The Upside: February Market Moves with Denise Chisholm

[00:00:22] Jordan Chevalier Hello, and welcome to The Upside. I'm Jordan Chevalier. It's been a busy start to the year for investors with the US bull run continuing, some Fed uncertainty and the rise of gold and plenty happening across the geopolitical spectrum. Joining us today to tell us what the data is saying about these key market moves as well as AI, US equities and, of course, to provide a sector update is Fidelity Director of Quantitative Market Strategy, Denise Chisholm. Denise, it's great to see you. 

[00:00:50] Denise Chisholm Great to see you, Jordan.

[00:00:52] Jordan Chevalier We'll get right into it. We've got lots of questions here from investors, they knew you were on the show. We're going to start here with sector opportunities. Now, what is your research pointing to when looking at specific sectors that investors should be looking at?

[00:01:06] Denise Chisholm If you think about the recent thesis coming into this year it was really all about durable earnings growth supported by the tax cuts that we saw last year and the Fed being able to renormalize policy, probably last year and this year. But into this I think we can ask ourselves, is the data supportive of that thesis? This week we saw a very important signal that not only reinforces the durability but also talks about sector opportunities from a signalling perspective. That's the inflection in ISM, which is the manufacturing diffusion index. This cycle has been very different than any other cycle. I mean, every cycle is always different, but for the better part of three years we have seen either a manufacturing recession or a manufacturing malaise. This was really in line with the fact that the median earnings growth for the median company in the S&P was in contractionary territory. We are seeing all of that emerge.

[00:02:02] We had a 20% jump in manufacturing new orders so that negates the probability that some of what we are seeing is like a false start that we've seen over the better part of three years. That inflection usually means that manufacturing upside is durable, earnings growth is durable and from a sector perspective the more industrial-focused sectors and sub-sectors have the highest odds of outperformance. This is an important cyclical inflection that usually supports industrials and manufacturing-related stocks and sectors.

[00:02:35] Jordan Chevalier Denise, that's great. I think there's no surprise here that our next question is on gold. There was a bit of a sell-off last week and things have recovered slightly. Can you take us through your thoughts, gold and silver, commodities as a whole, what are you thinking?

[00:02:50] Denise Chisholm I will say the interesting part when I look at the data is, you know, last year and into this year we have been talking about the AI bubble and is it a bubble in technology? If you just define a bubble in terms of the percentage rise above the 200-day moving average you'll see the Nasdaq and the dot-com bubble was about 60% ahead of its 200 moving average and gold is about the same. And yet, no one has talked about it at all as a bubble. Look, I mean, that's sort of the interesting side note that I think is interesting as it relates to gold but when you look at the data, RPMs, I'm equity research, so they come to me and they say, what does this mean? Gold is up 80%. It's a top quartile move. Does this mean I should be scared in terms of equities? Does that mean it's a move towards we should be worried about inflation?

[00:03:39] The interesting thing is in the data, and we have the data obviously going back to the '70s, is that there is no consistent relationship between gold and a dollar debasement or higher interest rates or even lower interest rates, or an equity market advance, meaning when gold is up in a top quartile way 50% of the time equities go up over the next year and 50% of the they go down over the year. It's really not a pervasive signal in any way. I think gold's strongest correlation is to the commodity stack, in part because, at the end of the day, it's been a really solid supply-demand dynamic relative to the rest of commodities. I think that that is what is different this cycle for gold. You have seen central bank buying of gold that is different this cycle than any other cycle. The problem as it relates to determining whether or not it's a bubble is that gold, unlike stocks, doesn't have a valuation, it doesn't have a dividend yield. I think that there is some angst over how high is too high.

[00:04:42] Now, I'm not a central banker but if I were to be one I think you would be worried about having too much of your reserves in something that can go up 80% and down, on a silver basis, 35% in a day. It may very well be that there is an underlying driver to gold demand but that may have gotten too far, too fast right now. I'm pretty cautious on the moves because as a portfolio manager once told me a long time ago, anything that can go up 80% can go down 80% as well.

[00:05:12] Jordan Chevalier Certainly very insightful. I know people at home will definitely appreciate those comments. Staying with gold a little bit, part of the gold story was driven by the appointment or the discussion of former Fed official Kevin Warsh being tapped to lead the Federal Reserve. Does this mean that gold is no longer a hedge because he's going to cut rates and respond in a way that will be a little more favourable?

