FidelityNow: Ilan Kolet: Who wins when AI works?

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Hi, I'm Ilan Kolet, Institutional Portfolio Manager and member

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of the Global Asset Allocation team here at Fidelity.

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The artificial intelligence trade has undeniably dominated equity markets

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through the first half of this year.

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Even with market volatility driven by the conflict in Iran, global equities

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have shown remarkable strength, returning 11% in the first half of

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the year, with the technology sector driving the majority of those gains.

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19 of the top 20 individual contributors to the MSCI

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All Country World Index's return were technology companies.

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Our multi-asset class funds are navigating this AI-driven environment with

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a two-part strategy. First, we're following bottom-up signals

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from our research analysts.

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Because their research indicates that the market continues to underestimate

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the true earnings power of these tech leaders, we maintain a tactical

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overweight to these equities.

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Second, we are keeping capital with active managers who are best

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positioned to identify individual winners and avoid the losers,

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while using futures to manage our overall market exposure.

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But as long-term investors, we also have to look at the potential secular

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macroeconomic implications of AI.

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That stream of research is focused on how AI will impact the structural

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drivers of long-term returns, namely, economic growth.

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Productivity, inflation, and interest rates.

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Historically, major technological breakthroughs drive productivity.

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Based on past innovations, our researchers estimate that AI could

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boost U.S. Productivity by nearly 1% per year.

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Now on paper, that sounds like a massive jump.

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However, it may not be enough to justify the aggressive earnings

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growth currently reflected in high valuations.

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The U.S. Equity market is pricing in roughly 10% real earnings growth over

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the next few years.

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Yet, a 1% productivity boost only nudges sustainable real GDP

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growth from about 2% to 3%.

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For the market's expectations to be correct, corporate profits

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will have to take an unprecedented share of income.

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Currently, corporate profits as a share of GDP in the U.S.

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Stand at 13% which is already the highest level

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in 90 years.

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To match market expectations, that number would need to climb into the high

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teens. Historically, the slip between capital and labour

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has remained fairly stable.

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Past innovations like railroads, electricity, and personal computers ultimately

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complemented workers, making them more productive and eventually

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leading to full employment.

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But this time, there's a possibility AI may actually be

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different.

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It's possible that instead of complementing the workforce, AI has the

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potential to act as a replacement technology.

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If AI truly is a replacement of technology, corporate profits as

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a share of GDP climbing to 20%, 40% or even higher is

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no longer an unrealistic fantasy in our view.

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In that scenario, current equity valuations aren't aggressive,

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they may actually be too conservative.

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We cannot know for certain which path the economy will take, but we do know

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that the extent to which AI replaces labour rather than complements

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it will be a very important driver of long-term capital

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market returns and far more important than things like quarterly chip orders.

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We're continuously studying these labour and profit margin dynamics to help

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guide our funds.

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In the meantime, we'll continue to rely on our bottom-up research to

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capture the opportunities for our clients.

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If you want to learn more about our views around AI, please check out our

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latest paper called Who Wins When AI Works, available now

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on Fidelity.ca.

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Thanks for watching.