En avant : Analyse sectorielle de Denise Chisholm - 24 avril, 2025

[00:00:22] Pamela Ritchie: Hello, and welcome to The Upside. I'm Pamela Ritchie. For the first time in over five years tech valuations have come down and really come down. Prices have cooled but earnings expectations remain steady and that disconnect has caught the attention of our next guest, especially with the sector trading in line with consumer staples. What is driving this reset and what might it tell investors about the tech sector moving forward? Joining us here right now to unpack her latest market thesis, including the sectors on her radar, is Fidelity Director of Quantitative Market Strategy, Denise Chisholm. Welcome, Denise. Always such a pleasure to see you. How are you?

[00:01:04] Denise Chisholm: Always great to be here. I'm well, Pamela. How are you?

[00:01:06] Pamela Ritchie: Very well, thank you. Delighted to have you amidst lots of headline discussions to actually help us focus a little bit in on certain sectors. In some ways I can't even believe that was how we started the conversation here that the tech sector actually is in line with consumer staples. I mean, that can't be right. Really?

[00:01:28] Denise Chisholm: Pretty rare historically. Yes, it is exactly right. I mean, that's where really you saw the valuation compression. We've seen a defensive rotation that took us about two-thirds of the way to typical recessionary levels in the United States. That's what you see when investors gravitate away from more cyclical sectors like technology, consumer discretionary towards sectors that are viewed as safer like utilities and consumer staples. That typically happens in a recession and we got two-thirds of the way there to average recessionary levels. That's where you saw, really, the valuation compression in technology but there was no valuation compression in consumer staples so now you are finding that these two very different growth sectors with very different growth dynamics are now priced exactly the same.

[00:02:17] Pamela Ritchie: The other thing we were mentioning there is this goes back sort of prior to the pandemic, it's a five-year time where lots of investors who didn't get into various tech names, some of the big ones, some others as well, I think just sort of thought, well, we'll never get in. I mean, that was almost an overriding sentiment, wasn't it? It was just impossible to get in if you didn't get in early enough.

[00:02:40] Denise Chisholm: No, I think that that's right. Over the last, I would say, three to four years, to your point, technology has traded richly in those top two quintiles. Again, you can measure it. Over the last 18 months I've really been talking a lot about market broadening, partly because I think that the risk-reward behind technology stocks was fine but when they're so richly valued you really rely on fundamentals being strong. In a lot of ways that was fine because fundamentals have been very, very strong in the technology sector but now what we've seen is earnings numbers haven't come down that much. They'll come down, don't worry about We can talk about that as well.

[00:03:19] What you saw is the entire underperformance in technology stocks was driven by valuation compression driving it back — again, we have the data going back to 1962 so now instead of being among the top two quintiles where sometimes you have average outperformance but maybe not by a lot, all of a sudden you're back down to median levels on relative forward P/E versus the overall market since 1962. That, historically, has been the sweet spot. Average outperformance of 500 basis points which doesn't sound like a lot but is a lot for a sector with well above 70% odds. We've really shifted to a situation where technology had a little bit of a negative risk-reward because of these valuations that was being bailed out by fundamentals, you're in a much better situation fast forwarding to today.

[00:04:09] Pamela Ritchie: It's fascinating to think that all of this has happened in such a short period of time. I mean, there's no question that earlier in the year, through last year, there were questions about, for instance, if the Mag Seven came down was it going to take the entire market with it? Would it, wouldn't it? It looks like last fall there was some, maybe some peaks in there, lots of discussion there so it's not like it's a new discussion of the valuations taking a bit of a hit but it's an extraordinary amount that the valuations have taken in terms of a hit, as you say, pricing towards a recession.

