FidelityConnects: Denise Chisholm: Sector watch – May 28, 2026

 

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Hello, and welcome to Fidelity Connects.

 

 

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I'm Pamela Ritchie. We see tech rallying alongside rising

 

 

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rate discussions. Is this a warning sign or is it a sign of

 

 

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growth? The real inflection markets may be waiting for and watching

 

 

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for could be growth, maybe not inflation says our next guest.

 

 

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What could the pricing situation that's going on

 

 

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with rates right now be telling us about the cycle?

 

 

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What does the rate environment and potential growth

 

 

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ultimately mean for equity leadership in markets?

 

 

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Joining us here today for another edition of Sector Watch is

 

 

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Denise Chisholm. She is Director of Quantitative Market Strategy at Fidelity.

 

 

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Warm welcome to you, Denise. How are you?

 

 

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It is warm here so it is a warm welcome this time, finally.

 

 

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It's kinda nice to have a little spring and summer happening and going on here.

 

 

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Why don't we begin with this rates discussion.

 

 

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It seems to be tied to the oil price.

 

 

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There's nothing particularly strange about that because the oil prices creates

 

 

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inflation in everything that we're doing in our lives in a lot of ways, the

 

 

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driving situation and so on. Does the Fed actually move on this information,

 

 

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on this type of inflation?

 

 

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In some ways I don't even think that the link is really strong with inflation.

 

 

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I think that we take that narrative as assumed and

 

 

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don't look back in history. You can all see that interest rates are going up,

 

 

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we can observe that. The rationale behind why they're going up, I think we need

 

 

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to be more open-minded. First of all, when you look at oil

 

 

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price spikes as it relates to overall inflation clearly there's

 

 

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an impact. As it relates to core inflation, how often it

 

 

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filters through, over any six-month period less than half the time.

 

 

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That's sort of data point number one, more often than not, which

 

 

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is not to say it's threadbare odds, but more often than not you don't see

 

 

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a pass through. And the more interesting relationship, again, it's monotonic,

 

 

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there's something linear about it. The bigger the oil price spike, the lower

 

 

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the odds over any six month period of the Federal Reserve to then go

 

 

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on and raise interest rates.

 

 

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They almost think of it in the same way that we've talked about it before, oil,

 

 

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more often than not, is almost a tax hike on the consumer

 

 

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that might be, just like tariffs, it results in

 

 

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some higher prices but usually not a broad level of higher

 

 

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prices.

 

 

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Could it be different this time? Absolutely.

 

 

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When you look at the vertical of oil prices up 60% which is more

 

 

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or less where we are over the next six months you see 25%

 

 

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odds of the Federal Reserve raising interest rates.

 

 

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It's certainly not zero, and we have no idea what this Federal Reserve will do

 

 

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but when you're leaning on history I think there are some cautionary flags

 

 

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to say that most often this isn't the rationale behind

 

 

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why the Federal Reserve is raising interest.

 

 

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The filter through, having it be like a tax in the way that you

 

 

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had described tariffs, it's complicated for companies to

 

 

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pass it through and to even see if they need to pass it through, first of all.

 

 

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You're getting hit at the pumps, you're getting hit at perhaps a few particular

 

 

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areas within the economy, but as you say, the pass through to sort of the

 

 

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other bits of what people are buying and trading and so on is not there,

 

 

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or we just don't know about it? I guess that's sort of ...

 

 

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it's a timing issue of how long it all goes on for.

 

 

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It is a timing issue, for sure, but you're already seeing corporate America

 

 

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struggle with the pass through.

 

 

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You're seeing this in large retailers who will go unnamed on this webcast in

 

 

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terms of the ability. In some ways from an inflation perspective I think, I

 

 

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understand that people are concerned about a resurgence of the '70s

 

 

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and '80s analogs but in some ways corporate America doesn't get

 

 

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to decide how much they pass through.

 

 

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The US consumer decides how much they

 

 

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absorb. If they don't have a meaningful amount of money that's

 

 

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increased relative to what they were just having from a real income perspective

 

 

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that was the case in the '70s and '80s.

 

 

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That was the case in 2021, '22.

 

 

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If there's not an underlying increase in terms of wage growth,

 

 

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nominal wage growth, real wage growth, you just don't see a marginal propensity

 

 

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to consume.

 

 

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You might end up in this situation where, yes, are there some prices where

 

 

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retailers are trying to pass through?

 

 

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You could almost look at the clothing budget of the CPI and say,

 

 

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well, that was up 4%, that's probably a result of higher oil

 

 

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prices. Yes, but quantity demand was actually down over

 

 

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5% on a real basis in retail sales.

 

 

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To the extent that there is a response for those higher prices

 

 

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those higher prices are unlikely to be sticky.

 

 

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I think that's what history is sort of showing us which is again,

 

 

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unless there's a whole lot of money dumped on the US consumer, as opposed to

 

 

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the offsets that we're getting, it's very difficult to see a situation where

 

 

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it ends up in all prices as opposed to just energy, goods and

 

 

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services. Because that's been difficult historically the Fed has

 

 

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been usually not prone to responding to it either.

 

 

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Another piece to sort of the oil and inflation story is you'll

 

 

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hear Japan, for instance, using its SPR,

 

 

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its reserves in the way that they need to.

