The Upside: Themes driving global markets in July 2025

[00:00:20] Jordan Chevalier: Hello, and welcome to the Upside. I'm Jordan Chevalier. Today we're joined by Fidelity Director of Quantitative Market Strategy, Denise Chisholm. Denise, thank you very much for joining us today.

[00:00:31] Denise Chisholm: Hey, it's great to be here, Jordan.

[00:00:33] Jordan Chevalier: For today's show we've gathered some questions from the audience and it's no surprise the top question coming in, it is all about tariffs. Looking at tariff research do you have any thoughts on what the data says historically, maybe some predictions for where things could go in this atmosphere?

[00:00:54] Denise Chisholm: I think this is a topic that's going to be with us for quite some time so it is important to study history. Now, look, I get a lot of questions about tariffs given that we haven't seen tariffs at this level since, basically, the 1930s. How can you think of that historically? I'll make two points, and I think that they're both important and they're related. One is that tariffs act like a tax, and that's important to consider because we have a lot of history with taxes that we can look at. Two is that, interestingly enough, when you look at tariffs in history they're not really inflationary. I mean, they might be temporarily inflationary but they tend not to have persistence in terms of higher prices.

[00:01:32] Let's break it down. First, tariffs as a tax, again, you have to make some assumptions and some guesses because you don't know who that tax lands on. It could land on the farm producer, some that could get absorbed through currency, some that can get absorbed, obviously, by the U.S. consumer in higher prices, but to the extent that the U.S. consumer doesn't want to pay higher prices then it gets absorbed into corporate profit margins. If we make some onerous predictions and say, well, maybe tariffs settle off at 15% to 20% of imports, it's about $3.2 trillion, and let's make some onerous assumptions and say half of that lands on the U.S. consumer, half of it lands on U.S. producers or U.S. corporations, and how much of a headwind is that, and is that headwind a tipping point that we've seen historically. That math ends up being around a $250 billion headwind for the U.S. consumer. Again, we're making some assumptions. That's about a 1% headwind.

[00:02:33] Now, interestingly enough, we have seen 1% headwinds historically in higher taxes in 1993, in 1968, and in 1982. None were recessionary, which isn't to say that that's a piece of cake and not a problem for the U.S. consumer, but it is to say that historical data is waving a big flag for you as investors, wait a minute, there might be offsets. The offset might come this time through lower energy prices that actually offsets those higher prices somewhere else. That leads me to point number two. When you study tariffs historically none of the instances, again, we don't have a whole lot of instances, but none of the instances end up with persistently higher inflation. It's partly because of that tax implication. It takes away purchasing power so if you have to spend your money on other items where prices are going up you have less money to spend elsewhere in the chain, where your marginal propensity to consume might actually decline and therefore other corporations' pricing power might decline.

[00:03:41] There isn't a lot of persistence to the inflationary impulse that you see historically. Most important, the last point, as this is getting dragged out, time is an important element. What you're seeing is goods have been in deflation so the longer we stretch out the implications of tariff, and the longer that it takes to get passed through the less of an inflation impulse it will likely be. As much as this is going to be with us for a while I think when you study history it might not be the tipping point from a recessionary shock, and it might not lead to persistently higher inflation either.

[00:04:20] Jordan Chevalier: Especially if things continue to sort of ... these deadlines continue to almost renew, right? They're kicked down in these 30 or 60-day periods, then maybe that's less and less of a tipping point as that trend continues.

[00:04:36] Denise Chisholm: That's right. There could be negotiations within any two weeks. The deadline keeps getting delayed. The longer you stretch it out the more income grows while it's being stretched out the less likely it is to be a shock to income.

[00:04:49] Jordan Chevalier: That's great, that's a great answer. Moving now to question two, a  question about your latest Q3 market research paper, it's available on your LinkedIn and Fidelity website, but it's about this renewed confidence in the U.S. Can you speak a little bit to that?

[00:05:08] Denise Chisholm: The interesting part when you look from a data perspective, when we had the initial Liberation Day shock what you saw was a decline in earnings estimates. Remember, earnings is how much investors think that companies are going to make over the course of the next year, and it basically, almost in an instant, in a month, went down to recessionary levels. Now, if that sounds bad as an investor, meaning, well, I guess corporations aren't going to make their numbers, they're going to miss earnings estimates, what  you see historically in the data is usually by the time that happens most of that has already been priced in. Remember, that peak-to-trough decline that we saw prior to Liberation Day, or during Liberation Day, was a 20% decline almost. I call it bear adjacent. Usually at that point when stocks correct that much, which only happens once in every four to five years, at that point if you just held your nose, closed your eyes as an investor and woke up a year later, 80% of the time you'd be higher one year later by an average of 20%.