[00:04:42] Denise Chisholm: Yes, both magnitude and speed. This was the speediest time to a correction, 10% down in US stocks, since 1900. This was the third speediest almost bear market. We're bear adjacent, we never quite got there on the close. The speed works both ways when you look at it in history. If you are worried, as an investor we should all be worried about those big secular slogging bear markets of 1973, the dot-com bubble in 2000, the financial crisis, all three of those bear markets that lasted multiple years were marked by the fact that it took 300 days to even get to bear market territory. When you look that there is a very strong relationship between the speed to the bear market and your potential upside.

[00:05:33] In fact, anybody who wants to see the scatter plot can go on my LinkedIn and see that scatter plot of all the 15 bear markets since 1957 and just how strong the correlation is. The faster you go into a bear market, you always have to be very cautious, the faster you can come out of it as well. Leadership, based on what I'm seeing in this technology data, might actually be very similar because the risk-reward when technology is starting at these median levels from an evaluation perspective is much better than we've seen over the last five years.

[00:06:07] Pamela Ritchie: You're looking at some very interesting comparatives to background and your quantitative look at things. Some of the headlines that we hear a lot, if you're looking at tech earnings or whatever, is that there's a slowdown in the CapEx cycle, or maybe they've reached, at least, the CapEx peak at this point to drive the AI data centre sort of story forward for some really big household names. What does that also have to do with the overall valuation? Some called it a bubble, some didn't. What about those peak levels, what did they have to do with the drop?

[00:06:41] Denise Chisholm: It's interesting. There is a lot of concern about if CapEx potentially freezes then growth might freeze or slow along with it. The interesting part about CapEx when you look at it quantitatively is less CapEx is usually good for technology stocks because if you're spending less you can produce more free cash flow. On the free cash flow that you produce you end up being cheaper on it which gives you valuation tailwinds. I think that that's exactly where we are. Some of that CapEx correlated growth slowdown might already be priced in. I think that that's the big part that investors need to struggle with now, is that the news might still be not great as it goes to going forward whether it relates to earnings but given the swiftness and severity of the underperformance in technology and the decline in the market overall the market has priced in a fair amount of that. When you think about bear markets, we're bear adjacent, that is actually equivalent to pricing in a 15% earnings contraction.

[00:07:52] Now you're in the situation where sure, earnings are going slow, they might even slow by a lot, but if they don't slow by as much as, I'm calling it a statistical average of 15%, then that's almost definitive upside in the market. You have to be sort of conscious of the fact that the market has already priced in a whole lot of bad news. Even if the news is bad then it still might be that the worst of the market reaction is behind us.

[00:08:20] Pamela Ritchie: So interesting. Take us to the earnings expectations. We'll often hear in finance price follows earnings. That said, this is kind of the reverse it looks like. Take us to earnings expectations at least which are hard for a lot of companies to read right now because of the tariff but maybe easier for tech giants.

[00:08:41] Denise Chisholm: Well, we'll see. I think that a lot of companies withdrew guidance because nobody knows nothing about tariffs. That was sort of the title of my note that I posted on LinkedIn as well. It is a confusing time and it is, obviously, an uncertain time. The problem with using uncertainty to stay on the sidelines as an investor is that high uncertainty sometimes recedes, most times recedes, and that slight improvement in uncertainty is a step towards clarity, and that second derivative is bullish for the market. Uncertainty might not be the problem that we're dealing with from an investment perspective right now. I think when you look back to earnings and earnings expectations I think it's back to what has the stock market discounted, and specifically in technology stocks. This is why I think valuation is so incredibly important.

[00:09:37] When you look at richly valued technology stocks when they're in those top two quintiles evaluation you are very dependent on fundamentals improving. When you're top quintile in terms of relative valuation you have 50/50 odds if operating margins still expand of that sector outperforming. If operating margin's decline you only have 10% odds. You've get to get those fundamentals right. But now, given our starting point at the median level, in that middle quintile between 40th and 60th per cent, you don't need to get those fundamentals right. As much as we often say that stocks follow earnings at times when stocks correct quickly there's a massive disconnect and stocks bottom well before fundamentals do. That's why I think it's really important to quantitatively look at those sectors that have this rich history of pricing in earnings declines before they happen. That's where technology is right now.

