FidelityConnects: Geopolitics and growth part three: A shift to international equities

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<b>Subtitles are AI Generated</b>

 

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Welcome back to our final session today.

 

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We're turning our attention beyond North America and shifting market

 

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fundamentals to geopolitical forces shaping earnings.

 

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Our next guest will walk us through what's driving international and global

 

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markets right now and what that may mean for investors.

 

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I'm joined by Patrice Quirion, portfolio manager.

 

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He oversees global and international mandates working closely with a deep

 

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research team that gives him direct insight into companies and regions around

 

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the world. Patrice, great to have you here.

 

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It's a pleasure to be here.

 

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I'd like to start with you, as I did with Joe and Jin, how do you

 

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deal with news like we got over the weekend.

 

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How does it change your approach that's already a busy one and a

 

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thorough one but what does it do when something like this happens for your day

 

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to day?

 

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This is where I think the full resources of

 

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research, both internal, external, a decent amount of

 

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experience come into play as well.

 

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Obviously, it feels like a big event at any point in time.

 

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The reality is on a somewhat regular cadence

 

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we will get some of those big geopolitical events.

 

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There is a little bit of a playbook. The reality is there's always a lot of

 

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uncertainty. As a result, the importance of addressing different scenarios,

 

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this is where our fundamental research team plays a critical role,

 

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helping us understand what happens if.

 

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In most cases we don't know exactly what will happen.

 

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So it's playing with scenarios, trying to compare that with what has been

 

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priced in or not.

 

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But it goes way beyond just the fundamental impact.

 

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I think there is a large aspect of it which is more tied to portfolio

 

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construction than how do we react.

 

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By that I mean it's often the change from

 

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a risk-on to a risk-off moment.

 

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As a result, to understand, and this is where our trading

 

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desk, our strategic asset allocation teams can help us

 

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understand, and our own observations lead

 

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us to have a very strong view on that, what was the risk-on

 

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trade? What parts of the market were getting crowded?

 

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Usually when we get an event like this we see at least an initial, like

 

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first few, days unfolding of that and reversal of

 

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some of the trends that were taking place.

 

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I would say it's really a combination of making sure we understand what's

 

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happening, trying to form an opinion on what the scenarios are,

 

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leveraging our fundamental research to help us understand the sensitivities

 

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to those scenarios, and keeping portfolio construction, risk control,

 

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maybe position weights, et cetera in the event of a

 

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short term reversal of that.

 

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Ultimately, the big question tends to be something along the lines of

 

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how long will this last for before we go back to a

 

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normalized situation?

 

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It's not easy, and I won't claim that we are here standing with

 

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much better information than others knowing how long that will last for.

 

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I think it's just to control the portfolio as a whole, to

 

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be comfortable in the meantime, and this is where different

 

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strategies will have different approaches. In my case, and a lot of

 

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my colleagues' case, we keep our eyes on the prize

 

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of what does it look like once we are past that noise.

 

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I think more often than not these type

 

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of events tend to create opportunities as opposed to moments where we

 

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need to panic. Easier said than done.

 

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I think with a combination of resources, experience, having seen

 

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similar events in the past, we really try

 

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to stay cool-headed, stay focused on mid to longer term

 

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fundamentals and take advantage of where there may have been exaggerations in

 

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the market.

 

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You are a value-oriented manager, you're contrarian, you've got the world at

 

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your fingertips, if you will, so you also see where your models

 

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are saying, it's probably oversold, there's opportunity as well.

 

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I think the biggest call to action for me

 

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... we, obviously, on a daily basis, crisis or not, we keep track of

 

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our best estimate of what a given security is worth, estimates

 

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of fair value or target prices, whatever way you want to frame it.

 

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The reality is the market always has those movements, there tends to

 

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be exaggerations created, so if we have

 

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a combination of something that was starting to look quite interesting and

 

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it gets further exaggerated by a crisis

 

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moment it becomes much more actionable.

 

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On the flip side, if there are parts of the portfolio that we feel were

 

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becoming fully valued and suddenly you have an

 

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event like this taking place that propels relative performance of maybe

 

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some of those fully valued assets even further it creates great

 

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rotation of capital opportunities within the portfolio.

