FidelityConnects: Live with Mark Schmehl

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<b>Subtitles are AI Generated</b>

 

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Hello, and welcome to Fidelity Connects.

 

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I'm Pamela Ritchie. The momentum behind AI continues to redefine

 

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how companies operate yet we're seeing a notable shift in

 

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sentiment as investors reassess the pace and the durability around

 

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software and AI applications.

 

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At the same time powerful new use cases keep emerging from

 

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automation that's slashing operating costs to models that are

 

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reshaping how global firms make some of their decisions.

 

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Are the massive infrastructure investments finally nearing some real

 

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returns, and with global adoption accelerating could the next wave

 

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of opportunity come from beyond the US tech giants?

 

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Happy to say that joining us here today to break it all down is portfolio

 

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manager Mark Schmehl.

 

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Mark manages several Fidelity funds including Special Situations,

 

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Global Innovators, and the Canadian Growth Company fund on which he's

 

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marking the 15th year as portfolio manager.

 

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A friendly reminder that our discussion here today features live French,

 

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Cantonese and Mandarin audio interpretation so join us in any of

 

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those languages. Welcome, Mark, great to see you.

 

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How are you?

 

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I'm great, Pamela, how are you?

 

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I'm very well, thanks. It's early on the west coast.

 

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You're on coffee number...?

 

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This is coffee number two.

 

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Yeah, that seems reasonable, seems reasonable.

 

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Great to see you. Thank you for joining us here.

 

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Let's begin with a little bit of the discussion of safe havens

 

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around the world just because that seems to be what's grabbing a lot of

 

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attention. Your fund, in fact, tries, you, try

 

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not to pay attention to a lot of the macro things that go on.

 

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You stay focused, stick to your knitting.

 

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In a strange way I think that that is actually true.

 

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I spent the last two weeks literally talking to everyone in the space

 

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who does AI, AI investing, the AI model

 

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companies, you name it, and it's really independent

 

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to a certain extent to what's going on in the Middle East with oil

 

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and the economy and politics.

 

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It's one of those things which it's so transformative

 

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to everything that we are going to touch that

 

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the companies are going to invest. The biggest, most capitalized

 

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companies in the world are the ones doing the investing and they

 

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really don't care about the oil price going up 10 bucks or 15

 

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bucks. This is a fundamental generational

 

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investment thing so they're just going to invest.

 

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That's kind of fascinating. You are known for, when you need to, selling,

 

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moving on, taking the sell strategy that moves quickly.

 

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Your investments move quickly by the very nature of them.

 

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Have you sold a whole lot or you've been having a lot of turnover of late

 

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Typically in a volatile period I'll be moving the funds around, trying to take

 

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advantage of...

 

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I think it's just that I want to own the things I want to own because they have

 

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the strongest fundamentals and those fundamentals aren't being impacted by

 

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what's going on. Now, if this goes on for a year, well, okay,

 

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maybe we'll have a different discussion but at the moment

 

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I just see zero, like zero impact to anything I'm investing in.

 

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It's fascinating. Bring us up to date a little bit on all the things that get

 

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discussed within AI. We won't be able to hit all of them.

 

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Are the models at this point, they're all being fed, they're

 

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all being made smarter, they're all moving along at rates within companies

 

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to the point where it sounds like some of them are getting to be accretive

 

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in sort of the halo, the high, the heavy asset and so on.

 

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Big companies that need to be transformed.

 

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Just bring us up to date sort of that world, and then there are many other

 

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stepping stones as well.

 

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I think this is one of the disconnects we're currently seeing.

 

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If I look at some of the memory stocks, for example, they

 

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trade at 2, 3 times earnings. These are companies that are

 

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growing really quickly, have great balance sheets, lots of cash, and they're

 

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trading at 2 times earnings. The market is saying, this is it, it's all over.

 

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You shouldn't buy these things, it's the peak, it's the peak, it's the peak.

 

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These companies cannot go out and invest in capacity to grow their

 

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business. The only way to convince the market that it's not

 

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the peak is the model companies have to show what their business is doing.

 

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and convince the market that this is not a peak, because so many investors

 

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are trained to say, no, this is the peak, it can never get any better than

 

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this. It's like wait, no, it's not.