 

 

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They bulked up because of concerns of what happened with Ukraine years ago.

 

 

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A lot of countries sort of learned that lesson.

 

 

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We hear conversations about whether there's a drop dead rate date for companies

 

 

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and countries around the world when they're just going to run out of oil.

 

 

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The date seems to move around a bit.

 

 

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I was just wondering if we're also kind of up against that for an inflationary

 

 

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story.

 

 

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That goes to the holding all else equal. Remember the running out of oil

 

 

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commentary as it related to 2007?

 

 

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Price will solve that before we ever run out of those barrels.

 

 

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If price ends up solving it I can guarantee you there will be a response

 

 

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on the rest of the globe.

 

 

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You're already starting to see that in the US.

 

 

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We started more or less at $60 oil

 

 

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and as much as maybe $100 oil isn't as high as you would

 

 

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think for a complete blockage of the Strait what you're

 

 

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actually seeing is that's a real economic gain to people

 

 

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who produce oil to the extent that it is sticky there.

 

 

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There's always a supply response.

 

 

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Don't fall prey to the hold all else equal argument

 

 

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because high prices tend to cure high prices.

 

 

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In some ways an alternative theory, and I do think it's a theory

 

 

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but we could measure it in a bunch different ways, maybe what

 

 

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the fact that the oil price is saying is not being as high as maybe people

 

 

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expected is that there was already

 

 

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a whole lot of oversupply already on the water.

 

 

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I think that that has a lot to do with it as well.

 

 

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When you look excluding the SPR we're not really anywhere

 

 

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in terms of inventories relative to demand days in the US that you would say

 

 

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is stretched currently.

 

 

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This all is sort of wrapped up in a bow of this so far has been

 

 

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very different of losing the ability to produce oil, which

 

 

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is kind of what we were going through in 2007.

 

 

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There was just no more in terms of excess capacity.

 

 

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The problem right now is getting the oil out of

 

 

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the area.

 

 

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It exists, it's there, it's sitting there.

 

 

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Exactly. I think that's fundamentally different. When you say that this is the

 

 

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biggest bottleneck in supply disruption that we've ever seen I would say yes

 

 

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but. There is yes but because the oil is still

 

 

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being produced. Always remember, I think the Suez Canal shut for

 

 

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seven years, five, seven years maybe even longer, but by the time it reopened

 

 

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it actually wasn't having any meaningful commerce go through it.

 

 

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There are alternative ways.

 

 

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Yes, they take longer, yes, they support a higher oil price, but don't

 

 

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ever underestimate the long term potential of governments and,

 

 

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in some ways, markets to actually solve problems

 

 

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that are supply shocks in their nature.

 

 

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It's fascinating. Weeks ago when the war was new

 

 

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you had mentioned don't chase, don't chase oil.

 

 

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This is not the moment to do that in a sense that's already passed.

 

 

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You also mentioned that when it ends, if it ends, when this all

 

 

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wraps up oil could really drop.

 

 

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Now that you see how much supply is out there, I think you had mentioned you

 

 

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thought there probably was but now we actually see it.

 

 

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It's almost like a discovery.

 

 

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What is the risk for the oil price to the downside?

 

 

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We always have to hold both tails I think in some ways

 

 

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equally conscious in our view, the right tail and

 

 

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the left tail. There are all kinds of things that always go wrong.

 

 

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Those are usually the narratives that I talk about a lot when investors ask

 

 

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me things, when portfolio managers ask me things.

 

 

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There is a scenario where things go well.

 

 

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There is something that is more like what Venezuela is

 

 

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experiencing in that if there is maybe a different style

 

 

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of regime, but still a similar regime that is

 

 

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able to produce at full capacity at some point over

 

 

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the next five to seven years even if it doesn't happen instantly, you

 

 

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end up with more supply than maybe we started with two years

 

 

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ago or five years ago if we look forward ten years.

 

 

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In some ways the excess capacity of that

 

 

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ability if things do go right, and you can say, well, Denise, I know that

 

 

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they're not going to go right. Maybe, we don't know that as investors.

 

 

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That's always the problem. I like to say, and this doesn't mean to be sort

 

 

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of glib about it, but Goldilocks

 

 

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often has the highest odds, meaning that I'm not saying that there aren't black

 

 

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swan events, there absolutely are, but it's very difficult as an investor

 

 

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to feel confident enough to bet on them.

 

 

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If there are things that go right that could be a situation

 

 

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where oil supply was actually much higher than you thought.

 

 

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If $60 oil was actually where we were with supply

 

 

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of a year ago  then what does that look like with more supply?

 

 

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That's absolutely fascinating. When we get back to the inflation story,

 

 

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what rates are being priced in or not in terms of

 

 

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cuts and actually hikes at this point, it takes you to

 

 

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what a hike ultimately would mean, and sometimes

 

 

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we think that that's to fight inflation.

 

 

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It's not always in your reporting that you've been doing and compiling over the

 

 

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course of the last week. What is actually potentially going on if a hike

 

 

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happens?

 

 

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I would say not only not always, I would say not often.

 

 

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If you look, again, from a statistical correlation perspective and say,

 

 

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well, it's actually oil price, like we talked about, there's very little

 

 

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relationship. Well, what if it's growth which we've talked a lot about.