 

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It's usually less about what has just moved a few percentage

 

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points over the past couple of days and more so about where

 

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were we starting to witness some extremes and if that is propelled

 

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further let's use that opportunity to take action on it.

 

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Although you're not an economist I'd love to ask you a macro question, and I'll

 

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preface that by saying that Denise Chisholm, who's familiar to our viewers, she

 

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just put out a note today and it talks about the fact that global events like

 

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what we're seeing, it's the exception not the rule that they create a headwind

 

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for the market. Can you comment on that?

 

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Yes, a few thoughts on my end.

 

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I think the first one to ask is to what degree, no

 

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matter how bad it may look for a given country or situation,

 

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to what degree is that having meaningful global economic

 

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consequences?

 

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In a lot of cases like wars or unfortunate

 

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events taking place more often than not

 

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they will be affecting small parts of the market

 

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that don't have dramatic overall economic implications and

 

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don't have the power to really change the larger cyclical

 

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structural economic forces at play.

 

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In this case there is a potential

 

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if that ... which is not what I would necessarily call

 

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a base case, far from it ... but if that goes on for too long

 

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or gets into an order of magnitude greater than

 

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what we envisage right now, given that so much of the

 

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energy flows through that region

 

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through the Strait, as Jin and Joe just talked about,

 

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there is a scenario where this could have broader implications than

 

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maybe a lot of similar events that tend to be making news for

 

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a few days and then we move on.

 

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Let's keep in mind also, I think in the current situation

 

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the vast majority of the world is incentivized to have energy

 

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that keeps flowing through the Strait of Hormuz.

 

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If most of the large superpowers in the world have that incentive we

 

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can probably gain a little bit of comfort that maybe other

 

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than a short period of time we will go back to

 

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a more normal situation around that.

 

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So this is where politics outweighs concerns.

 

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Right, and incentives. I think that's it's really important to understand

 

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incentives because that dictates a lot, who has which incentive,

 

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who has the most power, now I think all large players have

 

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the incentive to make that a temporary event as

 

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opposed to something that has the potential to really change like long term

 

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cyclical or structural trends that we're seeing in global markets.

 

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Thank you for the perspective on what we've been seeing, and I'm sorry to throw

 

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you an economics question but we had to go there and you had a wonderful

 

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answer. I'd like to go now to where are you seeing opportunities outside

 

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of North America?

 

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That thematic has been, I think, at play for the past almost

 

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two years, since the US election where I do think that

 

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we come from a point that historically looks quite extreme

 

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in terms of US expectations,

 

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valuations, starting point on the economic cycle versus the rest of the world.

 

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The US, in my opinion, on many fronts, consumer spending, corporate spending,

 

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government spending, is closer to a peak, maybe with

 

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the exception of the middle class and below consumer, we can come back to that,

 

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but where the rest of the world, being either Europe,

 

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China and as a result, quite a number of emerging markets,

 

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are starting much more towards a mid or

 

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troughish starting point on their economic cycles.

 

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That on its own creates, I think, very divergent

 

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potential risk-reward looking a

 

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few years out.

 

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It was not only that. It was the fact that it was combined simultaneously

 

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with very historically divergent valuation on those

 

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earnings streams, divergent expectations about trajectory

 

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of those earnings dreams, I think it created that

 

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extreme that in my opinion shifted the risk-reward balance

 

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towards international markets at large.

 

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We can come back to that, it's important to differentiate

 

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international markets is not one market, there's very different dynamics

 

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taking place, but if we generalize I think international

 

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was looking more favourable.

 

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You never know what exactly the catalyst would be to create that change.

 

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You can have an opinion on a situation being

 

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maybe out of proportion or stretched but what will cause it to

 

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reverse.

 

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I think what caused it to reverse is a combination of

 

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maybe weakening confidence into

 

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the US as an economy for global investors.

 

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We see that manifested not only on equity evaluation but we see it through

 

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the currency as a great proxy for that as well.