 

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You've spoken about how well you can

 

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see what's going on back there but at the same time what portion does

 

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it make of the fund itself?

 

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It's funny, the two Canadian funds it's about 6.5%, almost 7%

 

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of the portfolio now.

 

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The same sort of exposure in the US, the closed-end

 

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funds, are getting four times the NAV, which is crazy.

 

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Americans are chasing these things like you wouldn't believe.

 

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I think Anthropic is about 2% of all my funds right now.

 

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SpaceX is similar. I think the prospects

 

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for both companies still look fantastic, especially

 

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for the AI companies. Oh, one of the things the AI companies

 

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... you can use your model to do is pick your bracket.

 

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I don't know if you read that today, it was in the Wall Street Journal.

 

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No, I didn't.

 

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Claude apparently has an excellent chance to win the Wall Street Journal

 

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March Madness Pool.

 

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Yes, I did see that, actually.

 

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That's one of the many things that you could do, one of the many developments.

 

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Well, it's super interesting.

 

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Things are moving very, very quickly and the things and the ways that we can

 

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incorporate it into our lives but it's really the companies themselves.

 

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Do you get to the point where you're ... you're investing in companies at 2

 

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times earnings, why would you go anywhere else?

 

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I guess the question is ...

 

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because it's cheap. It's like a value play.

 

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Other companies that are putting it to work, that's

 

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happening? The accretive piece, the productivity piece, I mean, this seems to

 

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be ... what do you see?

 

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Absolutely. Companies are definitely... especially in coding.

 

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I mean, if you were a software engineer you don't code anymore, like, you just

 

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don't. You use Claude Code or you use Cursor or you use Codex.

 

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It just does all the work for you, all the grunt work that you don't

 

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want to do. Folks are now experimenting with the agents that are showing up on

 

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our desktops like Claude Cowork.

 

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We've been messing around with Claude for Excel.

 

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We are all going to use this stuff and we're going to use it aggressively.

 

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It's very funny to watch as it rolls out.

 

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The first phase is, this doesn't work.

 

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The second phase is, I hate this, this is going to take my job.

 

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The third phase is, holy cow, I can do a lot of stuff.

 

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I guess the next phase after that is companies are like, great, you can do a

 

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lot of stuff, let's do more.

 

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We're seeing this journey from

 

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the executive suite which is we're going to use AI to improve efficiency

 

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and then we're going to fire people, and then they go, wait, we're not actually

 

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going to fire people, we're just going to do more stuff with it.

 

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I think that the last part of that journey will be now we can grow faster.

 

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That's a big part of the thesis I have for the whole economy

 

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barring what's going on in the Middle East, which I can't quite figure out why

 

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we're doing this, but I think that the economy will

 

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grow faster with AI as an input because labour

 

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has always been the big bottleneck, right?

 

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There's only so much you can do.

 

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I think there's still only so much you can do with the big physical things

 

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but with respect to office work and intelligent work or whatever you want to

 

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call it we're removing a bottleneck which is human productivity, and

 

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we are going to be able to grow faster.

 

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I think the economy's going to actually grow faster and have a higher speed

 

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limit for a period of time as we start implementing AI throughout

 

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our ecosystem of apps and processes.

 

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Can it save us from sort of the short term ...

 

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higher interest rates are being discussed and certainly priced in--

 

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Hundred per cent.

 

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--and the entire inflation story? Can it power us through the other side? No Inflation.

 

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I think that folks are like, oh, yeah, we're going to have inflation because

 

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oil is up, and that has historically been true, but we have this productivity

 

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boom coming at us which no one has seen before and

 

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it is going to make every office worker 5 to 10 times

 

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more productive. The numbers you see from the software engineers, they've got

 

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like 6 or 7, or in some cases 17 agents running.

 

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It's all being limited by compute power not by their imagination.

 

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We are going to be so productive.

 

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Oil's going up, yes. Labour is the biggest part of any inflationary

 

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cycle every single time.

 

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Labour prices are not going to go up, they're just not, because we're going to

 

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have AI in here substituting for labour and there's just no way.

 

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I do believe in higher structural energy as a result of what's going on in the

 

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Middle East and that may or may not be good for energy companies.