[00:10:38] Pamela Ritchie: Spread out technology for us a little bit. We know the big players, the Mag Seven for sure, are you looking there? Those have been sort of astonishing valuation changes but where else within the sector?

[00:10:52] Denise Chisholm: I'm a little bit more sector industry, sub-industry than sort of pulling out individual stocks, partly because you can't backtest those individual stocks. Those Mag Seven are, I think, prior to this we were talking about FAANG. How do you associate a group of stocks is, I think, always a problem when you think about it quantitatively. The sectors, industries, and sub-industries are often similarly priced when you look back in history. Here where you can divide technology into hardware, software and semiconductors I see the sweet spot being software stocks. That's where we really have that valuation support that I was talking about, where you can look at relative forward price-to-earnings or relative price-to-book and both are well into the bottom half of the distribution, both have really strong track records of discounting bad news in advance so I'm betting less quantitatively on earnings going up because if I know maybe some uncertainty has caused earnings to be softer than you would otherwise expect, if I know those sectors, industries or sub-industries can discount that bad news in advance I'm much more willing to bet on those as an investor. I do think that software is the sweet spot within technology.

[00:12:09] Pamela Ritchie: Software has been talked about quite a lot in terms of being tariff immune, which you mentioned earlier, but software even more particularly than other parts of tech has been an area where people are going to keep their subscriptions up to file their taxes and their various forms of software that they use. Just kind of take us there. We are living through, I mean, headlines are all over the place right now and it does feel like tectonic shifts in even what tariffs were promised and retaliated against even last week. Just sort of a little bit of a safety element.

[00:12:45] Denise Chisholm: Right, it's moving quite quickly. I think that there's two elements to the tariff aspect of it as it relates to idiosyncratic risk for any sector, industry or sub-industry. One is that supply chain risk that you highlighted. Hardware and semiconductors are going to be much more dependent on that supply chain risk associated with tariffs than software companies. All of technology, and in some ways all of consumer discretionary, is at risk to the recessionary risk potentially created by the impact of larger tariffs than we're seeing right now. I think that that's, again, backing up. That is a risk for all of the economically sensitive sectors. Then, again, the question becomes what's priced in? Given the fact that we priced in two-thirds of the way to a recession both on valuation spreads and this defensive rotation you're seeing it in the valuation of tech stocks themselves, you do have to be open-minded because we could end up in the exact same situation we found ourselves in in 2022, which is that the market has gone most of the way to pricing a recession that might not actually happen.

[00:13:52] Pamela Ritchie: Which is sort of that V-shaped potential that could be there. The other thing that we mentioned a little bit, well, I don't know if actually we've mentioned it here but the inflation story vis-a-vis, again, the tariff story which is sort of self-imposed and in theory can be taken back. When you look at tariffs as a tax, either on growth or a tax to consumers who don't then want to buy whatever that good is going one way or the other, the inflation story gets a bit batted around here as well. Is there something that investors should be aware of even just looking at earnings based on whether they're going to be sort of shot up through inflation or even be the subject of rate cuts which should see things fall in terms of inflation.

[00:14:42] Denise Chisholm: I think it's interesting when you think about tariffs over the short term, the CPI is going to pick up any tariffs as a price increase. Over any intermediate term I think the tariffs are more likely to be a deflationary shock, meaning that certainly some prices are going to rise but some other prices might actually fall because your marginal propensity to consume if you're forced to choose a tariff item, again, you have a substitution effect, but If you're forced to choose a tariffed item then maybe your marginal propensity to consume goes down in other places and that pricing power declines as well. Over the long term I think that this is more likely deflationary. Maybe we can call it disinflationary. Deflation is sort of what I fear more from a tariff impact. Going into this, again, when I look at the data, so we'll take the CPI, we'll take the core CPI so that's ex food and energy, if you take out shelter, which has its own sort of long lag calculations, we were running under 2% as we came in to the potential tariffs.