 

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We also started to see signs of hope from a depressed

 

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level on either government spending in Germany,

 

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on either maybe signs of stabilization on

 

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the China front from real estate, from the AI

 

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side that brought optimism, also saw that with maybe

 

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an accelerating pace of corporate governance change

 

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in Japan that was eventually followed by

 

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election there which were quite favourable.

 

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We saw, as all of that was happening, sort of a resurgence

 

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of commodities, especially on the metal side, that typically tends to

 

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help a group of emerging markets much more so than

 

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the US. You start to have the combination of all these events that led to

 

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international markets outperforming by a nice margin over

 

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the past 18 months.

 

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The question is, where are we on that transition?

 

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I will bring it from two aspects.

 

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I think on one side those cycles tend,

 

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historically speaking, looking back, not that it's a guarantee for the future,

 

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but those tend to be relatively long cycles.

 

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It's not something that lasts a few quarters and reverses.

 

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Those geographic or pockets of leadership changes, assuming this

 

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is one of them, can last from a few years to

 

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a decade. We just are basically coming out of

 

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a decade of US exceptionalism, outperformance

 

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on many, many aspects.

 

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I think from that standpoint can keep on going, potentially, if history rhymes.

 

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From a valuation differential the gap did close but is

 

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still more favourable to valuation of most securities

 

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in international markets relative to comparables in

 

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the US. Then there's that notion of where are we

 

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in the cycle, cycle that is in a lot of cases driven

 

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by the consumer, by real estate and construction

 

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and autos and transport, call it the old economy, if

 

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that was to improve, if we have sort of a Main Street economy

 

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recovery from lower interest rates, savings rates that

 

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are maybe overly elevated in other parts of the world, if that

 

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comes back there's simply more leverage to that in

 

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most international markets than there is in the US.

 

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If we go from a decade of

 

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technology, software, non-capital intensive parts

 

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of the economy leading the charge for growth, and if we move to

 

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something that becomes a little bit more sort of asset intensive,

 

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generally speaking the rest of the world is maybe better positioned to benefit

 

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from that.

 

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Putting all of that together is I think why there is that

 

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maybe need to consider international markets again,

 

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very different between different countries or regions, but

 

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maybe to have that to a greater extent than global indices

 

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that would be still today weighted sort of well above two-thirds of

 

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weights in the US market.

 

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There's a few points I want to unpack from what you were just saying.

 

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One was Japan. I know Japan is an area of focus for you, you were there

 

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in 2025.

 

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Japan has shown itself as a great diversifier.

 

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I think as of last year three years in a row of 20% growth in that marketplace,

 

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in that exchange. What are you seeing in Japan and is it true that it's a

 

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very good diversifier for investors?

 

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I think there's definitely an element of diversification across international

 

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markets but Japan specifically. The yen, it's

 

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less the case now than it was in the past but it still acts as a risk-off

 

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currency in most cases.

 

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The economic outlook, the valuation, the money flows, there's a lot

 

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of what's causing the benefit of that diversification which is

 

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simply markets that are becoming increasingly correlated,

 

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or inversely correlated, when money flows somewhere it

 

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tends to come out of another part of the market and vice versa.

 

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Japan is still a pretty good diversifier on that aspect, in my opinion.

 

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Yes, it's been three years of strong performance for the Japanese market.

 

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I think it's a good reminder of what can happen when

 

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sentiment gets overly negative.

 

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If we go back three years ago the picture on Japan was

 

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extremely out of favour, was seen as to some extent not really

 

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investible, negative interest rate, terrible demographic

 

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outlook, poor governance in a

 

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lot of cases.

 

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You introduce a little bit of change and it's incredible to what extent the

 

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market can react to it, especially when valuations are coming from fairly

 

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depressed levels.

 

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Clearly Japan is not in the first month of

 

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of that. It's been going on for some time, the market has done well.

 

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I think we need to start to be a lot more selective about what do

 

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we own in Japan but keep that

 

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parallel in mind when we think of China today, which has

 

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a lot of the same concerns that Japan that a few years ago.

