September 2024 CIO perspectives – Andrew Marchese

hello and welcome to Fidelity connects a Fidelity Investments Canada podcast connecting you to the world of investing and helping you stay ahead with the Bank of Canada set to make a rate cut announcement in the next coming days we sit down with portfolio manager and Fidelity Canada's Chief investment officer Andrew maresi to get his latest insights on the market landscape and what a rate cut could mean for the broader economy Andrew says in his opinion a cut of 25 or 50 basis points doesn't really matter what concerns him is what a cut would signal to the market Andrew says when you get into these rate cut Cycles it's really about making sure that Central Bank reaction matches the economic backdrop most importantly Andrew notes the fate of the economy could probably be determined by one macroeconomic metric and that's unemployment that's why you saw a dip in the market in August when the US reported higher unemployment numbers for him he's concerned about the speed and the magnitude by which central banks cut he also says we should be less concerned about a potential recession and be more mindful of possible leadership changes going into 2025 and what that means from a market perspective this podcast was recorded on September 3rd 2024 let's begin with 50 versus 25 because we are on the cusp of all of these different Decisions by central banks around the world does anyone need a 50 does anyone need a 25 bases um point cut uh my personal opinion is no nobody needs a 50 um I think if we were to get one I think my concern would be what is that signaling uh to the market in other words is the economic um situation a lot worse than what we perceive it to be uh so that could really kind of ruffle markets because it it could look kind of panicky uh I don't as I said I don't think that's in the cards the consensus is it's not in the cards so um when you get into these right cut Cycles it's really about um making sure that Central Bank reaction is matches kind of the economic backdrop uh if you get into a scenario where central banks um appear to be behind the curve the Market's that's when you get kind of get into trouble with the market are we behind the curve some would argue yes I mean some would argue the fact that real rates are are meaningfully above the natural rate of interest and have been above the natural rate of interest for some time what that translates into is a very tight monetary backdrop which constrains an economy um I said back in January I said it again in April the fate of the economy could probably be determined by one uh macroeconomic metric and that's unemployment we saw unemployment in the US kind of Gap up in um early August and that's what kind of caused the volatility that we saw in the first couple days subsequently there were other bits of economic data that seemed to quell the Market's fears but that's the one that's going to determine how central banks and in this case the Federal Reserve reacts and that's almost an admission that if unemployment were to get worse the cor the correlation would be then Global the profits would get worse and therefore the central bank would then be in a reactionary phase and cut rates what it really means I think for the fate of the market is it's the speed and the magnitude by which they cut so which is sort of why I was asking the 50 basis point because that it as you say that that would create potentially a little bit of a panicky situation what is the bigger risk right now we'll start sort of with Canada we'll flip back and forth obviously to get your Masters in Business perspective on all of this but in Canada what is the bigger risk recession or inflation recession um I still don't think it's a um highly probable scenario um but we did see in August I think when the unemployment data got worse in both Canada and the US um I I think you know the consensus out there for the market was um if you look at those who may have been saying that there was a 25% chance of recession they took their numbers up to maybe 30 or 35% that was the the kind of consensus if you went around the you know to a lot of the Bulge bracket firms in the US um but the takeaway is it's still below 50 so I I I think one would think that economic data should still weaken a little bit but from an investing perspective corporate profits have actually been very good there's been a slight disconnect between the state of the North American economy and the robustness of uh corporate profits can can I ask you about that because because it's a sentiment question you know there there is a gloominess yeah um but then we see earnings and they're fine yes so what what is that I mean often the economy and the stock market are not as uh in they don't skip in time in the same way but is that all it is I think there's a lot of things kind of going into it one is still kind of a postco hangover that's affecting some businesses and it's not you're not operating on kind of a a normal steady state there's still some catch up in in certain industries um I think margins have been handled quite well uh by a lot of companies so that helps the corporate practice The Profit backdrop um I think in the early cycle those companies have not been fine and those are the ones most impacted by consumer spending so when you're saying sentiment sentiment directly feeds into how does the consumer feel well if we look at some of the results from a lot of the US early cycle stocks they haven't been great now if you look at some of more of the later cycle stuff um it's been good the two best sectors in Canada have been energy and materials gold has done very well um this is sort typical late cycle yeah yeah Utilities in the US have done exceedingly well so it feels kind of like and I said this back in April as well it feels like a prolongation of the late cycle we didn't get the cuts uh that the market was expecting because the economy was generally a little