 

 

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The manufacturing recovery that has been in a malaise for three years

 

 

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is finally starting to see an inflection.

 

 

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You've seen a durable goods orders number that is actually top

 

 

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quartile, which is fairly rare and only happens 25% of the time, and

 

 

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usually begets more growth in terms of job growth and

 

 

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profit growth. You're starting to see an underpinning of a

 

 

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durable expansion that we really haven't seen in quite some

 

 

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time. Is there a relationship between this burgeoning growth and

 

 

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the ability, or the inflection, in terms of the higher probability of the

 

 

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Federal Reserve to raise interest rates?

 

 

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There, in fact, is. Again, it's monotonic, it doesn't mean it's

 

 

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certain that the Federal Reserve has to raise interests rates but if you had to

 

 

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bet on a scenario and say do oil prices usually lead to

 

 

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a more hawkish Fed, not usually, no.

 

 

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Do higher growth expectations, or higher growth prints, lead to a more hawkish

 

 

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Fed? Yes, more often than not.

 

 

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When you look at that you say, okay, well, let's play this out.

 

 

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Now you're in top quartile growth, you know that growth is actually going to

 

 

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inflect over the next year, say we had this perfect foresight, and

 

 

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the Fed hikes, you're right, you get it, you nail it and you know exactly

 

 

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what the Fed's going to do. What are the odds that the market goes up?

 

 

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In that growth vertical of top quartile which is I think where we are on a lot

 

 

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of the manufacturing indicators from a signalling perspective, you actually

 

 

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have above average odds, and the odds in the market are 75% to go up

 

 

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over any year in either scenario.

 

 

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When higher rates are just a reflection of growth

 

 

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the market has had very little problem with it.

 

 

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It's completely fascinating how that is filtering its way through.

 

 

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You mentioned at the beginning one of the ways to get proper inflation

 

 

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that goes everywhere is governments dumping a whole lot of money into

 

 

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the economy. That was very much a COVID response for lots of countries around

 

 

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the world. What about the amount of CapEx being dumped into the economy?

 

 

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People will argue it's not going everywhere but, I mean, that is

 

 

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growth/inflationary, no?

 

 

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It's interesting. There's not a whole lot of correlation between growth and

 

 

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inflation overall, meaning that most growth is not inflationary, which sounds

 

 

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a little strange because you would think that there would be some sort of

 

 

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correlation if the economy grows faster than you would see inflation.

 

 

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If you look at the two series, download real GDP over the course

 

 

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of 1962 to present, and you take either the core CPI or the overall

 

 

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CPI and let's say I get the inflection right, real

 

 

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GDP inflects, we go from 2% real GDP growth to 4% over

 

 

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the course of the next year, what are my odds that core inflation accelerates

 

 

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as well? It's 50/50, meaning that not

 

 

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only is there demand increasing but oftentimes at the same

 

 

00:14:04,643 --> 00:14:08,714

time supply increases, there's some increase

 

 

00:14:08,714 --> 00:14:12,718

in productivity. There are all kinds of other moving variables

 

 

00:14:12,718 --> 00:14:16,922

that say, again, back to the you got to be careful holding that

 

 

00:14:16,922 --> 00:14:20,492

all else equal. We'll say we're going to hold supply constant while demand

 

 

00:14:20,492 --> 00:14:24,697

accelerates. But supply isn't constant, supply is constantly moving

 

 

00:14:24,697 --> 00:14:28,801

as well. In some ways CapEx is correlated to that.

 

 

00:14:28,801 --> 00:14:32,771

From an inflationary perspective, back to the what you can measure,

 

 

00:14:32,771 --> 00:14:36,809

CapEx cycles, however you measure it and you can measure it a bunch

 

 

00:14:36,809 --> 00:14:40,880

of different ways, are usually disinflationary in nature because there

 

 

00:14:40,880 --> 00:14:45,751

is more often than not a supply response with it.

 

 

00:14:45,751 --> 00:14:48,687

That's fascinating.

 

 

00:14:48,687 --> 00:14:50,656

What are some of your favourite growth?

 

 

00:14:50,656 --> 00:14:53,859

You're looking at durable goods, you were mentioning CapEx, the investment that

 

 

00:14:53,859 --> 00:14:56,662

companies are making, what else do you need to see?

 

 

00:14:56,662 --> 00:15:01,033

What else are you seeing to help you get to that growth, what

 

 

00:15:01,033 --> 00:15:04,169

looks like a growth scenario taking place?

 

 

00:15:04,169 --> 00:15:07,006

It is a growth scenario and I think it's more durable growth than people are

 

 

00:15:07,006 --> 00:15:11,010

giving it credit for. If you break down durable goods orders, orders are sort

 

 

00:15:11,010 --> 00:15:15,080

of the leading indicator. Companies are like, yes, I want

 

 

00:15:15,080 --> 00:15:19,051

more goods usually that begets the virtuous cycle of

 

 

00:15:19,051 --> 00:15:22,955

more growth in the future which is why you see other companies having to hire

 

 

00:15:22,955 --> 00:15:26,825

more workers so you see the statistical inflection that you see.