[00:15:49] I do think investors need to be a little open-minded about to the extent, and, of course, nobody knows what happens, to the extent some tariffs recede or we do start to see deals or we do start see something like not 30% tariffs actually come to fruition, then maybe inflation is lower than you think and maybe the Fed can cut earlier than you think to cushion any growth slowdown that you were already fearful about. You might end up in this odd position where, to the extent that we don't have the growth shock that were implicit in tariffs, we might actually get a valuation tailwind as well as the Fed is more able to cut. It's not just that earnings don't need to come down as much as you thought but it might be that rates come down more which bolsters multiples, especially on high-growth sectors like technology stocks.

[00:16:46] Pamela Ritchie: The Fed being able to cut but, potentially, not because they have to.

[00:16:53] Denise Chisholm: Correct. It's because they can because inflation is lower. The why behind why the Fed is cutting is always important. If the Fed's cutting because unemployment is rising and rising rapidly that's not a good situation for the equity market. If the Fed is able to cut because they are able to renormalize policy so as inflation slows real rates should come down as well to make sure that monetary policy doesn't remain too restrictive.

[00:17:25] Pamela Ritchie: You have said, I think, in the past also that the next shoe to drop kind of is earnings. Is that fair? I mean, we've been talking about earnings expectations which builds in all the sentiment concerns that we have here but we are actually going to continue to see the earnings reports. They're still coming through amidst all of these announcements back and forth on tariffs. Sort of the guidance story is in there but the actual earnings themselves, how should we be thinking about this, particularly for tech.

[00:17:57] Denise Chisholm: I think it's interesting because we're in this tough position where everybody's looking for the next data point or for the next signal but the signal is now in hindsight. I think that that's really the trick. While we're looking at earnings as the potential next shoe to drop i might not be the next shoe to drop because of that valuation support because of what that sector has already priced in. I mean, in some ways, it's a little bit in hindsight just like that CPI data was. Everybody's over the fact that, hey, look earnings coming in, seems pretty good. It seemed like we were, for the most part, beating expectations and earnings growth was fairly strong and getting a bit more diffuse so you had more actually from a median, you had more breadth of median earnings expectations. I think there's still the concern that the threat of tariffs, we'll see how it all turns out, the threat of tariffs or actual tariffs might actually be enough to potentially quell that earnings to potentially actually lead to an earnings decline or maybe even a recession. But now the problem that you're presented with is most of the stocks and sectors have already priced in some of that. If it's not that bad you might be looking at a rear-view signal instead of just looking at the dislocations in the market.

[00:19:13] Pamela Ritchie: Let's take that a step further to actually the discussion of US assets being sold off, being bought back into. There's been some fast moves in that. There's some structural set-ups for it for money moving internationally. You can see where that comes together and ties up with a bow to an extent. It's been rapid and very volatile in terms of money, it appears, coming out of US assets. What if they're priced quite well and we sold off too quickly, or those that did.

[00:19:48] Denise Chisholm: It may very well be that the end of American exceptionalism is just slightly premature, if that is actually the case, because we haven't really seen a big move in terms of earnings growth. We haven't seen a huge shift down even in terms of earnings expectations for the US. When I look at the data that we have going back to the' 90s for Europe, EM, Japan, we're still seeing, on average, outside the US lower earnings growth and sometimes contractionary earnings growth. There's not, so far, a big disconnect in terms of earnings growth but there has been a big disconnect in terms of valuation. Just, to your point, the speed of all of this, all of these, this defensive rotation, the rotation into Europe, the decline in sentiment, all of it has seen less than 1% of the time historically. Most of the times, including this rotation international, if you said, okay, let's look and see if there's a statistical relationship, once you see a rotation like this should I bet on it historically or should I bet against it historically?