bit better than most were expecting um and so they got pushed out and that meant that late cycle trade got prolonged and that's why I see think you've seen those sectors that I just alluded to uh do pretty well this year yeah and do we have to I mean if it's late cycle does that mean that a recession has to come for us to get to the next thing some some we just get this soft landing and we're okay yeah uh we don't need a recession um I think in this backdrop it's hard to kind of um think about where we've come from where we could be going and you look at the Spectrum of outcomes that are before us um it's hard to create one that's really Draconian like so I I think you know while things might yeah and I think why things think while things may weaken economically um and that's fine it it appears that central banks are on the scene right so this isn't I think there's a good the market has has been told and communication by central banks has been very strong that there's a safety net coming so I think what you just have to be mindful of is possibly leadership changes as we go into 2025 from a market perspective and and as always just making sure that what You' forecasted from a profit and cash flow perspective and looking at from a valuation perspective makes sense for Holdings in your portfolio I'd be more worried about that than I would be saying are we going to get between now and then six interest rate cuts out of the US or eight like to me that matters a little bit less than what we're actually focusing in on a bottom up fundamental basis at a company ideosyncratic level okay so let's say there are leadership changes there are reactions some of the things would still be intact for instance we seem to be in an easing cycle yeah that's probably not going to change I mean again Pace magnitude but but that would probably be the backdrop which essentially means a fed put you know this is what people are talking about this fed put that's there's room to be risky for those that can stomach it because there's a backdrop there's a safety net yeah and that's in both countries in the I I I agree with that and I I that's why I said I'm more concerned about leadership changes and looking at stocks that have not performed well particularly those in the early cycle if you were to go back you weren't talking about elections you're talking about leadership of yeah yeah yeah leadership leadership of the market get caught up in the election Cycles okay yes yes no leadership of the market and and it's really about if you if you look back in history um and we'll focus on the S&P 500 and and the US in general just because it's a nice deep broad Market um typically what you find is those early cycle stocks start actually performing well about halfway through the rate cut cycle so if you had a crystal ball and you said well the Federal Reserve is going to cut six times between now and the end of when they're cut whatever that may be historically using that as as as if the pass is prologue you would want to start buying after the third cut you would start want and hopefully those stocks are actually sufficiently cheap too that that would be the the normal Playbook um does it start a little bit sooner this time because it's been so well Tel it's hard to tell hard to say U we'll see but um if you have valuation as kind of a good crutch and you buy cheap then you're probably paid the waight so you don't have to stick you don't have to to really get through the mental gymnastics in your head and go well should I buy the fourth cut or the third cut like you should probably already be there and just wait and wait it out as long as you've done your homework on the security and and I think that's what RPMs are trying to figure out for those stocks that have not performed well we probably got to do more work on those ones because they're probably from a risk reward standpoint and a rate cut cycle perspective probably there's more reason for optimism on a multi-year basis going forward than you know something that's worked for a long time kind of expensive pricing light cycle pricing in kind of more of a blue sky scenario how much can we really get out of this and if we're wrong or they trip up on earnings or or something or do something you know kind of irresponsible with their Capital deployment then we got a lot of down side so you want to kind of you know those are the the the arguments that we're having internally or the decisions we're trying to take internally about balancing risk and reward let's take that into positioning for a second because it can help with I mean as it happens the magical third cut we think from the bank count is tomorrow um what sort of could like for instance can alts help you through a period like this we'll we'll talk about where things belong and and what could help but it it is a volatile time it's a very interesting time and as you say there are a lot of blown out valuations in other parts of the market right now what would be sort of a couple of different ways you could pluck different products to help you steady the ship through this well you mentioned the alts I I like if I think about our alts are our kind of 13030 long short um directional long short alts I mean what they really capitalize on is kind of a discrepancy in the marketplace in terms of uh earnings performance and valuation right so you can really kind of if you're confident as a PM and going along the Securities that you think have positive earnings trajectories better than Market consensus numbers and you know better valuation and conversely short those that don't meet that criteria you have a kind of a a small levered way to play that and so from an idiocratic stock selection standpoint our our Longshore portfolios give the portfolio manager an opportunity to really exploit their stock picking Acumen the other liquid alternative that we have um uh which is the market neutral which is kind of very interesting it is meant