Webcast – Charting the course: CIO outlook for 2026

Pamela Ritchie [00:00:26] Hello and welcome to Fidelity Compass, I'm Pamela Ritchie. In the post-COVID world, traditional market cycles don't really look the way they used to, and the old playbook may no longer apply. Are market cycles even broken? One explanation our next guest raises is that Canada doesn't have an inflation problem so much as we perhaps have an affordability problem Which changes how we think about corporate spending stimulus and government debt So how do we navigate this new landscape and what could change that narrative? Very happy to be joined here today by Fidelity's chief investment officer and portfolio manager Andrew Marchese for a discussion on where equity markets are today and ultimately what will be driving them into the year ahead. Warm welcome to you, Andrew Marchese, how are you?

Andrew Marchese [00:01:11] Very good. Thank you.

Pamela Ritchie [00:01:12] Happy New Year!

Andrew Marchese [00:01:14] As well.

Pamela Ritchie [00:01:14] Delighted to have you here. We'll invite everyone to send questions in over the next 25 minutes or so. Let's begin with market cycles being broken if they are. How so?

Andrew Marchese [00:01:25] Yeah, I've had this kind of working hypothesis going on for maybe a couple of years now. And it really is born out of the fact that I think we've entered into an era where, as many of our viewers know, the M2 money supply has been growing at a radical pace. And if we even think back 50 years, in the financial system, we've cured every problem or crisis with more liquidity, more capital. And so... As we enter into recessions or times of crises, the 87 crash, GFC, COVID, the solution to every problem has been to add a radical amount of liquidity. And yet we've never really extracted it. If you take the US as kind of the poster child for that, and that's true of every other nation around the world, at least every other developed nation, you have a big liquidity bolus. And what it does is when you have liquidity like this and you react in kind to even every small crisis, you don't go through the typical boom bust scenario. So we saw that in the early 80s and the early 90s with those recessions. And when you come out of that recession, the economy and the stock market follows a fairly predictable playbook. What leads by how much, how the transition occurs from one sector to another, from one style to another, et cetera, et cetera. And with COVID, we injected a huge sum of money into the system because of that crisis, all the while still never working off what we injected in the GFC. And we've now entered into a realm in late 2024 where global central banks were stimulating to the tune of probably about the fourth largest amount in modern history in a period of time that was actually absent a recession.

Andrew Marchese [00:03:20] Yeah. Sorry.

Andrew Marchese [00:03:22] Again, as I say, you don't go through these boom bust scenarios, and as a result, leadership in the marketplace and even relative corporate profit growth doesn't resemble the old playbook.

Pamela Ritchie [00:03:35] It doesn't get cleared out, replenished or renewed in that sense.

Andrew Marchese [00:03:39] Correct. And as a result, there's more idiosyncratic things going on in the market. Generally valuations are kept higher because your discount rates are kept lower. And that doesn't allow for, as I said from an investment standpoint, that typical playbook that exists in early cycle, mid cycle, late cycle, and retrenchment. And so that's the world we're kind of having to navigate with. And when you have this measure of liquidity as well... Secular or thematic investing tends to dominate because your propensity to bear risk goes up naturally. And that means your horizon by which you look out becomes longer. And generally speaking, it will increase speculation. You will take near-term assumptions and extrapolate them into the long term, which can be dangerous. So, I think all of that kind of is the system we're in right now. And so from an investment standpoint, I think, at least for equities, you have to trade off what you think are secular themes intermingled with things cyclically that may be improving on the margin, although the magnitude of the improvement will probably be muted relative to past cycles.

Pamela Ritchie [00:04:53] It's so interesting that that's what's underneath it, because we often are just layering on top the AI boom, which of course is, by most accounts, an industrial revolution on top of a pretty liquidity-filled market that's there. So yeah, you sort of get a sense of what is driving. And that's a lot of good news in terms of money in there. What about the painful rate cycle that we just went through where they raised interest rates to try and soft up some of that COVID cash now coming back down in most countries?