 

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I think that the overall economy is just going to grow faster with

 

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lower inflation for a long time.

 

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That's my bet.

 

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That's an amazing bet and it's incredible.

 

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You're smarter than most of us so we'll see how that goes.

 

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It sounds right. How, ultimately, on the energy compute side

 

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of things, I mean, if interest rates don't go up then it's,

 

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in theory, easier for any company to continue borrowing to build that

 

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out and to get there along the track that they think will be tricky and bumpy

 

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and maybe take a while, but it's not going to be suddenly upended by higher

 

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interest rates. Is that right?

 

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I don't think so, no. I really do believe ...

 

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and also it's interesting, the energy thing.

 

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Energy is an engineering problem.

 

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When you're building a data centre you are solving for your

 

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energy prices and what you're trying to get is more tokens per unit of energy.

 

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As you implement new technology, whether it's CPO,

 

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whether it is the latest Nvidia machine, whether it's better networking,

 

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everything is a result of token per watt.

 

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That token per watt curve continues to come down.

 

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I don't think investing in

 

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utilities, electricity, I mean, while we need it

 

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I think we're going to continue to solve for it. Like your fridge, your fridge

 

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is so much more energy efficient now than it was 50 years ago.

 

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That's going to be true for every data centre built.

 

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I don't think energy's going to be as big a rate limiter as I believe the

 

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market currently expects, but I could be wrong on that, because every part

 

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of the engineering compute cycle is designed to reduce that energy component.

 

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Okay, that's fascinating.

 

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An area of your portfolio has always, I think it's usually, or usually

 

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included gold. That's been kind of a fascinating thing to watch

 

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over the course of the last year and very Canadian.

 

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It's powered the TSX, certainly.

 

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Is that something that you can continue ...

 

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I mean, is there a way that you hedge within the portfolio?

 

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I mean, that's not always ... you're not really a balanced fund but at any rate

 

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you do use that sometimes.

 

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It's very difficult. I run all these different products and mandates.

 

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In Canada gold is a huge chunk so I have to own it.

 

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I have always owned some in my innovation portfolios

 

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as well as a hedge, it sort of trades inversely

 

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to NASDAQ, except now it doesn't.

 

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No, it doesn't. It's a risk [crosstalk].

 

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With respect to Canada, I still own a lot of gold.

 

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I don't think that the rationale for owning gold has changed in any way.

 

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Government deficits worldwide.

 

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There's so many reasons to own it but I think that it

 

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has now started to trade with technology, so its

 

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old reason to own it

 

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as a diversification tool is gone.

 

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It's less compelling to me than it was and as a result I own less of

 

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it than I used to. But I will always probably own a little bit of gold because

 

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it's just a very interesting asset class for me.

 

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Back in November were sort of the first rumbles that the pieces of the stock

 

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market that would be disrupted, you know, software and so on and it went

 

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through to insurance and every other industry that I'm sure you saw coming

 

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six years ago. Within that how much is overdone?

 

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This is a question. It's an interesting moment because markets are getting

 

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sideswiped for lots of different reasons.

 

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A month ago we were talking about AI disruption in everything.

 

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Is it an interesting opportunity to go and buy up software?

 

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Take us through software.

 

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I mean, I don't want to be a doom ...

 

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if you're in the software space I'm not trying to be a doom and gloom guy

 

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but it is being transformed and the market doesn't know what the business

 

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models look like and we can sort of see how the software

 

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business model is changing.

 

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It's going from labour was the big constraint because knowing how to

 

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code was really, really difficult and you had to have all these smart people to

 

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do it, we just got rid of that.

 

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You're going to replace all of that with compute.

 

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You're basically going to pay for tokens and you're going

 

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to use that to do your coding.

 

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The business model is no longer the same. It used to be really high margins,

 

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high terminal value, it is now moving to a low margin commodity business

 

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with bad terminal values.

 

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Commodity business, so interesting.

 

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Well, yeah, it's a commodity business.

 

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I have a few software analysts internally, they've been covering this space for

 

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15 years, they're all like, it's cheap, it's cheap, it's cheap.

 

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I say, no, no, it's not the same, it's a different business.