[00:20:51] Over and over again historically you'd want to bet against, meaning that those extreme moves are most often, not all the time, not sustained. Now, of course, it could always be different this time but from my vantage point the reason why I like all of these historical probabilities is because you do find that these patterns persist despite the fact that it is always different this time.

[00:21:16] Pamela Ritchie: Because it's been, I mean, so much of it is tied up into because it has been so rapid, for good reason. We've all been watching our screens. We understand where the turmoil comes from and the concern but it is very fast in terms of the measurements that you're looking at.

[00:21:32] Denise Chisholm: That's exactly right.

[00:21:34] Pamela Ritchie: Let's take a little bit of a look back to sort of the overall earnings story. We hear a lot about every company figuring out where they are, whether they are or aren't tariff-proof, where the exposure is, and ultimately what their margins are, which often means large-cap. Big companies tend to have a bit more room in many cases and also for pricing power, generally. Can they demand a higher price and push through the tariffs? Tell us a little bit about margins and what you're seeing, ultimately, again, for the tech sector.

[00:22:09] Denise Chisholm: For the tech sector, I mean, we've seen operating margins expand every year for, I think, the last four years, which is, historically, a really good set-up for the sector given the valuation we're seeing. I will say that when you think about tariffs, if you just step back I know that there's not a lot of analogues from a tariff perspective historically but I do think one of the best ways for investors to think about it if you can just get rid of the is this the end of international or global trade as we know it, at the end of the day it's a cost shock. We've seen cost and supply shocks before, obviously, coming from the pandemic. What we have seen during the pandemic is that high margin companies, again, high margin companies that are flexible, have the best odds to succeed in a cost shock. That is still technology companies. As much as this is different it doesn't really matter to corporate America where the cost increase comes from or why the cost increase is there. In a lot of ways we kind of saw this movie before. The more flexible the company is the more likely it is that you can sustain those margin trends.

[00:23:25] Pamela Ritchie: Is there a reason to come back to the consumer staples story? It is just so fascinating. Consumer staples has been the place where people have hoped to find safety in a volatile market. It's a defensive play, ultimately. I think you and I spoke at some point about whether some parts of tech, maybe not broadly software, but certainly, again, some of the household names are closer to staples. You actually have to buy a new phone every few years, you have to find a dishwasher every few years when it breaks. There's sort of an element of looking at the two sectors as having a few more ties together than perhaps they did back in the early days. Is there anything that brings them closer together based on that?

[00:24:10] Denise Chisholm: No. I think it's interesting. We've talked a lot about consumer staples back in the '80s and certainly the early '90s being both offence and defence. They got that way because it was persistent demand in downturns. They had personal care products that everybody really wanted to continue to consume and also was part of a growing category at the time. It was offence as well because consumer staples were growing EBITDA, I think, 15% a year back in the '80s. They provided that ballast of offence and defence, which isn't to say that they never sold off but certainly when you looked at it through any two or three year increment that's what you saw historically. I think that technology stocks have a lot of parallels.

[00:24:51] Like I just said, in terms of operating margin expansion through both good times and bad times technology stocks have been able to retain their pricing power. Again, we might be able to argue whether or not it's going to be different over the next five years than the last five years but if it's not and that pricing power remains now they are exactly priced as those consumer staples companies that don't have that pricing power, that don t have that margin expansion. When you look at consumer staples as a sector they've actually had the worst margin expansion of any sector in my database over the last 18 months going back to the '60s. The fact that they're priced the exact same way, I think it makes an easier relative bet to bet on technology stocks that have been more persistently able to grow cycle to cycle.

[00:25:45] Pamela Ritchie: And just more innovative. Although, I was going to say, there has been an argument, as you say, that the group, consumer staples, hasn't been able to have the same type of innovation, obviously, as tech. That said, some of them have had to become quite tech savvy and sort of call themselves a tech company in their own way selling consumer staples but their sort of logistical side of things has come up.