to be its returns are designed to have you know we would define success as mid singled digit like returns irrespective of the market backdrop so the returns are not correlated to the market I think it's really interesting from this perspective it's kind of an after tax perspective which is people still talk about you know term deposits or fixed income I think from that perspective you know after tax you get your returns as capital gains and possibly some as dividends so while it's mid single digits there might be actually some after tax benefit holding that versus something in a term deposit which could also give you kind of that four to 5% range but it's taxes income right so plus you have the kicker that if we're doing really well from a stock picking perspective maybe it's a little bit more than the typical mid you know mid single digits um but we would define success as mid single digit like returns um with an uncorrelated product to equities so I think that that from a a net portfolio perspective offers a lot of benefits it's fascinating to what extent will the rate differential that that we're expecting well I mean at the moment we have a rate differential between Canada and the US but how will that also play out for investors as they're looking through this right now I mean whether Canada needs to get going faster with the cuts which it has and the C and then the US does less well what do investors need to sort of be aware of well I think one of the things that so that would dovetail into foreign currency right so exchange rates and one of the things you have to be mindful of in our position when we're doing diligence on companies and understanding the backdrop for profits is how does Foreign Exchange affect margins so if you're you know in this case if the Bank of Canada were to cut a third time and the US still hasn't they've given all indications I think consensuses for uh a cut later on here in September but you have that interest rate disparity does the Canadian dollar weaken relative to the US dollar as we go forward and if so what does that mean for businesses that um sell in Canada but maybe have to procure raw materials that are are um Dollar in US dollars so so that that affects margins so that we have to kind of embed that in our our um you know sensitivity analysis around margins and so I think you have to really um conversely you know if you get a product or like oil and gas if you're selling a product in USD but you're all based in Canadian dollar cost that may be beneficial if the Canadian dollar weakens relative to the US dollar if that interest rate disparity maintains itself or even widens out more so one of the ways to really look at it first and foremost and a lot of people don't always think about it is in margins yeah in margins that's fasinating and it goes back to the earning story obviously lots of questions coming in let's let's put um let's put just what do you think of the Canadian dollar strength do we call it strength it's held in there I'm surprised it actually has held in as well as it has um I've you know been on the record much like David wolf um part of our GA team that you know Pro USD kind of going forward U the Canadian economy is definitely weaker i' I've maintained that the Canadian economy is weaker than the US economy there is the more a greater need for rate Cuts in Canada than there is in the US we've had two in Canada we have haven't had any in the US so that's kind of been proven right but the currency as you said hel has held in there um for how long we'll see um you know and but um no I tend to be in agreement with someone like David wolf yeah okay really interesting uh great batch of questions coming in so Andrew could the government's uh I think this is talking about Canada but maybe you can do both could the government's recent changes to immigration policy have any impact on the markets has this been um priceon it's hard to take a big topic like immigration and kind of filter it through to individual Industries either revenue or cost side right and so there has been chatter about what does that mean for real estate um what does it mean for um Telecom services and just like Mobile plans and stuff like that so it's really hard to like you you know it it is either a headwind or a Tailwind but to quantifi it is actually a big challenge so you do your you do your bottomup work and then you kind of come to your conclusion on an Outlook or a forecast for Revenue um but it's hard to really attribute how much um is due to say a factor like immigration or the curtailment of immigration but you you should know in general whether it's a headwind or a Tailwind for so for those kind of two aspects I talked about whether it's real estate in certain areas um mobile communication Revenue they're more of a headwind than certain a Tailwind right so but it's hard to really quantify it another question which Canadian Canadian and American sectors are you most interested in over the next 12 months so as you turn over those rocks yeah so I said back in January and April I was kind of an outlier on that I was more intrigued by things like utilities which are now starting to show their kind of Merit and and I was kind of you know doesn't sound that glamorous to be talking about a utilities companies but um you know everybody talking about Ai and whatnot and there have been great returns in that but um I thought the better risk reward lied in some of those things that were being forgotten about like Staples and utilities and as we move through the r cut cycle what I'm more interested in now with things that haven't worked and a lot of those are in consumer discretionary we're talking about a weak consumer almost daily or a weakening consumer that's probably a better way to say it um due to mortgages basically the due to due to debt burden uh due to fear about you know maybe you're you're a little concerned about your job right so you curtail your spending um all