Andrew Marchese [00:05:27] Yeah, it was short-lived, I think, really. I mean, it's it was really late 21, for the most part, 2022. And we saw the inflation numbers. Central banks were kind of behind the curve. And the market understood at some point that its forecast for interest rate hikes were far too conservative. And so there was a resetting of equity valuations, as you kind of remember, for first nine months of 2022. The NASDAQ underperformed the most, right? So you have those large multiple stocks. You know, the MAG-7, generally speaking, all the valuation multiples got squeezed. Earnings, generally-speaking, were okay, but it was really about resetting based on higher discount rates. And then, before you know it, it was kind of over, and we were in a stimulus environment starting in the second half of 2024, so it only took two years.

Pamela Ritchie [00:06:18] Yeah, sort of short, painful for some, but perhaps not a clearing event in that sense.

Andrew Marchese [00:06:23] Yeah, if you look at empty money supply figures, yes, definitely not a clearing event, definitely not a resetting event. And so that has implications, as I said, for risk-taking in all elastic classes, currencies. So this is kind of a new world we're living in, and in my opinion, we probably passed an important threshold. And so, that's the world we are going to have to deal with for the foreseeable future.

Pamela Ritchie [00:06:50] With all that said, is investing right now in what's going to work perhaps longer term, more like an early cycle though? Or actually are the sectors becoming a bit intermeshed because of AI? I mean you've got large tech companies that would trade as tech companies but in some cases own a big chunk of energy project, whether that's more clear or not. So what kind of company are they?

Andrew Marchese [00:07:16] Right, exactly. I think the AI, not only theme, but the AI real effect on capex and the general economy is spilling over to a lot of industries as a result. So you mentioned energy and the build out of data centres, which has implications for construction, energy requirements. It has implications of nuclear and therefore uranium. It also has implications for. Industrial commodities like copper, nickel, silver. And so the spillover effect is large and I could keep going and going and that. So you're right. There's an overarching secular theme that's kind of either pulled profits forward or made the total addressable market, the profit market for those industries much bigger. All the while, traditionally you talk about early cycle. The early cycle stocks are typically banks, hotels and restaurants, so things related to travel, transportation stocks, very early, housing, autos. Well those last three, transportation, housing and autos, generally speaking, earnings for industries have been negatively revised over the next last sorry eight quarters.

Andrew Marchese [00:08:36] And so.

Andrew Marchese [00:08:37] They're very much in the doldrums and they haven't participated. I mean, historically if you look back at the market over 100 years, if you had a crystal ball and you know how many interest rate cuts were coming and what was the total order of magnitude, you would start buying those early cycle stocks about halfway through. And it would feel terrible because you'd wake up every day and you'd be reminded that layoffs were occurring. The profitability of these companies was terrible. The economic outlook was terrible, but as the market always does, it's a forward-looking discounting mechanism. It would start buying these stocks, and they would actually start outperforming towards the latter portion of a recession. And quite frankly, a lot of their gains would happen in the first year of a new cycle. And so if you weren't there early, you probably missed a lot recovery. That was not true in this last period of time. Why? We're kind of cutting rates in the absence of a recession.

Pamela Ritchie [00:09:34] It's like we skipped the recession.

Andrew Marchese [00:09:36] Some people call it a prolongation of the late cycle. Others will call it like we're actually going through cycles. If you look at the manufacturing PMI and service PMI data, it's oscillating around 50. So what the market is actually doing is it's reacting on the cyclical side to positive inflexion, negative inflexion as opposed to, you know, decades ago when that number would kind of get into the low 40s. And it top out in the top 60s and you have these big, much higher amplitude cycles that were well-defined and with, generally speaking, greater predictability in terms of duration. Now we just kind of seem to oscillate. And so what it's doing is it's causing kind of a back and forth-ness, if you will, in terms leadership of the market to a degree, all the while the overarching themes of certain things like AI or defence spending. Where there's real fundamentals, but also a great leap of faith looking forward in terms of the durability of the cash flow is also being coupled with things that you would typically not think would work when you're... Would not... Things that are being correlated which would otherwise be uncorrelated. So I think that's the world we're dealing with.

Pamela Ritchie [00:10:56] Dealing with. The fact that you're talking about the cycles of PMI, the growth measures, does it also make leadership or the way that you are investing shorter term because things turn over fast?

Andrew Marchese [00:11:09] I think there's a danger in doing that because of the unpredictability. So I think one of the things, you know, as we know, it's been a very, well, if you look at the S&P 500, it has been a concentrated market. And prior to last year, it was a very U.S.-centric market. So it was radically outperforming everything, the rest of the world. That was not true last year. The rest of world made a nice comeback, and that's good to see. And hopefully, as we look forward into this year and beyond, you get a more diffuse CapEx regime globally amongst many industries, and that allows the market to kind of broaden out to a degree as opposed to this very concentrated beast that's been, for the most part, in the post-COVID era.