 

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Certain companies like Canadian Shopify is not really a software business,

 

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it's an e-commerce platform and they get paid by payments so it's more

 

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of a payments company.

 

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It's sort of being lumped in with software.

 

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There's some names within the software space that aren't really software but in

 

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general that whole sector is just not worth investing in,

 

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at least not at this time.

 

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One of the other pieces, and I think this is where you are invested, in sort of

 

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pieces of the infrastructure buildout.

 

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Then, of course, you get these questions of are we overbuilding, which

 

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is part of the peak discussion in AI and so on.

 

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Could we possibly overbuild? We go back to the fibre optic cables that

 

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were laid and too many and too expensive and still paying it off and so on, is

 

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the analogy true?

 

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It's not a good analogy because we

 

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built a lot of that fibre and we didn't have a use for it.

 

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It's sort of like Bitcoin. Hey, here's this technology but we don't know what

 

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to do with it.

 

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With this compute that we're using for AI, these companies

 

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could grow so much faster if they had more compute because the use is so

 

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powerful and it is being used for so many different things.

 

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Every time you install a box it's sold, and it's sold at a profit.

 

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This is not the same thing. We should be thinking about token production like

 

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oil. You can never have enough energy.

 

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You can never have enough intelligence.

 

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We will never have enough.

 

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The question will be, ultimately, what do we pay for it, what kind of return do

 

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we get on it, but we're so early in this cy-, we're still early that

 

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we don't know what that is.

 

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You just know it's going to continue because we need more intelligence more

 

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quickly. The fact that the model companies are growing at the speeds of

 

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which they're growing at such scale.

 

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And governments, too. Governments are using this, everyone is using this to do

 

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what they need to do, whether it's a charity, all levels.

 

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Take us into a sector that I know that you've invested in and

 

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liked over the years. Healthcare is something that is being disrupted.

 

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AI is very good for healthcare for lots of research reasons, you can see why,

 

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and within hospital situations,

 

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personnel, so on. Just take us through any sector that is not really being

 

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affected by this, or choose one that you'd like to tell us about because I'm

 

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dying to hear how you see it being deployed in a particular sector well.

 

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We are not seeing the outcomes yet that we expect.

 

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We're hearing a lot about we're using it here.

 

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Procter & Gamble used it to launch a product, they

 

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launched it in, like, I think it was four weeks instead of six months, the

 

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time to market for a new product. They used the AI to build the chemistry for

 

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the new shampoo and design the product labelling.

 

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That's an example where you just shorten the time to market

 

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using your AI.

 

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We've talked to lots of drug companies who are using it in their research, it's

 

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letting them do more research more quickly and screen more things.

 

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Is it creating new medicines?

 

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It probably will but we haven't seen it yet, it's a long cycle.

 

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Governments are using this to do reviews faster.

 

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Everything speeds up, I think is the answer.

 

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Everything speeds up and things happen faster, products get

 

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better faster, as a result your competition

 

[00:17:12.297]

gets better faster so you need to race to continue to do

 

[00:17:16.335]

all that. It's impacting everything but it's

 

[00:17:20.406]

hard to point to, oh, this is this magic AI moment.

 

[00:17:24.643]

There are sectors of the market where I don't think that AI is going to change

 

[00:17:27.346]

a whole lot. Those are those big, dirty physical sectors like,

 

[00:17:31.683]

you know, energy is not going to ...

 

[00:17:33.385]

it's going to change on the margin a little bit. Mining, transportation,

 

[00:17:37.389]

you're still going to need to ship stuff around. A railroad's not going to

 

[00:17:40.092]

really change from AI, right? You're still going to ship grain and logs

 

[00:17:44.463]

and it's all going to go on a train.

 

[00:17:46.532]

There are many parts of the market where AI won't really

 

[00:17:50.736]

disrupt it. In some respects I think those parts

 

[00:17:54.706]

of market may turn out to be the new bottlenecks because AI

 

[00:17:58.911]

efficiency will not improve the speed at which a railroad drives

 

[00:18:02.915]

around.

 

[00:18:04.817]

If my theory on a faster economy because labour productivity goes up,

 

[00:18:09.888]

those physical bottlenecks that you're going to hit in those old,

 

[00:18:14.193]

dirty industries that you can't really change that fast.