the interest rate hikes that we have had they take a while to actually impact Behavior so maybe they're happening and the first few Cuts you don't react to the first few Cuts right as a consumer you're like okay well you know maybe I got 50 basis points um more to play with but I'm not going to do anything because maybe I'll have a 100 or 200 in the future right and so it takes a while for the cuts to actually make their way through the economy but what that means for investing I'm more intrigued by the early cycle discretionary names particularly if those stocks have really felt the effect of negative earnings revisions right or negative Revenue uh revisions uh companies that have lowered guidance going into next year those to me are more intriguing because of the cyclical nature of their businesses you know when they do work again they're going to really work so I I I use a phrase around the office a lot with our research staff like what we playing for which which is a way of talking about risk reward if I can find Securities that I think over the next three years will double uh and maybe they only have 10 to 20% downside that's pretty good risk reward um I really shouldn't concern myself where the next 10% of return lies I'm going to get paid to wait on a three-year basis right and that's what I need to really focus on there are more of those opportunities I think in consumer discretionary than some of the secular stuff that has um really worked where you have great performing companies they're awesome companies um but you're paying full fair so to speak for them so if they have any trip up or slip up there's more downside necessarily than upside really interesting well let's just stick with some of those secular Trends because a lot of it is is the AI Story how does Canada play that really meaningfully I mean we talked a lot about the infrastructure buildout of AI do we do we provide all those resources for that build out is that how we take part uh there's definitely a power consumption angle to all of this through data centers and and whatnot so I think that's part of the reason why you've seen us utilities both not only from an earnings perspective work well but uh from a multiple expansion perspective and they have rate Cuts working for them too so you have kind of the trifecta of reasons why the stocks are working well that power consumption angle is going to continue to be a uh a theme kind of a second derivative type of theme going forward obviously you get less leverage with that theme than you would for somebody who manufactures chips sure like the whole semiconductor industry we're bit behind to get there so there's not a direct way to play it in Canada per se but to the extent that you have a Canadian utility company that has Assets in the US that F feed into that data center thesis that's part of it um natural gas needs to be you know going into some of these utility companies that the basin's been opened up who distributes it look into right yeah so yeah look into that kind of stuff but on a direct basis it's hard to talk about it in Canada yeah when um when you talk about theumer just jump back to the consumer um we actually saw a lot of like sort of apparel and consumer type earnings over the course the last week and a half or so and things some many things were fine actually so just wondering to dig further into discretionary like where is the trough what are we talking about that is the hardest thing to do when looking at consumer discretionary stocks is to pick EV valuation metric or metrics that provide adequate crutch that you're like well I'm pretty close to that to to the floor yeah yeah I'm pretty close to the floor I don't know if I'm on it but I'm I know I'm close um it's really hard to do with consumer discretionary stocks because unlike materials names which have usually boom bus type thing yeah they're boom bus they trade at a discount to book and as long as you know the balance Sheet's going to be fine under some pretty Draconian commodity price forecast you can safely buy them below book consumer discretionary stocks work a little differently only because there is some kind of um um maybe there's a fashion element to it that kind of gets phased out maybe there's a change in the industry um think air right Airbnb versus hotels you know like that kind of stuff restaurants can be a little challenging because now they're Global and things move at a different different Cadence depending on the region you're talking about that's the hardest thing to think about but one of the things what we try to do is look at Peak earnings power of a company so when things would be blue sky at some point in the future years down the road how much could this company possibly earn attach a multiple that you think is reasonable to that and how far are you away from that today so as long again as long as you don't think there's something really permanently damaging in the balance sheet then you can say well I got 150% upside or 200% upside or 300% upside I'm gonna I'm not going to fool around I'm going to buy this and wait and so if I if I'm wrong and it goes down another 10% then I buy more that so you get into that kind of behavior because at some point in time the cycle turns and then you're off to the races then what you'll find is quarter after quarter they start printing positive numbers and you want to be there before then then after you want to ride the ele elevator up do you look back back to the the co days where we were buying stuff things lots of stuff because it was all we could do and there were some real Peaks made oh yeah and then of course we could get out and we sort of but I mean do you look back to that for sort of what you thought were Peak earnings you're only going to go forward I guess but no I think that's a great question I think you actually have to normalize for it that was an unusual part time and you have to and consumers overc consumed and they overc consumed