 

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When you hear too much negativity,

 

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a market being obviously

 

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structurally challenged or obviously non-investible

 

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according to some, I think it's a sign of an

 

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extreme taking place that could be worth starting to

 

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look more closely at. That's certainly what I'm trying to do with our

 

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[crosstalk].

That's the contrarian in you, isn't it?

 

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Hello, investors. We'll be back to the show in just a moment.

 

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else you get your podcasts. Now back to today's show.

 

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Absolutely.

 

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Another point you mentioned was about the consumer, and if there was a letter

 

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attributed to a consumer it would be the letter K.

 

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Can you comment on this K-shaped sector?

 

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The reality is although markets have been relatively good

 

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over the past few years the middle class,

 

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especially the bottom part

 

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of the consumer population, has been under tremendous pressure

 

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from higher interest rates,

 

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the inflation shock that just eroded a lot of purchasing power.

 

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At the same time the consumer has been, especially

 

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in the rest of the world, especially in Europe given the war in Ukraine,

 

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especially in China given what happened to real estate, the consumer has been

 

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extremely nervous, careful, elevated savings rates

 

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in a deleveraging mode for a number of

 

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years in the case of China, for a decade in the

 

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case of Europe. As a result, we sit today at a point where

 

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I think we are starting relatively close to a bottom,

 

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cyclically speaking, on consumer spending, especially on larger ticket

 

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discretionary spending. Think of autos,

 

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large goods.

 

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The consumer has still been spending on services.

 

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Some of that is structural, won't change.

 

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The large goods all the way up to housing, ultimately,

 

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has been under a number of years of relatively depressed

 

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fundamentals.

 

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On the other end the high-end consumer has

 

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been faring relatively well but is not

 

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as willing to spend the additional dollar of

 

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wealth, a lowered propensity to spend.

 

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I think for a lot of the economies, including for upcoming election in

 

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many parts of the world, we need to address that middle class which has

 

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been under pressure. We are starting to see, or we

 

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will start to see, the delayed impact of lower interest rates which

 

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will help. We will see the rebuilding,

 

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maybe slowly, but rebuilding of the real disposable income spending

 

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power from wages that are still growing at a pretty healthy clip.

 

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While prices are high the inflation rate has reduced so now wages

 

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are outpacing general inflation.

 

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If you get that combination of confidence coming back from a delevered

 

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perspective with excess savings, with real disposable income

 

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coming back and lower interest rates you can start to dress a picture which I

 

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think is not fully acknowledged, or certainly not priced into the

 

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market, where we get that discretionary spending coming back.

 

[00:19:45.083]

It will positively impact very different sectors than what

 

[00:19:49.121]

has been working for the past number of years.

 

[00:19:52.391]

Again, given the different weights and different market indices

 

[00:19:57.129]

could benefit some of the European and Asian markets more so than it

 

[00:20:01.300]

would benefit the US market if that was to take place.

 

[00:20:05.204]

It remains a base case for me, hard to tell exactly when it happens, obviously,

 

[00:20:08.407]

the events of this past weekend

 

[00:20:12.411]

with potential energy shock, a shock of confidence that's introduced,

 

[00:20:16.415]

maybe it delays things a little bit but back to what we discussed

 

[00:20:20.752]

starting this segment I think it's important to keep our eyes

 

[00:20:25.023]

on the long or midterm fundamentals and not be

 

[00:20:28.961]

overly distracted and not totally changing our positioning

 

[00:20:33.398]

or playbook based on what happens in the short term.

 

[00:20:36.168]

I do think that scenario remains likely over the next

 

[00:20:40.539]

number of quarters ahead of us.

 

[00:20:42.407]

When you say long term and distracted it makes me think of tariffs.

 

[00:20:46.044]

Tariffs are, or at some point will be, an effect to the consumer.

 

[00:20:50.015]

Could you explain to us ...

 

[00:20:52.150]

companies that you're talking to globally are faced with volatility

 

[00:20:56.388]

when it comes to tariff rates and implementation.

 

[00:20:59.491]

How are they discussing balance sheets and forward

 

[00:21:03.595]

thinking to people like yourself as a portfolio manager when there's so much

 

[00:21:07.466]

uncertainty today?