Pamela Ritchie [00:11:50] It's really interesting sort of how all this has happened and where Canada fits within that because You're taking a look globally obviously to make your decisions, but very interested in how sort of the Canadian equity market looks within this Overall changing picture and if we're following the non cycle cycle as well

Andrew Marchese [00:12:11] I think there's a lot of things going on in the Canadian market. I mean, first and foremost, its leadership last year was largely due to gold. The gold and precious metals security subindex is roughly about 14.5% of the TSX. That subindix was up more than 100% last year, if you look at all the securities, and a lot the junior miners were up 200% plus. So that had a long way to leading kind of the TSEX. And now that being said, industrial commodities like copper. And other metals, those stocks had very handsome returns last year. I think in terms of Canada leading, it starts with those two themes about gold, we can talk more about that, but also commodities in general and where we are maybe at the start of something bigger. People have talked about what the AI build out will require in terms energy, but more specifically some of the materials that are going to be needed. For that. So there's a direct play in Canada. The problem with that is, relative to our last kind of bull market and resources in Canada, which was in the knots, a lot of companies have been acquired. There aren't a lot ways to play this in Canada and there's not a lot of ways to plays to play it globally. So I think there is a scarcity of resources in the ground. That's causing the action that we're seeing on the part of the United States and other governments to kind of. Get their hands on these very scarce minerals and assets, procure them for themselves, hold on to them dearly, and that is going to have an impact on natural resource securities, whether it be in Canada, Australia, other parts of the world, the emerging world where some of that stuff will be. It has the potential to increase M&A activity over several years, as long as the CapEx build out and some of this AI related stuff keeps going.

Pamela Ritchie [00:14:09] Okay, so let's go there because this is, for many, one of the big risks of whether AI is a bubble and whether it bursts. But I think you've just pointed to so many places that are exposed ultimately to the discussion and the build out of AI, which we haven't fully arrived, but the build out has begun.

Andrew Marchese [00:14:31] The AI theme in general is probably, you know, it has been for a select group of securities the biggest reward in the market. It's also, I think, the biggest risk in the markets. And so, you, you- you know there's been a lot of questions related to it. Is it similar to the dot com bubble of 1999? There are some similarities. There's more differences than there are similarities. At least by the hyperscalers, the capex spending is largely coming out of cash flow, which it was not in 1999. The level of valuations is actually not close to where you saw it in 99. There was far more speculation in ancillary industries that didn't have a hope in succeeding. The similarity is it was a hardware capex cycle in 99, it's kind of both a hardware and software capex cycle this time around. It's not completely direct drive. But I think with that, we talked about things like uranium and data centres and energy, and I could go through a list of things. I think if you have to examine the risk to the capex cycle in AI, the best place to start is probably is the durability of the hyperscalers, the profits that is, fully in place because that will dictate the amount of spending. If you think the earnings, for whatever reason, in those companies gets derailed in a big way and they got to, you know, pare back on their capex spending, then that has the knock-on effect to everything, and that's what the market will be worried about.

Pamela Ritchie [00:16:08] It's so interesting because it's almost one of the huge questions is whether the other 493 so-called will find AI as accretive. It's ultimately monetized within their companies. But in fact, that question that you're posing there of whether the hyperscalers, which is a much smaller group of stocks, 79, we're not sure exactly, can still be, can have it be accreted. Their spending is accretion to what they're doing, essentially. Yeah.

Andrew Marchese [00:16:34] Yeah, we're not going to know if the whole ROI argument is valid for years to come. And it may be quite a while. Really? Years to come? Well, I don't think anybody, and I'm not going profess to be the person who has the best idea, but I don't think anybody really knows what this looks like. This looks like when it's all said and done, and don't really think anybody understands the pace of it. So we don't know the pace and we don't know the magnitude of where the productivity gains are going to come from, how they're going to show up, and... What we look like as a society when it's all said and done.

Andrew Marchese [00:17:08] Because of that. It's a breather, yeah.