Goods or things versus service right and and I talked a year or two back two years back that there would be a transition within the consumer from goods and things to service-based stuff people you know you've heard about revenge spending and travel or stuff like this and we're seeing that we've been seeing that all summer and you know that kind of thing yeah right and and so I think you have to normalize for covid when doing that analysis about what the peak earnings power is of the um of the company in question because I don't think anybody logically would pay for that because it it was a one-off that was off yeah Canada moving forward let's come back to sort of the rate story and where our economy goes um you're suggesting keep an eye on the labor story because that's what the fed's doing Canada doesn't really have like the Bank of Canada doesn't really have to have that dual they don't have that dual mandate but as an investor you're going to be watching that pretty closely is that is that sort of the biggest macro piece of what we're going to watch Mar merging forward that that probably Tiff Macklin is looking at too probably I yeah probably I think as a change the Canadian investing I mean if you see that number get worse then the knock on would be that Canadian based profits in other words companies that sell in Canada produce in Canada to a domestic to a domestic audience largely speaking so what does that mean Banks Telecom you know grocery stores those are the companies that are made in Canada selling to Canada right so you analyze each of those businesses and you kind of think about you know um does that mean if the Canadian uh consumer is weakening uh what is the impact to that business um at hand so for a bank does that mean businesses in Canada tend to weaken does that put burden under loan loss Provisions going forward you know um and that's the natural knock on effects is when an economy weakens that Lan loss Provisions at Banks rise okay so that's one thing but what's the order of magnitude right would they is it Are we almost there yet will it be bigger you didn't get much out of the bank earnings did you no they seem to think it was fine they're looking right they always tend to think it's okay so I mean it doesn't do them any good to kind of no stick their neck out right so but um it's one of the things we'll watch for yeah this one of the things you watch for certainly what would you kind of like to leave investors with right now this is this is a moment there's no question and and and people are um turning to you to you know sort of how do you stick handle us through this um what do you think steady on or yeah I I I came into this year saying market returns for this year will largely be largely speaking will be kind of normalized plus or minus one standard deviation I had the setup for that kind of thing I think that's other than the NASDAQ which is kind of like a an outlier on the AI theme if you look at Global markets that's been the case but we still got four months to go right and so we'll see how that all kind of shakes out um but I think it's still Steady As She Goes it's an earning driven Market I I've used the phrase without a bust it's hard to get the boom right so it's kind of this you kind of just keep moving along try not to over it sounds very boring but I think it's actually very constructive don't overpay for things look at things that are out of favor add those to your portfolio know what your winners are um you know you ride your winners maybe a little longer because they're actually performing at a high level I think investment quality as a factor for those who who look at ETFs based on factors investment quality as a factor will continue to work I think that's something that you want to continue to look at um rather than say momentum momentum's tricky because momentum historically you know you can go back for 7500 years momentum as a factor generally works but when it doesn't you don't want to be anywhere near it uh the class the most classic one was the global financial crisis momentum as a factor worked for 8 years and then in a matter of about 4 months it destroyed all the Value Plus that it accured in those eight months like it in four months you destroyed over eight years worth of value which is incred I mean that's the extreme of the extremes but I think you always have to be wary about how much momentum you have in your portfolio because it's one of the things that can go wrong quickly and when it when the market turns that that's the factor that has the most volatility so just to sum up we started with you mentioned you know kind of Steady As She Goes with the rate Cuts maybe 25 based what is your expectation versus 50 it's it's consensus in the market is for 25 yeah yeah and so there is sort of this steady on message and Mar I'm sorry just any final thoughts no I just say I think it continues to be an earnings driven Market I I I said that coming into the year and I focus on earnings and cash flow delighted to have you here and share your thoughts with every thank you thank you thanks for listening to the Fidelity connects podcast if you haven't done so already please subscribe to Fidelity connects on your podcast platform of choice and if you like what you're hearing leave a review or a five-star rating Fidelity mutual funds and ETFs are available by working with a financial advisor or through an online brokerage account visit fidelity.com find information on future live webcasts and don't forget to follow Fidelity Canada on Twitter and Linkedin thanks again see you next time the views and opinions expressed on this podcast are those of the participants and do not necessarily reflect those of Fidelity Investments Canada ulc or its Affiliates this podcast is for informational purposes only and should not be construed as investment tax or legal advice it is not an offer to sell or buy or end 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