 

[00:21:09.134]

The reality is for a lot of corporate management teams

 

[00:21:13.038]

that uncertainty around where do we set our production base

 

[00:21:17.876]

is definitely in the forefront since April but has been on their minds

 

[00:21:21.913]

since a number of years.

 

[00:21:23.582]

Actually, a lot has been done, mostly ever since the first

 

[00:21:28.253]

Trump presidency where I think

 

[00:21:32.324]

a lot of companies have been rethinking their supply chains

 

[00:21:36.395]

globally. There's been that notion of China plus one, which is

 

[00:21:40.599]

nothing new, it's been going on for 10 years where let's keep the production

 

[00:21:44.803]

base in China where it makes sense but let's have another centre,

 

[00:21:49.041]

either in Mexico or Eastern Europe or Southeast Asia.

 

[00:21:53.779]

A lot of progress has been made on that to the point where

 

[00:21:57.949]

today the reality is what is still manufactured

 

[00:22:02.688]

outside the US or in China specifically

 

[00:22:07.492]

tends to be made there for very good and very hard to change reasons.

 

[00:22:14.232]

There is still maybe an element especially in higher value

 

[00:22:18.337]

added goods of production that could shift around.

 

[00:22:21.506]

I think the highly strategic sectors like semiconductors,

 

[00:22:27.312]

like batteries for electric vehicles, to name a

 

[00:22:31.450]

few examples, that will probably come back to the US, and

 

[00:22:35.520]

was already coming back to the US.

 

[00:22:39.157]

For a lot of the rest I think the corporate world

 

[00:22:43.228]

is on hold of not knowing where do we shift

 

[00:22:47.165]

that production. The uncertainty despite the tariffs

 

[00:22:51.303]

that was trying to maybe bring clarity of where should you bring your

 

[00:22:55.173]

production is not having that impact at this point.

 

[00:22:59.044]

I think more often than not in our discussions with

 

[00:23:03.081]

companies it is more in a mode of let's wait

 

[00:23:07.252]

and see until we have clarity on stability of

 

[00:23:11.623]

policies around tariff, and in some cases

 

[00:23:16.194]

as long as stability of those policies through different administrations,

 

[00:23:20.966]

so potentially waiting for the next election to see if those stick

 

[00:23:25.203]

or not.

 

[00:23:26.204]

I'd like to leave a message. I think there is

 

[00:23:30.175]

maybe an increasing realization that

 

[00:23:34.112]

tariffs might be needed to protect

 

[00:23:38.483]

an increasing number of industries from what I would describe as

 

[00:23:42.821]

I think an increasingly competent, competitive

 

[00:23:48.226]

Chinese multi-national that has

 

[00:23:52.264]

sort of won their domestic markets and are setting their eyes on taking

 

[00:23:56.701]

share of exports or of local presence in

 

[00:24:01.406]

international markets, and the rest of the world where

 

[00:24:05.744]

that Chinese competition is not welcomed will need

 

[00:24:09.815]

to protect itself. I think as a result I am in the camp that

 

[00:24:14.719]

tariffs are probably here to stay from that

 

[00:24:18.924]

standpoint.

 

[00:24:20.759]

Emerging markets may welcome that increased competition

 

[00:24:25.096]

but I think for most Western markets there

 

[00:24:29.468]

will be that reaction mechanism in place and tariffs is probably

 

[00:24:33.538]

how it will manifest itself.

 

[00:24:36.308]

,I think what's been going on for the past number of quarters is

 

[00:24:41.346]

in a way the symptom of that maybe to

 

[00:24:45.450]

some extent loss of competitiveness of an increasing number of

 

[00:24:49.554]

industries in Europe, in the US, in Japan

 

[00:24:53.525]

relative to fast coming, increasingly better

 

[00:24:57.462]

quality, still cheaper price, in some cases better technology

 

[00:25:01.833]

competitions from other markets.

 

[00:25:04.369]

Patrice, you have a keen eye on today and short term

 

[00:25:08.607]

but you also have a key eye going out a decade.