Andrew Marchese [00:17:09] Yeah, and then because of that, you can't draw an ROI argument. You can just say we're spending for the future because we think it's going to be big. And if we're not there, then one of our competitors are going to there and we will not be a going concern at some point in time. So you have this prisoner's dilemma, so to speak, of spending. And so I think that's the biggest thing to ask oneself when you talk about AI in general is just the durability of the... Profit backdrop for those companies spending all the money and then when do the productivity gains truly show up? And if they show up, it's going to be really needed because We had this discussion during the GFC, which was you know, you're printing all this money QE Etc, etc

Pamela Ritchie [00:17:57] How do you know it's an aphrodite? It's not an athrodite.

Andrew Marchese [00:17:59] Right, but the bigger problem is the debt. So all the debt that's building up on the balance sheet of the government and whatnot. And so at some point in time, you have to service this, and there's only two ways to service it. You can grow your way out of it, or you can inflate your way of it. We all stood around in 2008 going, well, there's really no new productivity invention on the horizon that's going to really escalate productivity and allow us to grow far faster. Than we have typically with a given employment base. Therefore we got to inflate our way out of it. And other than a brief period of time, 2022, we were still in this kind of disinflationary world after that. So if you think that all this money printing and prices going up for natural resources eventually lead to some kind of inflation down the road. How you thread the needle on this whole thing, on this debt problem, what could be an inflation problem at some point in time, is that you undergo massive productivity gains. We all used to think it was going to- It's going to kick in. Right. We all use to think, it would come in the form of something on the energy side, like cold fusion or something like that. Maybe it comes in the from of AI, and that's how you thread the needle.

Pamela Ritchie [00:19:17] And then to use AI for the extraction of all the resources that are needed. I mean, it gets applied everywhere, in that sense, and so the productivity sort of comes in and kicks in. What else do you think in terms of what's working of the TSX, which had an enormous year last year, can continue? Is there a broadening of the tape in the sense you mentioned what gold is worth within the TSx? Of course. It does seem to be moving to industrial metals in a different way. So there is a broadening there, an expansion of it. Is that sort of where you go with this?

Andrew Marchese [00:19:54] Yeah, I think, you know, the banks have been a good place to play. If you're bullish on a local economy, then you have to be bullish on the local banks, by definition. Banks have had some pretty good returns over the last two years. I think the banks would say they're bullish in Canada because our administration is finally showing some signs of, you now, and it was kind of imposed on us through the trade and tariffs that, you know, time to make. New trade partners and invest in Canada and maybe we get new pipelines and maybe we get tankers in the ports in B.C.

Pamela Ritchie [00:20:27] Is maybe enough.

Andrew Marchese [00:20:29] Well, I think right now it's people are – all the discussions and what we're reading in the media and whatnot are all the same in the sense that everybody seems to be saying and at least initially doing the right thing. So there's optimism that these things will get done. There will be new trade alliances formed between Canada and other countries. We recognise full well through our budget we have to put more money into defence spending. We have to get more stuff out of the ground. So I think there's optimism there.

Pamela Ritchie [00:21:01] So we're at that stage still. We're at this.

Andrew Marchese [00:21:03] We're at that stage, and this is a multi-year, multi-decade type of approach to things. So are we going to get better, significantly better in 12 to 24 months? No. The expectation is that maybe there's a, for lack of a better word, a regime change going on that we start thinking about our country differently than we have for the past 50 years.

Pamela Ritchie [00:21:22] In terms of the way it trades, I mean, which has already started.

Andrew Marchese [00:21:25] Who it trades with, how we kind of stick up for ourselves, changes in policy, changes in taxation, all that kind of good stuff.

Pamela Ritchie [00:21:37] With all that said, then let's take a look at the US. The tariffs came out, Liberation Day happened. A lot of stuff bounced right back up after a dark week there. But a lot came back. But there were investors who were scared right off permanently, too. What are some of the opportunities you see there?

Andrew Marchese [00:21:57] You know, a little bit of this is in hindsight, and admittedly, I was surprised on how quickly the market moved from a kind of a risk-off mentality to a risk on mentality. It literally happened over the course of a week or two, yeah. And in hindsight what happened was the market looked forward to both an immense amount of fiscal stimulus that is actually still, it's going to come into effect in first half of this year, and then... The effect on business and the consumer will lag thereafter, and then monetary stimulus as well. So you got two forms of stimulus, and the market kind of priced in the worst in terms of tariffs and then radically changed its attention to more what could happen in the years ahead because you had the fiscal and monetary stimulus coming, as well as the There's always a lot of oil kicking around the ground. And the Trump administration is going to do their best to keep oil at $50. And...