[00:05:38] Denise Chisholm Yeah, it's a little bit sort of the bubble portion about it. I think that the dollar debasement trade around the lack of Fed independence this cycle was one of the drivers to gold. Again, that was the thesis behind central bank buying that you do actually see. Now, what we had happen was a more credible central banker come in to potentially chair the Fed that we haven't seen yet. From that perspective, that might provide that shakeout of maybe trees don't grow to the sky because maybe the dollar debasement narrative didn't have as much legs as the market originally thought.

[00:06:11] All of that said, I think that it is more that we will see what the data brings in terms of inflation and what the Federal Reserve can do over the course of the cycle. My going in position is a little bit different than most others, which is to say that inflation, when I look at the data, and we just saw the ECI come out recently, you don't see a whole lot of sustainable wage acceleration such that you would see persistent inflation down the line. Warsh or whoever would share the Fed, it very well might be that the data continues to allow the Fed to normalize monetary policy which might mean, to your point, that there might be a more shakeout continued in the gold space.

[00:06:59] Jordan Chevalier That's great, Denise. I know this is probably not the last time we'll talk about it but we'll keep our eyes focused for the future on that one. Turning now to tech, I can't believe we haven't talked about tech yet, we'll turn now to some questions here about tech and the AI bubble story. That bubble story is still sticking around a little bit and we've had some major tech companies, they've reported earnings so far this year. What are your thoughts so far on the tech story and, I guess, more closely how that all relates to AI?

[00:07:27] Denise Chisholm The shakeout that we've seen over the last month, specifically driven by software stocks, but for the most part what we've seen across the technology stack is it would have to go down as the worst bubble in history when you think about valuation. Not only are we cheaper from a forward P/E basis, so price-to-earnings basis, than we saw during the tariff tantrum but we're actually well into the bottom half of the stack when you look over the course of the data that we have going back to the '60s. Now that technology as a sector on a relative basis versus the rest of the market is definably cheap, meaning that it's in the bottom half of the distribution, that skews your risk-reward positive. If you're concerned that, yes, they are spending too much CapEx and returns might be diluted over time and maybe your operating margins come down a little you would see that that's reflected in the multiples almost instantaneously over the course of the last month.

[00:08:23] I think that this is very similar to what we've seen over the better part of the last five years, those shakeouts are very, very quick and you see these sentiment and valuation resets that's supportive in that it provides the ability for technology to continue to be leadership for the long term, as opposed to being what I would call a true bubble, which is when a bubble truly inflects higher, the only way lower is through popping that bubble. What we're seeing is something much more sustained. As soon as you get a shakeout like this you already have valuation support, the risk-reward improves and the outperformance can continue. I do think that technology is not ... when I look at the data it doesn't look anything like the bubbles in 2000 and I think valuation is already supportive.

[00:09:11] Jordan Chevalier That's great, thanks so much for that. I think we'll end off today's show, of course, with the top three and bottom three sectors. Let's start with the bottom three and then we can end with your top three sectors, Denise.

[00:09:23] Denise Chisholm The bottom three is still energy in the sense that I think that the recent run is a negative risk-reward here, mainly around the fact that the sector just looks too profitable to me, which means that there's more downside. Then I'll pull in the defensive stack, given that ISM manufacturing inflection that we just saw it would be very odd to see a defensive rotation so utilities and consumer staples are much more negative risk-rewards to me. Those are my bottom three.

[00:09:47] Jordan Chevalier Okay, and looking now to the top three, we'll end there.

[00:09:52] Denise Chisholm On the top three, this will be a restack in terms of what we talked about. With technology I do think is an outperformer. I don't think that the risk-reward is massively negative for technology but I think that there can be room for other sectors to be better situated. I think industrials is the number one based on what we saw during this manufacturing inflection. The other two that I've talked about recently, still financials and portions of consumer discretionary. The top three are industrials, financials and consumer discretionary.

[00:10:21] Jordan Chevalier Thanks so much, Denise. It was great to chat and we'll see you next time on The Upside. Thanks again.

[00:10:26] Denise Chisholm Great to be here.

[00:10:28] Jordan Chevalier Thanks for watching everyone. Just a reminder that The Upside webcasts, they do air daily so keep an eye on your inbox so you don't miss an invitation to the next show. If you haven't done so already sign up for The Upside newsletter so you don't miss out. Video podcasts are released frequently, both The Upside and Fidelity Connects. Just search Fidelity Canada on YouTube, Spotify and Apple podcasts. Thanks for watching. I hope you'll join us again on The Upside. I'm Jordan Chevalier.