[00:06:07] There is a really strong sort of historical evidence that says as much as we are worried about what this might mean to profits the market is a discounting mechanism, and that's what makes it really hard as investors because you're not going to get a ton of good news but you might get news that is less bad than the market has already discounted. A lot of the math I go through when you look about, well, what happens after stocks decline 20%, sometimes it's too late to be bearish if you have a one-year time horizon, and what happens when earnings numbers have come down this much, usually it means it's too late to be bearish and stocks are actually up over the next year. I do really see a positive risk-reward coming out of what I'd like to call a valuation reset around Liberation Day that I do think leads to a positive valuation reset that leads to a better risk-reward in the S&P 500 and, likely, a better situation for U.S. leadership going forward.

[00:07:10] Jordan Chevalier: That's great. Is there a timeline as an investor for those sorts of outcomes or is it just something that you have to monitor as things continue to run through this process?

[00:07:21] Denise Chisholm: You always have to monitor as things continue. The way sort of my discipline has evolved is that I'm looking at every piece on a one-year time horizon. If you're looking to, Denise, what's going to happen over the next three to six months, I'm probably not the person that's going to answer that. Usually when there's volatility I want to be able to look through that volatility and see if there's opportunity. The one thing that I always watch, and I think that was very different this time versus what we saw in 2022, or even in the banking crisis of 2023, was that the credit markets were actually quite sort of sanguine, meaning credit spreads were much more narrow. That's a fancy mathematical way of saying the credit market wasn't very worried about companies going bankrupt.

[00:08:08] That's an important market to watch because we always say, as equity investors, the credit market is usually the smarter market. When there's a whole lot of fear in the equity markets and stocks go down a lot, and if there's not that subsequent fear in credit markets, that's usually a good risk-reward. It's almost like the math, if you've ever heard the term climbing the wall of worry, that's usually what happens when the credit market says, yeah, there's not really anything to see here but the equity market panics. That's usually a really good setup. As much as we want to monitor things going forward that's one of the key things that I monitor, where credit spreads are, what investors in the credit market are pricing risk at, and where is that relative to the equity market. Right now the credit markets is saying there's a lot to worry about, which leads to a positive risk-reward for equity investors.

[00:09:03] Jordan Chevalier: Great, so keeping an eye on that credit market is key. Fascinating. Moving into sectors, a question here about which sectors you're favouring, and I've heard it coined sort of a hybrid situation right now where you're getting these rallies but we're also getting periods where things are sloping down. Can you talk a little bit about that environment and then sectors that you're sort of favouring through those market conditions.

[00:09:30] Denise Chisholm: You bring up a great point in terms of volatility. I always say volatility is, I'm going to get a little quanty here for a second because I like the data, is an asymmetrical signal, meaning that when you see an elevated VIX or there's high levels of uncertainty that's actually a buy signal, historically. Again, it goes back to the fact that by the time you've already seen it in the data it's usually priced into the market. That return to what investors call complacency isn't usually a bad thing either, meaning when situations are certain or when volatility indicators are low that isn't an opportunity to sell stocks, historically. We've been sort of gyrating between this very volatile or high VIX or high uncertainty regime to a very, quote, complacent environment. When you look at this historically those are the two best situations for equities, historically. You want that quick reset.

[00:10:26] That's, I think, what we're living through, which is another way to say in terms of leadership, what you saw in the, I'm going to call it bear adjacent market we saw in April, was a really strong reset in what has been sector leadership in U.S. technology. At that low technology stocks underperformed the S&P 500 by over a thousand basis points. At that low they were back to median valuation levels. We haven't seen anything like that ... again, we have the data going back to the '60s, we haven't seen anything like that in the better part of four or five years. Now, look, the stocks have re-rated but not as much as you would think, because although technology stocks are hitting all-time highs earnings growth has continued to grow faster than the rest of the market. That means that the stocks aren't nearly as valued as heavily as they were just three months ago, and that, when you look at the historical data, that's the sweet spot for the setup.

[00:11:29] Again, in my data that sort of kept me, I would say, on the back foot for technology over the course of the last couple years because when you do hang out in the top two quintiles of valuation it's not that it has to be bad for the stocks, it's just that you get this asymmetrical situation where the fundamentals have to go your way. If the fundamentals don't go your way, meaning the stocks don't improve earnings or operating margins, then there's more downside historically. Based on this big valuation reset you all of a sudden have much better probabilities even if margins don't expand, even if profitability isn't what investors think it would, which is, again, sort of a mathematical way of saying technology has this really long, rich history of pricing in bad news before it happens. This is what I'm seeing in the data. This is what makes me optimistic for the U.S. overall because technology has been such a strong leadership sector. You're seeing this in semiconductors and you're seeing this in software and you're seeing this overall in the technology sector.

