have any problems with technology.

 

24:26.998 --> 24:30.068

I do think that there's other things that you can own, and that's been true at

 

24:30.068 --> 24:33.572

some points and not true at other points. I think industrials are a great

 

24:33.572 --> 24:37.709

example. I think the housing area of industrials and both consumer

 

24:37.709 --> 24:41.580

discretionary is a great example. I think that there are pockets of materials

 

24:41.580 --> 24:45.250

that are great examples of things that you can own because that's almost like

 

24:45.250 --> 24:47.052

opposite what technology is.

 

24:47.052 --> 24:51.223

Technology's got a lot of CapEx and less free cash flow than it's

 

24:51.223 --> 24:55.260

had. Steel is in the exact opposite position where they've already rammed

 

24:55.260 --> 24:59.364

CapEx, are now cutting CapEx and free cash flow is increasing off of what have

 

24:59.364 --> 25:01.233

been historically trough margins.

 

25:01.233 --> 25:03.502

That's usually actually a good setup.

 

25:03.535 --> 25:07.005

There are different setups in the market that I do find interesting but from a

 

25:07.005 --> 25:11.109

rank order perspective I'd say technology, it's run a lot so I think from the

 

25:11.109 --> 25:13.979

trough to the peak it was up 35%.

 

25:13.979 --> 25:17.516

I don't know what happens over the next three to six months but technology,

 

25:17.516 --> 25:21.019

industrials, materials, and the housing portion of industrials and consumer

 

25:21.019 --> 25:25.090

discretionary all look interesting to me.

 

25:25.090 --> 25:29.060

This is fascinating. If we watch what the the Fed needs

 

25:29.060 --> 25:32.731

to do over the next little while, they're gonna study, they're going to not

 

25:32.731 --> 25:37.102

move too, too quickly, what are the indicators

 

25:37.102 --> 25:40.672

that you get a sense of that they do need to watch quite carefully, or, in

 

25:40.672 --> 25:43.041

fact, could they just go on hold?

 

25:43.041 --> 25:47.279

I mean, the market is pricing in some hikes but do you see it closer to

 

25:47.279 --> 25:51.082

potentially being a hold?

 

25:51.082 --> 25:53.585

I do, actually, if I was a betting person.

 

25:53.585 --> 25:54.686

I know, I'm sorry, I'm not supposed to ask that.

 

25:54.686 --> 25:57.422

I would say that they don't hike. I should bet my boss again.

 

25:57.422 --> 26:02.260

I had that one bet with him as well, what was that, two years ago?

 

26:02.260 --> 26:05.263

I would say the same thing. I don't think that they're gonna hike in part

 

26:05.263 --> 26:08.633

because I don't think that inflation is going to be durable, mainly because of

 

26:08.633 --> 26:12.804

what I laid out. I also think the labour market is

 

26:12.804 --> 26:15.840

much weaker than I think that they give it credit for in the Phillips curve

 

26:15.840 --> 26:19.878

analysis, meaning that I think there's definitely some people on

 

26:19.878 --> 26:24.082

the FOMC, and maybe the majority of people on the FOMC, the low unemployment

 

26:24.082 --> 26:27.552

rate means that labour market inflation might be sticky and that wages are

 

26:27.586 --> 26:29.821

going to go higher. But wages haven't gone higher.

 

26:29.821 --> 26:33.158

I think there's more supply in the labour market than people think.

 

26:33.158 --> 26:37.128

Again, back to this doesn't look like boom times for me, if you're looking at

 

26:37.128 --> 26:40.699

college-educated workforce, I think it's the Kansas City Fed that does the

 

26:40.699 --> 26:43.935

specific unemployment for them, that's actually at the highest levels that

 

26:43.935 --> 26:48.373

you've ever seen historically kind of in a non-recessionary period.

 

26:48.373 --> 26:51.476

The labour market is not firing on all cylinders.

 

26:51.476 --> 26:55.513

I think when you think about what they will be looking at, I think that

 

26:55.513 --> 26:59.618

it might be redefining, or redefining how they interpret it as

 

26:59.618 --> 27:03.555

it relates to R-star and in terms of where the policy

 

27:03.555 --> 27:06.291

rate should be relative to all that.

 

27:06.291 --> 27:09.961

I think that when you net it out for me I think it creates a lower likelihood

 

27:09.961 --> 27:12.063

that they will likely hike this year.

 

27:12.063 --> 27:13.898

That is fascinating. We'll leave it there.

 

27:13.898 --> 27:15.700

Denise Chisholm, it is such a pleasure to speak with you.

 

27:15.700 --> 27:18.436

Thank you so much for your time. Have a good rest of your day.

 

27:18.436 --> 27:21.072

Thanks for watching or listening to the Fidelity Connects

 

27:21.072 --> 27:25.377

podcast. Now if you haven't done so already, please subscribe to Fidelity

 

27:25.377 --> 27:28.747

Connects on your podcast platform of choice.

 

27:28.747 --> 27:31.583

And if you like what you're hearing, please leave a review or a five-star

 

27:31.583 --> 27:35.553

rating. Fidelity Mutual Funds and ETFs are available by working with

 

27:35.553 --> 27:38.923

a financial advisor or through an online brokerage account.

 

27:38.923 --> 27:42.627

Visit fidelity.ca/howtobuy for more information.

 

27:42.627 --> 27:46.464

While on Fidelity.ca, you can also find more information on future live

 

27:46.464 --> 27:50.602

webcasts. And don't forget to follow Fidelity Canada on YouTube, LinkedIn,

 

27:50.602 --> 27:51.903

and Instagram.

 

27:51.903 --> 27:54.773

We'll end today's show with a short disclaimer.

 

27:54.773 --> 27:58.610

The views and opinions expressed on this podcast are those of the participants,

 

27:58.610 --> 28:02.547

and do not necessarily reflect those of Fidelity Investments Canada ULC or

 

28:02.547 --> 28:06.551

its affiliates. This podcast is for informational purposes only, and should not

 

28:06.551 --> 28:09.087

be construed as investment, tax, or legal advice.

 

28:09.087 --> 28:11.389

It is not an offer to sell or buy.

 

28:11.389 --> 28:15.727

Or an endorsement, recommendation, or sponsorship of any entity or securities

 

28:15.727 --> 28:20.532

cited. Read a fund's prospectus before investing, funds are not guaranteed.

 

28:20.532 --> 28:24.102

Their values change frequently, and past performance may not be repeated.

 

28:24.102 --> 28:26.438

Fees, expenses, and commissions are all associated

 

28:26.438 --> 28:28.239

with fund investments.

 

28:28.239 --> 28:30.842

Thanks again. We'll see you next time.