 

 

00:15:26,825 --> 00:15:30,796

If you say, okay, of the seven durable goods orders categories

 

 

00:15:30,796 --> 00:15:34,600

that we have machinery, transports, and then there's two that are technology,

 

 

00:15:34,600 --> 00:15:37,636

computers, and I think electrical equipment because that encompasses semis,

 

 

00:15:37,636 --> 00:15:41,774

what of those seven, how many are actually

 

 

00:15:41,774 --> 00:15:45,344

accelerating? All seven, all seven.

 

 

00:15:45,344 --> 00:15:47,379

You can measure this historically.

 

 

00:15:47,379 --> 00:15:51,350

It's interesting, when you have a top quartile diffuse, I

 

 

00:15:51,350 --> 00:15:55,454

would say CapEx recovery, manufacturing recovery, we can

 

 

00:15:55,454 --> 00:15:59,158

call it a bunch of different things, that top quartiles level is four to seven,

 

 

00:15:59,158 --> 00:16:03,195

what does earnings growth look like over the

 

 

00:16:03,195 --> 00:16:06,065

course of the next year? That also has a relationship.

 

 

00:16:06,065 --> 00:16:10,536

The more diffuse the inflection in terms of the CapEx recovery,

 

 

00:16:10,536 --> 00:16:15,007

the more likely earnings growth is to be durable and persistent.

 

 

00:16:15,007 --> 00:16:19,278

We're still sort of back in this I would call secular bull market dynamic

 

 

00:16:19,278 --> 00:16:23,382

of the durability of earnings growth is what I see getting

 

 

00:16:23,382 --> 00:16:27,419

confirmed over and over and over in the indicators that

 

 

00:16:27,419 --> 00:16:31,657

I'm watching. The more durable earnings growth is the longer

 

 

00:16:31,657 --> 00:16:36,195

the cycle lasts, that is what drives the secular bull market.

 

 

00:16:36,195 --> 00:16:40,466

If we bring back in the oil discussion and see it, as we said,

 

 

00:16:40,466 --> 00:16:45,170

drop like a rock does that suddenly change, for instance,

 

 

00:16:45,170 --> 00:16:49,141

leadership for equities? I mean, does the consumer and

 

 

00:16:49,141 --> 00:16:53,278

some of the struggles that it's going through right now just get solved there?

 

 

00:16:53,278 --> 00:16:57,883

I mean, it's usually not that easy but is there a case to be made that

 

 

00:16:57,883 --> 00:17:02,721

discretionary or something could move into a leadership position?

 

 

00:17:02,721 --> 00:17:05,224

There are definitely still the persistent negative correlations between

 

 

00:17:05,224 --> 00:17:09,261

consumer discretionary stocks and either the price of energy, or energy stocks

 

 

00:17:09,261 --> 00:17:12,564

themselves as a precursor to that.

 

 

00:17:12,564 --> 00:17:16,001

You certainly see that sensitivity where you would say if I have perfect

 

 

00:17:16,001 --> 00:17:19,104

foresight and you know that energy prices are going to drop, consumer

 

 

00:17:19,104 --> 00:17:22,775

discretionary as a sector has had at least in history 70% odds of

 

 

00:17:22,775 --> 00:17:24,977

outperformance, either coincident or after that.

 

 

00:17:24,977 --> 00:17:29,081

I think that this is the area of the market that is struggling

 

 

00:17:29,081 --> 00:17:32,851

the most with passing through price.

 

 

00:17:32,851 --> 00:17:36,855

You are seeing that margin compression disproportionately more in consumer

 

 

00:17:36,855 --> 00:17:39,591

discretionary than anywhere else.

 

 

00:17:39,591 --> 00:17:43,862

In some ways, as much as we think as investors, well, we're

 

 

00:17:43,862 --> 00:17:48,500

looking at higher oil prices and therefore that will degrade margins, it's

 

 

00:17:48,500 --> 00:17:51,036

not clear that that's across the broad S&P.

 

 

00:17:51,036 --> 00:17:55,074

Technology stocks, specifically, still have a

 

 

00:17:55,074 --> 00:17:58,410

whole lot of pricing power, as do some industrial stocks.

 

 

00:17:58,410 --> 00:18:02,381

The area that's being squeezed is getting narrow and

 

 

00:18:02,381 --> 00:18:06,318

narrow so when you look at margins for the S&P 500 there's very little

 

 

00:18:06,318 --> 00:18:10,289

correlation between higher energy prices and lower margins in the

 

 

00:18:10,322 --> 00:18:13,492

future. That's the interesting part as well.

 

 

00:18:13,492 --> 00:18:17,463

I think that it has, again, less of an impact on what has been

 

 

00:18:17,463 --> 00:18:21,266

resistant to margins which has been current leadership that I think is still

 

 

00:18:21,266 --> 00:18:24,570

future leadership in terms of technology stocks.

 

 

00:18:24,570 --> 00:18:26,672

That's fascinating. Bring in Kevin Warsh.

 

 

00:18:26,672 --> 00:18:29,908

He was brought in last week, at the end of last week.

 

 

00:18:29,908 --> 00:18:33,445

It seemed like a smooth handover in a lot of ways.