 

[00:18:17.863]

That's sort of what I'm thinking about longer term, those might be the new

 

[00:18:21.900]

bottlenecks that we want to invest in.

 

[00:18:24.002]

That's probably a three or four year out problem but something I'm thinking

 

[00:18:27.806]

about.

 

[00:18:28.707]

So X company wanting to launch a product can do that a whole lot faster

 

[00:18:33.145]

but getting space on the rail car to get it across the country or continent

 

[00:18:37.316]

will still take the time.

 

[00:18:38.450]

Doesn't change.

 

[00:18:40.786]

In fact, as you say, new bottlenecks ultimately.

 

[00:18:45.524]

Amazon has built this huge physical network

 

[00:18:49.128]

of trucks, shipping, and warehouses,

 

[00:18:53.298]

and old physical stuff.

 

[00:18:55.033]

Hard to fix, hard to make better.

 

[00:18:56.768]

AI doesn't really ... I mean, it helps a little bit on the margin but you still

 

[00:19:00.239]

need the big warehouse and all the trucks.

 

[00:19:03.509]

On the other side, they also sell all the compute.

 

[00:19:05.711]

They have this AWS and they're selling all the compute capacity, they're

 

[00:19:10.115]

participating in the AI cycle.

 

[00:19:12.151]

they have this big, sort of dirty retail business, this

 

[00:19:16.121]

is going to not change much, and then they have this AI AWS business

 

[00:19:20.459]

which is going to start growing faster.

 

[00:19:23.495]

These are the types of stocks I'm trying to find and it looks compelling to me.

 

[00:19:27.332]

Whether that works or not, I don't know, but it really looks compelling as a

 

[00:19:30.335]

mix of businesses.

 

[00:19:32.571]

That's fascinating, as a mix of businesses. The next question was a bit about

 

[00:19:36.375]

hyperscalers but you can take it to other companies as well that are investing

 

[00:19:40.646]

and making as part of their business heavy, dirty, whether it's

 

[00:19:44.616]

nuclear, whatever it is, they're trying to incorporate power into their

 

[00:19:48.720]

actual umbrella of their company itself.

 

[00:19:50.856]

Are they still tech companies or are they more mixed use?

 

[00:19:54.426]

What is the future of that? It sounds like an interesting place to watch, and

 

[00:19:58.730]

to have you watch it for us, but does it mean something for investors that the

 

[00:20:02.434]

companies they think are in certain sectors are now almost multi-sector?

 

[00:20:08.173]

I think each hyperscaler is unique in its own way.

 

[00:20:11.376]

I like Amazon because of the retail and whatever.

 

[00:20:14.479]

but their other business, their hyperscaler business, will be fine.

 

[00:20:18.417]

Google, they have a hyperscaler but Google is its own special unique animal

 

[00:20:22.421]

that we could talk about for four hours.

 

[00:20:26.458]

Each hyperscaler is a little bit different and needs to be thought about

 

[00:20:30.429]

differently. I think it's interesting that in many ways they trade as a unit

 

[00:20:34.233]

but they're actually very different stocks with different asset mixes.

 

[00:20:38.403]

Is it the end of the Mag-7 then because it needs to be?

 

[00:20:43.075]

I don't think so but I think you need to stock pick your

 

[00:20:47.079]

way through it. I don't think you can just own Mag-7.

 

[00:20:51.350]

The S&P 500 just owns the Mag- 7.

 

[00:20:54.486]

I think we should be able to beat the S&P by owning the right ones of this.

 

[00:20:59.591]

I don't know if that continues or not but I'm just saying you can definitely

 

[00:21:03.362]

add alpha by picking your way through the Mag-7, which I don't think was

 

[00:21:07.599]

clear even a couple of years ago.

 

[00:21:10.168]

No, that's really interesting.

 

[00:21:12.437]

There are many points to point to but if you were to talk about sort of a new

 

[00:21:16.541]

pinnacle, it's when the names that you've mentioned, the OpenAI,

 

[00:21:20.746]

SpaceX, and so on, when they go public.

 

[00:21:23.148]

Can you just give us a little bit of a runway view on that?