 

[00:25:11.443]

What are some things that you are thinking of over the next decade and that we

 

[00:25:14.980]

as investors should be thinking of as well?

 

[00:25:16.948]

I think there's a long list and there's always uncertainty around that so I

 

[00:25:20.118]

won't claim to have perfect visibility on it but things that I like to

 

[00:25:24.289]

reflect on when we have discussions with companies, we ask a lot of

 

[00:25:28.226]

questions and we touch on a few of those.

 

[00:25:30.929]

I think are we in a world of a growing Chinese sphere

 

[00:25:34.966]

of influence globally. I think the events of the past

 

[00:25:39.004]

few years is playing along that potential

 

[00:25:42.941]

for China that could emerge as a potential beneficiary of

 

[00:25:47.145]

all that uncertainty that took place, notably around the US for

 

[00:25:51.416]

the past number of quarters.

 

[00:25:55.287]

This is one thing. If they gain that sphere of influence it

 

[00:25:59.224]

opens the door to bring their products, to bring the companies,

 

[00:26:03.662]

and I think it's going to be most visible initially in emerging markets, to

 

[00:26:08.199]

ask the question of what happens to Western companies' profit pools

 

[00:26:12.370]

in those markets when they are suddenly maybe subject to much more intense

 

[00:26:16.007]

competition is one thing to keep in mind.

 

[00:26:17.742]

I think the underinvestment

 

[00:26:21.813]

in the real economy at the

 

[00:26:25.884]

trade-off of investing heavily into the technology

 

[00:26:30.221]

economy, software, et cetera, AI at the moment, has

 

[00:26:35.093]

potentially led to a number of those old economies'

 

[00:26:41.066]

manufacturing capacity, notably in resources, to maybe have

 

[00:26:45.036]

been underinvested over the past decade.

 

[00:26:47.739]

If that comes back, if demand comes back there and we are facing

 

[00:26:52.510]

lack of production and lack of investment for a period of

 

[00:26:56.581]

time I think it could dress a relatively positive commodity

 

[00:27:00.518]

story or commodity CapEx story for, I

 

[00:27:04.556]

don't know if it's a decade but call it for the next five years to come.

 

[00:27:08.593]

There again, a lot of international markets or emerging markets

 

[00:27:12.864]

are really well positioned as big commodity producers, exporters, and

 

[00:27:17.769]

this is another element that we've tried to express in the portfolios.

 

[00:27:21.573]

Lastly, if I can leave one element of maybe not

 

[00:27:26.177]

opportunity but the diversification across sectors but also across

 

[00:27:30.382]

geographies is not only to benefit from what can work but also

 

[00:27:34.686]

to protect ourself from what could no longer be a

 

[00:27:38.823]

positive contributor.

 

[00:27:41.259]

For investors who have some degree of fears

 

[00:27:45.397]

around the sustainability of the CapEx boom we're seeing around artificial

 

[00:27:49.134]

intelligence, semiconductors, data centres, et cetera, obviously

 

[00:27:53.238]

the US market is extremely heavy on these components in

 

[00:27:57.175]

the indices, if we were to fear an

 

[00:28:01.212]

end of that I think the benefit of diversification in

 

[00:28:05.250]

other markets that are much less exposed to that, not only for the

 

[00:28:09.521]

companies and their indices but also the second derivative of

 

[00:28:13.858]

less wealth that is tied to that, which may lead to

 

[00:28:18.129]

a lesser negative wealth effect if that was to unravel,

 

[00:28:23.368]

maybe more capacity for other industries to pick up, for the government to

 

[00:28:27.338]

step in, I think you can dress a picture where parts of

 

[00:28:31.376]

the world certainly have the potential to offer a great

 

[00:28:35.346]

diversifier in the case of an adverse scenario on what has really been leading

 

[00:28:39.317]

the markets for the past number of years.

 

[00:28:41.152]

Excellent. Patrice, the world is in front of you.

 

[00:28:43.588]

It's all opportunity and it's exciting to you and exciting to us.

 

[00:28:46.191]

Thank you for educating us on it today.

 

[00:28:48.359]

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[00:28:50.995]

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