 

 

00:18:33,445 --> 00:18:37,382

I mean, it's only the beginning, of course, but from what

 

 

00:18:37,382 --> 00:18:41,753

you know from his history and what's sort of been stated,

 

 

00:18:41,753 --> 00:18:46,325

again, what's the case for at least staying on hold because

 

 

00:18:46,325 --> 00:18:48,660

of the person and sort of background that we know.

 

 

00:18:48,660 --> 00:18:53,132

You can't make full predictions but we'd love to know your thoughts.

 

 

00:18:53,132 --> 00:18:57,503

I think that he's in a tough spot in the sense where if this

 

 

00:18:57,503 --> 00:19:01,440

is transitory it ultimately ends up being actually correctly transitory.

 

 

00:19:01,440 --> 00:19:04,143

It's probably too early to know that.

 

 

00:19:04,143 --> 00:19:07,980

Like I said, it's not clear how long this is going to persist.

 

 

00:19:07,980 --> 00:19:12,217

There is time for maybe rate hikes resuming later

 

 

00:19:12,217 --> 00:19:16,255

in the year if we see the impact that we just talked about, a different kind of

 

 

00:19:16,255 --> 00:19:20,459

tail event where oil prices not only revert to where they were

 

 

00:19:20,459 --> 00:19:24,463

but even potentially head lower. That's a very different situation that, again,

 

 

00:19:24,463 --> 00:19:28,734

we should be open-minded to. I think that that data in terms of playing out

 

 

00:19:28,734 --> 00:19:31,003

is important to let it play out.

 

 

00:19:31,003 --> 00:19:35,007

I do think that something Jay Powell said over and over again over

 

 

00:19:35,007 --> 00:19:39,144

the last year is that the Federal Reserve right now has time.

 

 

00:19:39,144 --> 00:19:43,081

As much as we're talking about which way will they go the

 

 

00:19:43,081 --> 00:19:45,117

level matters a lot as well.

 

 

00:19:45,117 --> 00:19:49,254

I don't think that where we are right this second in

 

 

00:19:49,254 --> 00:19:53,225

terms of where the Federal Reserve is means that they are well into

 

 

00:19:53,225 --> 00:19:55,961

restrictive territory for the overall economy.

 

 

00:19:55,961 --> 00:19:59,965

There are definitely some pockets that could benefit from lower rates but there

 

 

00:19:59,965 --> 00:20:04,069

are also in aggregate areas that are offsetting that as well from

 

 

00:20:04,069 --> 00:20:08,006

a growth perspective. From a balancing perspective I don't think

 

 

00:20:08,006 --> 00:20:12,311

it's very clear that the Federal Reserve has to move right now.

 

 

00:20:12,311 --> 00:20:16,381

I do think on the flip side of what you think about Kevin

 

 

00:20:16,381 --> 00:20:20,452

Warsh's, I would say ethos, has been one of

 

 

00:20:20,452 --> 00:20:24,256

them, which is I think that he can tackle early rather than later, is that

 

 

00:20:24,256 --> 00:20:28,327

forward guidance aspect which is interesting to me because

 

 

00:20:28,327 --> 00:20:32,397

I always say that when you look back through Federal Reserve history

 

 

00:20:32,397 --> 00:20:34,733

is that over the long term all you see is change.

 

 

00:20:34,733 --> 00:20:39,571

When you look at do we want to target the discount rate, do we want to target

 

 

00:20:39,571 --> 00:20:43,675

reserves, do we want to target federal funds effective rate, do we want to

 

 

00:20:43,675 --> 00:20:45,510

actually make a target into it?

 

 

00:20:45,510 --> 00:20:49,848

Do we want to say that there's guidance in terms of towards 2%

 

 

00:20:49,848 --> 00:20:51,984

inflation? Do we want to have a dot plot?

 

 

00:20:51,984 --> 00:20:56,188

All of these things have been different in any 5 or 10 year increment.

 

 

00:20:56,188 --> 00:21:00,259

To have another difference where, well, if we look at what we

 

 

00:21:00,259 --> 00:21:04,396

were trying to do was to give guidance so that it could be

 

 

00:21:04,396 --> 00:21:08,467

an additional boost in terms of monetary accommodation, that's

 

 

00:21:08,467 --> 00:21:10,902

probably not necessary anymore.

 

 

00:21:10,902 --> 00:21:14,940

I think rolling that back is going to be interesting to see how the

 

 

00:21:14,940 --> 00:21:19,144

market reacts to that. Maybe at first blush there will be narrative around the

 

 

00:21:19,144 --> 00:21:23,315

decline in transparency but it's also not clear to me that the Federal Reserve

 

 

00:21:23,315 --> 00:21:27,519

had a particularly good track record at being able to correctly

 

 

00:21:27,519 --> 00:21:29,321

forecast inflation.

 

 

00:21:29,321 --> 00:21:33,425

You're sort of left with the dynamic that we were talking about, is

 

 

00:21:33,425 --> 00:21:37,529

the Fed more reflective of the cycle rather

 

 

00:21:37,529 --> 00:21:40,098

than creators of the cycle?

 

 

00:21:40,098 --> 00:21:44,636

If that's true maybe this whole rate discussion and transparency

 

 

00:21:44,636 --> 00:21:49,241

and forward guidance is a little less of an impact than many think.