 

[00:21:25.884]

That will obviously be an incredible moment when that happens.

 

[00:21:29.755]

We don't know when it'll be.

 

[00:21:32.024]

I hope it's this year.

 

[00:21:34.159]

SpaceX is its own unique animal and not really related to AI.

 

[00:21:36.995]

It's part of the whole Elon complex.

 

[00:21:39.631]

Again, that's another 10-hour discussion.

 

[00:21:42.601]

I hope that happens this year because they need more compute capacity and the

 

[00:21:46.571]

only way to finance it is to get this market to pay attention to the fact that

 

[00:21:50.142]

it's not a bubble, that it's actually needed.

 

[00:21:53.478]

You literally need every single token to do all the work that

 

[00:21:57.516]

we need to do, it's just astonishing how little

 

[00:22:01.586]

the market cares. We need to change that narrative.

 

[00:22:06.058]

I'll end with macro just briefly, though, do you think on the other side of

 

[00:22:09.728]

whatever it is we're in the midst of right now there's actually an acceleration

 

[00:22:14.232]

towards some of these themes?

 

[00:22:16.101]

As you say, maybe wiping a bit of the doubt away because this is where the

 

[00:22:19.938]

market needs to focus. Is there, again, maybe not a seminal moment but almost

 

[00:22:24.142]

a clearing of fog of war and what is

 

[00:22:28.280]

actually the structural everything.

 

[00:22:31.249]

I think so. I think we need to get there.

 

[00:22:34.419]

We need to resolve whatever is going on in the Middle East right now, however

 

[00:22:37.322]

that's going to get resolved. The most important thing is, and I do

 

[00:22:41.593]

tend to believe it, we probably are at artificial general intelligence.

 

[00:22:47.299]

We probably will hit it this year or next.

 

[00:22:49.901]

We will create a sentient AI.

 

[00:22:53.839]

I think you're going to see  and so does everybody in the industry.

 

[00:22:58.410]

That is going to change the world in fundamental ways that are way more

 

[00:23:01.613]

important than whether or not we are bombing Iran.

 

[00:23:05.317]

I think folks need to start to think about it and what does that mean to the

 

[00:23:09.321]

market, what does it mean to their professional careers?

 

[00:23:13.358]

I think it's going to be a big, big moment and we need to starting thinking

 

[00:23:15.961]

about it. I'm thinking about now. I always tell people I live in the future,

 

[00:23:18.830]

I'm living in that world where we have this sentient AI

 

[00:23:22.801]

and it's a little bit strange.

 

[00:23:26.071]

That'd be nice to live in the future. Today's not so great anyway in a lot of

 

[00:23:29.441]

different ways.

 

[00:23:29.641]

No, I know, right? It's really tough out there.

 

[00:23:31.977]

It's really tough to read the news these days.

 

[00:23:34.413]

Anyway, I think that's what we're going to see.

 

[00:23:36.214]

Okay, this may dovetail with this, final question coming in from one

 

[00:23:40.318]

of the advisors, how should advisors communicate market volatility declines

 

[00:23:44.523]

in a way that builds confidence rather than fear?

 

[00:23:46.958]

I actually think you've pointed to a number of those but just to sort of put it

 

[00:23:50.128]

into a final thought.

 

[00:23:53.432]

One of the things, experience helps a lot.

 

[00:23:56.101]

When I was a junior portfolio manager I kind of freaked out a lot faster.

 

[00:24:00.272]

Having been through the wars many times now I have a lot of scars and I really

 

[00:24:04.109]

know what to do.

 

[00:24:05.977]

The key is to sort of react quickly and

 

[00:24:10.148]

then underreact and think about longer term.

 

[00:24:14.019]

Where do you really want to be in terms of your portfolio and

 

[00:24:18.089]

your investing, and try and just sail

 

[00:24:22.360]

through the storm as best you can making as few mistakes

 

[00:24:26.498]

as possible.

 

[00:24:28.166]

That's really what I try and do every time, is cut down the number of

 

[00:24:32.304]

mistakes that I make as I go through this mess.

 

[00:24:34.539]

It's inspiring to speak with you, Mark Schmehl.

 

[00:24:36.541]

Thank you for joining us here today.

 

[00:24:38.276]

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