[00:26:08] Denise Chisholm: Yes, on the stock level there is always options. When you look at the sector they sort of look like that just at the end of the day they're doing what they just did, which is provide a defensive option. In fact, of all the defensive subsectors like health care, utilities, you can maybe even call real estate there, the old telecommunication services, all of that, actually, consumer staples has done the best. It's because I think at the end of the day you do go and buy your toothpaste and buy toilet paper. Those personal care items are much more sort of safe from that perspective. But yet in consumer staples now disproportionately we saw an average recessionary rotation. How much more as an investor are you willing to expect? It was about the average recessionary rotation we saw sort of in the financial crisis and around the time that we saw in the dot-com bubble.

[00:27:06] Pamela Ritchie: Isn't that interesting, the rotation into it. So it might be about done there, it could be about that done. Take us longer term and just sort of take us back to putting this into perspective of what ultimately some of the historical analogies help us look to sort of medium term.

[00:27:23] Denise Chisholm: I always like to think about what's priced in because we can always assess maybe it's going to be different this time, what does the international global trade dynamic mean? When I look cycle to cycle every cycle is very different. The pandemic was very different than the financial crisis, was very different than the dot-com bubble, which was,  of course, different from the two recessions in the '80s and then the oil embargo in the '70s. None of these are similar to each other and yet these strange patterns of dislocations exist in very similar fashion and are predictive in much the same way, meaning when investors get fearful they sell anything they think is risky, like technology stocks, they buy anything they thing is safe, like consumer staples stocks, and you get this gap that is an expression of fear that's the opposite of what you want to do, meaning it's a great contrarian indicator to take the long view and think about stocks over the course of the next one or even three years because once stocks are down almost 20%, because again we didn't quite get to 20 %, over the next three years since 1957 they were only down once.

[00:28:39] Pamela Ritchie: So the odds of it. Just to sort of close out because I think you've probably got all kinds of people joining you here today thinking, well, maybe this is just a second in a lifetime opportunity to get into certain names that have been a bit unreachable for some time. Is there a little bit of a cautionary note that goes along with that? It does look like a fascinating set-up, the way you laid it out.

[00:29:00] Denise Chisholm: It is. I mean, at the end of the day it is a fascinating set-up but it's not the same set-up as we saw in 2022. When we were speaking in 2022, and I think we were speaking back then, that was fully priced to a recession. If you heard what I said we're about two-thirds of the way there. That's most of the way there but you still kind of have  to get the call right in the sense that tariffs at 30% are a potential recessionary shock. The way I think about that is $3.2 trillion of US imports, again, we always have to think about what's the cost to the US consumer, 30% tariffs, and if maybe a third to half hit the US consumer, not all of it will, some of it'll be substituted away, some will be absorbed by the foreign producer, some of it will be observed by currency, but what lands on the US consumer divided by $25 trillion of their income, it could be a 2% hit.

[00:29:56] So 1% hits, historically, we've seen by tax increases. We saw that in 1968, I think, 1993, 1982. That's not as much of a headwind as that seems and it's definitely a strong headwind. It's not enough of a headwind, historically speaking, to kick the US consumer into recession. But a 2% shock, usually historically seen from oil prices or the Fed has been, historically. If we put tariffs into the same bucket then 30% tariffs across the board are a recessionary shock and we did not fully price a recession.

[00:30:36] Pamela Ritchie: Fascinating. Denise Chisholm, thank you for taking us deep inside this moment to take a look, sort of shine a flashlight around and where the opportunities might just be right there in front of us. We appreciate your time.

[00:30:47] Denise Chisholm: Always great to be here.

[00:30:48] Pamela Ritchie: That's Denise Chism joining us today from Boston. Thank you for joining us here on The Upside. You can follow us at Fidelity Canada, on LinkedIn for all kinds of timely market updates, also for expert analysis on what's driving the conversation. Thanks for watching. We'll see you again soon. I'm Pamela Ritchie.