 

 

00:21:49,241 --> 00:21:53,345

There's an awful lot of Fed speak that's taken over the airwaves over

 

 

00:21:53,345 --> 00:21:56,581

the course of the last several years and probably only been growing over the

 

 

00:21:56,581 --> 00:22:01,153

last several years. Just to think of aspects of that were taken out

 

 

00:22:01,153 --> 00:22:05,424

and less crystal ball-ism would be really

 

 

00:22:05,424 --> 00:22:09,494

interesting. It sounds like Kevin Warsh has a lot of ideas that

 

 

00:22:09,494 --> 00:22:13,732

you have brought to our attention, and others as well, about how to restructure

 

 

00:22:13,732 --> 00:22:17,936

things. For instance, how much belongs on the Fed balance sheet versus

 

 

00:22:17,936 --> 00:22:23,241

being perhaps transferred to Treasury seems to be one discussion.

 

 

00:22:23,241 --> 00:22:27,713

Just the discussion about rates potentially needing to hike or this new

 

 

00:22:27,713 --> 00:22:32,250

vision of either growth or inflation or something that needs to be reacted to,

 

 

00:22:32,250 --> 00:22:34,019

does that come first?

 

 

00:22:34,019 --> 00:22:38,990

Can the other things structurally get going at the same time?

 

 

00:22:38,990 --> 00:22:43,128

I think it probably all comes at once, at least in the early stages of

 

 

00:22:43,128 --> 00:22:46,331

all of it. I think that there's discussions, and there have been discussions,

 

 

00:22:46,331 --> 00:22:50,268

on the balance sheet. There already have been discussions about what does it

 

 

00:22:50,268 --> 00:22:53,772

mean to own mortgages, what does it mean to own long term debt as opposed to

 

 

00:22:53,772 --> 00:22:57,109

short term bills, what do all these things mean in terms of what that would

 

 

00:22:57,109 --> 00:23:00,345

mean to the reserve requirements of our banks and what that means for

 

 

00:23:00,345 --> 00:23:04,282

regulation. I think these conversations have already been happening and

 

 

00:23:04,282 --> 00:23:08,420

in some ways I think people put more of a fine point on maybe there's a

 

 

00:23:08,420 --> 00:23:12,491

disagreement, where I think that maybe the agreement is around the fact

 

 

00:23:12,491 --> 00:23:16,061

that it needs to be tackled. Maybe the disagreement would be on timing and

 

 

00:23:16,061 --> 00:23:20,332

exactly how far. I think there's actually more agreement than

 

 

00:23:20,332 --> 00:23:24,069

maybe the market portrays in the narrative.

 

 

00:23:24,069 --> 00:23:28,707

I think that, yes, balance sheet is an issue, forward guidance is an issue,

 

 

00:23:28,707 --> 00:23:32,611

what rates should be is an issue, both the level and whether or not they hike

 

 

00:23:32,611 --> 00:23:36,581

and lower. All of those things I think are gonna be ongoing over the course of

 

 

00:23:36,581 --> 00:23:40,719

the next year. The question is whether or not all of those things impact the

 

 

00:23:40,719 --> 00:23:41,553

market.

 

 

00:23:41,553 --> 00:23:45,590

The interesting thing, to get back to the Federal Reserve, I think that the

 

 

00:23:45,590 --> 00:23:49,394

pushback on my view is to say, yeah, Denise, I know what you're saying  but we

 

 

00:23:49,394 --> 00:23:51,863

just did 2021, 2022.

 

 

00:23:51,863 --> 00:23:55,934

If you're wrong on inflation and the Fed has to hike a lot, I knew you just

 

 

00:23:55,934 --> 00:23:59,337

said that the Fed hiking was more often than not a reflection of growth, not a

 

 

00:23:59,337 --> 00:24:02,240

deterrent to it, but that seemed like a really bad setup.

 

 

00:24:02,240 --> 00:24:04,976

That's where magnitude matters.

 

 

00:24:04,976 --> 00:24:08,480

When you say, yes, they have to chase inflation, we just talked about why I

 

 

00:24:08,480 --> 00:24:11,850

think that there's not going to be a significant amount of pass through, from a

 

 

00:24:11,850 --> 00:24:13,685

magnitude perspective that would be problematic.

 

 

00:24:13,685 --> 00:24:18,190

If you say, well, the Federal Reserve is going to hike

 

 

00:24:18,190 --> 00:24:22,227

25, 50, maybe even 100, that's in these middle two quintiles of

 

 

00:24:22,227 --> 00:24:26,465

history so it's sort of more like just incremental in

 

 

00:24:26,465 --> 00:24:29,301

nature, that's actually the sweet spot for the market.

 

 

00:24:29,301 --> 00:24:33,371

What we're talking about in

 

 

00:24:33,371 --> 00:24:37,108

terms of narrative, I don't want to say it's a sideshow in the sense that it's

 

 

00:24:37,108 --> 00:24:41,112

not important and it's not important to discuss but it might not

 

 

00:24:41,112 --> 00:24:45,817

be the critical driver that you think it is for the overall market.