[00:12:33] Jordan Chevalier: Absolutely. Staying with sectors, are there certain sectors that in that environment you think might face some potential headwinds as well?

[00:12:42] Denise Chisholm: Let's talk about energy. That is a sector that everybody, certainly, the portfolio managers I talk to, always there's definitely sort of an impetus to own energy stocks, especially when there's geopolitical risk. The interesting part, and I wrote a piece about this on my LinkedIn, is that when you look at what's been going on the last, let's call it 10 to 15 years, with U.S. shale production the volatility of oil has changed, meaning that it's less likely, it's half the incidence, to have a top quartile price spike than it has been historically because U.S. supply has changed the game. This is important because as much as, yes, shale production will likely slow because prices are lower that's important to have happen, although as much as inventories might go down that doesn't always support prices. The market is often too smart for that. Even though there's less inventories, if the market knows that excess supply is going to come back on once prices go back up, that usually sets a cap.

[00:13:50] That's a headwind for energy stocks, not to mention the fact that 2022 was literally, in the data we have going back to the '60s, the best fundamental situation, high operating margins, high return on equity, that energy investors have ever seen in the data. We're still renormalizing from that. When you're renormalizing that is in and of itself a headwind. You have these two historical changes of excess supply weighing on sort of price and then excess, or over normalized, fundamentals weighing on that as well. I think the risk-reward for energy stocks is still negative.

[00:14:30] Jordan Chevalier: One more question here, it's about tax cuts in the U.S. Is there data there that you're looking at, and what sort of a timeline might investors be looking at for sort of the potential impact of these cuts to make themselves known?

[00:14:44] Denise Chisholm: The biggest impact when I study the data is on the corporate side. I think that that is the most influential as it relates to the market. We can argue about other areas but that's the area that I'm watching. As much as it's not a change in the statutory rate, it is as much of a drop in the effective rate of 700 basis points or 7%. This is really influential when you study history. Now,  when you look at the effective rate sometimes that's caught up in recessions but if you look at either statutory changes where the corporate tax rate goes down or effective tax rates ex sessions, what you'll find is usually that makes earnings growth more durable. You don't just get a boost during that year, you get a boost during the following year. The really interesting part to history is you don't just get an earnings boost, you actually get valuation boost as well.

[00:15:39] Now, if you're one of those investors that are concerned that, well, stocks are already priced for perfection, it's really interesting, when you look at the data and you say, well, let's just take the starting point as really expensive stocks, top quartile of their history going back to the 60s, does that lead to a different outcome? The answer is no. What it shows you is that if earnings growth is visible and durable the market will price it in before it happens. A fancy way to think about that is valuation in any one year isn't always predictive of future equity market returns because from a philosophical perspective what you're really trying to figure out is in a normalized environment, we call that mid-cycle earnings, what are earnings going to be, and then what should you price them on that? It could be a situation where earnings growth, or profitability, is just more durable to that mid-cycle than investors think. Because that durability is there, stocks actually are cheaper than you think as well. That's how I think corporate tax reform, more than tax cuts that we saw in the effective rate, could bolster stocks over the next year or two.

[00:16:49] Jordan Chevalier: Oh, that's great. That's a fascinating outlook. One final thing here, we were on your LinkedIn looking at the upcoming resources and we saw this cute new member of the Chisholm family.

[00:17:02] Denise Chisholm: Distractor-in-chief.

[00:17:04] Jordan Chevalier: Distracter-in-chief, I love that. This is Penny, Denise. How has it been going with Penny?

[00:17:09] Denise Chisholm: That is Penny. Yes, she's 13 weeks old today, she's adorable. She's also a handful but she is sleeping through the night now so that's a good thing. So far she hasn't destroyed any of my shoes or socks which I've heard Labradors are notorious for doing.

[00:17:27] Jordan Chevalier: Well, that's great, that's excellent news. Thanks again for sitting down with us here on the Upside. We'll see you next time.

[00:17:33] Denise Chisholm: Yeah, it's great to be here.

[00:17:34] Jordan Chevalier: Thanks, Denise, and thank you all for watching. For more please head to fidelity.ca in the investor education section or follow Fidelity Canada on YouTube, LinkedIn and Instagram. I'm Jordan Chevalier, see you next time on the Upside.