 

 

00:24:45,817 --> 00:24:50,155

Fascinating. You do kind of wonder how that

 

 

00:24:50,155 --> 00:24:53,124

filters through and comes through. One question I wanted to ask you, just going

 

 

00:24:53,124 --> 00:24:57,062

back to the consumer, the potential for the consumer to have less

 

 

00:24:57,062 --> 00:25:01,399

of a burden if, should, oil prices come down, we don't know about that,

 

 

00:25:01,399 --> 00:25:05,370

but as this AI cycle continues and you watch

 

 

00:25:05,370 --> 00:25:11,109

where things are being affected, we've we've heard some comments that

 

 

00:25:11,109 --> 00:25:15,514

ultimately the growth could be coming more from sort of business-to-business

 

 

00:25:15,514 --> 00:25:19,918

discussions rather than very sort of consumer-led industrial

 

 

00:25:19,918 --> 00:25:21,686

revolution talk.

 

 

00:25:21,686 --> 00:25:25,857

I only ask you that in the sense that you wonder if this is more

 

 

00:25:25,857 --> 00:25:28,660

sort of an industrials or a consumers discussion.

 

 

00:25:28,660 --> 00:25:32,564

We both know both of our countries are heavily dependent on the consumer to

 

 

00:25:32,564 --> 00:25:35,200

drive the economy, that's just the way it is.

 

 

00:25:35,200 --> 00:25:39,170

Is there something you see there shifting at all with what we

 

 

00:25:39,170 --> 00:25:42,674

know so far about the impact of AI?

 

 

00:25:42,674 --> 00:25:46,611

I think what we're seeing, right, who knows how it ultimately will impact, but

 

 

00:25:46,611 --> 00:25:50,682

what we are seeing that we can actually measure is that most of

 

 

00:25:50,682 --> 00:25:54,386

industrial production or consumption, I would say job growth, a lot of the

 

 

00:25:54,386 --> 00:25:57,789

leading indicators are pointing to accelerations across the board.

 

 

00:25:57,789 --> 00:26:01,793

If you had to pick one and say it's more dominant in manufacturing or it's

 

 

00:26:01,793 --> 00:26:04,930

more dominant in the consumer, right now the leading indicators are saying

 

 

00:26:04,930 --> 00:26:08,099

exactly what you said. It's more dominant in manufacturing.

 

 

00:26:08,099 --> 00:26:12,270

You're seeing a really strong inflection in NAPM new orders

 

 

00:26:12,270 --> 00:26:16,274

or ISM new orders, you're saying this durable goods order recovery.

 

 

00:26:16,274 --> 00:26:20,312

The question is, is that a bad thing for the overall either market or

 

 

00:26:20,312 --> 00:26:24,316

future growth? The answer is no, which is not to say that the

 

 

00:26:24,316 --> 00:26:26,451

consumer isn't a big portion of the economy.

 

 

00:26:26,451 --> 00:26:30,355

It's just to say that I think we're in a vertical where industrial production

 

 

00:26:30,355 --> 00:26:34,292

on average grows faster than consumption.

 

 

00:26:34,292 --> 00:26:37,596

As long as both grow that's the trajectory.

 

 

00:26:37,596 --> 00:26:41,833

In some ways growth is always somewhat

 

 

00:26:41,833 --> 00:26:42,100

concentrated.

 

 

00:26:42,100 --> 00:26:46,004

There's always some sort of leadership dynamic about it.

 

 

00:26:46,004 --> 00:26:49,407

I think it's always interesting when we talk about, well, growth is in ...

 

 

00:26:49,407 --> 00:26:53,578

I just saw a headline on one of the

 

 

00:26:53,578 --> 00:26:57,515

news stations that the top 17 now encompass

 

 

00:26:57,515 --> 00:27:00,185

50% of the earnings growth. I feel like we keep saying is it FAANG, is it

 

 

00:27:00,185 --> 00:27:04,155

Mag-7, now we're talking about the top 17.

 

 

00:27:04,155 --> 00:27:08,460

All of that is a function of the fact that growth is good

 

 

00:27:08,460 --> 00:27:11,863

and it's actually accelerating by and large everywhere.

 

 

00:27:11,863 --> 00:27:16,134

The fact that it's really strong in pockets doesn't have to be a negative.

 

 

00:27:16,134 --> 00:27:19,237

I say it doesn't have to be a negative because you can figure it out

 

 

00:27:19,237 --> 00:27:23,174

historically. We can look at when these pockets have been strong

 

 

00:27:23,174 --> 00:27:26,411

in growth and everybody else has been a little weaker in growth but still

 

 

00:27:26,411 --> 00:27:30,415

growing, that's not a driver for the overall market because

 

 

00:27:30,415 --> 00:27:34,853

there is growth. If growth underpins the durable earnings growth

 

 

00:27:34,853 --> 00:27:38,823

then durable earnings growth always underpins a secular bull market.

 

 

00:27:38,823 --> 00:27:41,226

That's absolutely fascinating.

 

 

00:27:41,226 --> 00:27:45,196

You mentioned about being in the sweet spot and how that ultimately

 

 

00:27:45,196 --> 00:27:49,200

works. In terms of growth and alpha and sort of the

 

 

00:27:49,200 --> 00:27:53,304

stock picking discussion here, and making sure that you're going specifically

 

 

00:27:53,304 --> 00:27:57,342

into particular companies to beat benchmarks and so on, how

 

 

00:27:57,342 --> 00:27:59,444

does growth work with the alpha story?

 

 

00:27:59,444 --> 00:28:04,049

What do you need in terms of rates and then taking a look at the growth story?

 

 

00:28:04,049 --> 00:28:07,585

I'm not sure there's any difference in terms of leadership, what we're seeing.

 

 

00:28:07,585 --> 00:28:11,556

I think that there's a big narrative around a short term correlation between

 

 

00:28:11,556 --> 00:28:16,027

technology stocks and rates, meaning that over the last 18 months

 

 

00:28:16,027 --> 00:28:19,431

lower technology stocks or underperforming technology stocks have been

 

 

00:28:19,431 --> 00:28:23,368

correlated with higher rates. The question is when you look back in the data is

 

 

00:28:23,368 --> 00:28:27,205

that persistent? Those short term correlations, we assume that we know the

 

 

00:28:27,205 --> 00:28:31,109

answer in terms of how they'll close or the risk but again, we don't have to go

 

 

00:28:31,109 --> 00:28:34,212

far. We can download the data and we can say, okay, if we have perfect

 

 

00:28:34,212 --> 00:28:37,582

foresight and we know that rates are going up but the growth position is

 

 

00:28:37,582 --> 00:28:41,553

strong, as I said, from a quartile perspective, if you say,

 

 

00:28:41,553 --> 00:28:45,590

okay, we've got either above average growth or below average growth

 

 

00:28:45,590 --> 00:28:49,427

and then I have perfect foresight and I know rates are going higher or lower,

 

 

00:28:49,427 --> 00:28:53,064

you see two really interesting things in history for the technology sector.

 

 

00:28:53,064 --> 00:28:57,402

One, higher rates are both verticals

 

 

00:28:57,402 --> 00:29:01,606

better than lower rates, not worse, so that short term correlation

 

 

00:29:01,606 --> 00:29:03,842

hasn't been persistent in history.

 

 

00:29:03,842 --> 00:29:08,379

The more interesting part is that what you see from a higher growth perspective

 

 

00:29:08,379 --> 00:29:12,684

and lower rates, what you would expect maybe the best performance

 

 

00:29:12,684 --> 00:29:16,821

to be is the worst performance.

 

 

00:29:16,821 --> 00:29:21,960

It's odd. It's almost like what we're talking about, rates confirm

 

 

00:29:21,960 --> 00:29:24,696

growth rather than derail it.

 

 

00:29:24,696 --> 00:29:28,967

Rates kind of get it right in terms of the overall cycle

 

 

00:29:28,967 --> 00:29:33,004

dynamic. Where we sit now with technology stocks being strong growers,

 

 

00:29:33,004 --> 00:29:37,041

and by strong I mean above average earnings growth when you look back in

 

 

00:29:37,041 --> 00:29:41,613

history, and with perfect foresight rates go up you have average outperformance

 

 

00:29:41,613 --> 00:29:45,717

of, I think, 500 basis points on a rolling basis, and they outperform about

 

 

00:29:45,717 --> 00:29:49,754

65% of the time. That's before you include valuation

 

 

00:29:49,754 --> 00:29:51,623

which boosts the odds close to the mid-80s.

 

 

00:29:51,623 --> 00:29:55,894

That's been the differentiation this cycle, which is

 

 

00:29:55,894 --> 00:29:59,931

earnings is very strong in the technology sector, so strong that

 

 

00:29:59,931 --> 00:30:03,501

even if you include the rally we've just seen the stocks are still in the

 

 

00:30:03,501 --> 00:30:08,006

cheapest half of the distribution when you look back to the '60s.

 

 

00:30:08,006 --> 00:30:11,876

That, again, back to those sort of monotonic linear patterns that we always

 

 

00:30:11,876 --> 00:30:15,914

want to give an eye towards, the cheaper the relative valuation of

 

 

00:30:15,914 --> 00:30:19,350

technology stocks the more likely they have been to outperform.

 

 

00:30:19,350 --> 00:30:23,521

You've got really good starting points of leadership so does it

 

 

00:30:23,521 --> 00:30:27,592

change leadership? My answer would be no, to the extent that rates

 

 

00:30:27,592 --> 00:30:30,795

confirm the growth that we're already seeing.

 

 

00:30:30,795 --> 00:30:34,632

Even if rates are higher, especially true relative to our starting point on

 

 

00:30:34,632 --> 00:30:38,436

valuation, I think the risk-reward in terms of technology stocks is still

 

 

00:30:38,436 --> 00:30:39,637

positive.

 

 

00:30:39,637 --> 00:30:43,875

Don't fear the hike as long as it's not too big.

 

 

00:30:43,875 --> 00:30:44,542

It confirms [crosstalk].

 

 

00:30:44,542 --> 00:30:45,443

Well said.

 

 

00:30:45,443 --> 00:30:47,278

Fascinating data that you bring to us.

 

 

00:30:47,278 --> 00:30:51,049

Denise Chisholm, thank you for joining us. We're always so happy to be able to

 

 

00:30:51,049 --> 00:30:53,218

listen to your insights. Have a great rest of your day.

 

 

00:30:53,218 --> 00:30:54,886

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00:30:54,886 --> 00:30:58,823

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