Pamela Ritchie [00:23:01] That seems to be a truth. I mean, there aren't a lot of truths out there, but the efforts towards that.

Andrew Marchese [00:23:07] I said that.

Pamela Ritchie [00:23:08] The goal of low oil. Yes.

Andrew Marchese [00:23:11] I think, I can't remember, I know I said it internally and I may have said it publicly as well that like February of last year, I said the one overarching consistency about Trump himself when he speaks, and a lot of this is the people behind the scenes in the administration who are pulling a lot strings, but the one consistency in the way he thinks about America and this love for the America of the 40s and 50s is it was built on cheap oil. Like, the one thing he really gets is... You want to help an economy or he wants to help his own cost, keep oil low. And this was before the recent events around Venezuela and all the sabre rattling with respect to Greenland and Canada. That was very consistent so they could, as he said, drill baby drill. And now with the U.S. Actions in Venezuela, there's the potential to keep it lower for longer.

Pamela Ritchie [00:24:10] Maybe we'll finish out on just allocation, what you might share, sort of your leaning into where fixing some is fitting into the overall portfolio. There are risks out there. There are concerns. Tell us a little bit about your allocation. I think.

Andrew Marchese [00:24:24] I think the one thing one has to watch is if we do get continued interest rate cuts in the US this year, we're pretty much mostly done in the rest of the developed world. But if we get more in the U.S., which the market is banking on at least two, it'll be interesting to see the reaction of the long end of the curve. If unemployment goes up in the us a little bit, it's probably a good thing. The 10-year yield has been range bound for about 12 months, in a pretty tight range thereof. But if you get too much stimulus and not enough economic weakness, I think the bond market will start to sniff that out, and you might see bond yields kind of move up.

Pamela Ritchie [00:25:11] There's a lot of stimulus in there from the one big beautiful dog.

Andrew Marchese [00:25:13] And you might get more on the monetary side. So interest rates on the long end could go from below fours to five. I think you start breaching five, you might have some problems and risk assets. So I think if you get more interest rate cuts, and depending on the environment in which you get them, you're gonna, this is my personal opinion, you would need QE to go along with that. You need yield curve control to go with that

Pamela Ritchie [00:25:38] There's a little bit in there already.

Andrew Marchese [00:25:39] Right. So you would have this environment where if you get that, you suppress that. At least in the short term, you could have a positive correlation between bonds and equities.

Pamela Ritchie [00:25:51] So with that, yeah.

Andrew Marchese [00:25:53] I think that's the one thing to watch. What Scott Bessent said last August comes to fruition, he wanted 150 basis points of interest rate cuts. I think you've had 25 or 50 since he spoke. So let's say you got 100 to come. I think your going to have to undertake some form of yield curve control if you intend to do that. So that has implications for how you think about your fixed income and investments and the mix, so to speak.

Pamela Ritchie [00:26:24] In the next, so to speak. Final message for institutional investors that are joining us today.

Andrew Marchese [00:26:29] You know, I would just say, like, we've had a great run in the markets and probably more so than most would have anticipated. Volatility will be higher because I think earnings and corporate profits have to do the line, share the lifting in terms of equity returns. It's going to be really hard to get much more multiple expansion from this point, both in the U.S. And the rest of the world. So right now, you know, the S&P 500 Wall Street estimates are for 13% earnings growth both this year and next. I think MSCI e-fee is about 8%, 9%. So that kind of puts if you assume no multiple expansion or contraction, that's kind of what you're looking at. You have to kind of say that's our base case of where the market could go from this point. So you have a positive earnings forecast backdrop. You have the lag effect of fiscal bill coming and probably more monetary stimulus coming. It's a hard environment to get too wildly bearish on.

Pamela Ritchie [00:27:32] Yeah, it really is. Right.

Andrew Marchese [00:27:33] Right, you know because you got

Pamela Ritchie [00:27:34] A lot of things holding you up.

Andrew Marchese [00:27:35] You got cheap oil, and you have some positive inflexion in both service and manufacturing economic data. So at least in the short term, despite the fact that risk assets are pricey, your discount rates are falling and are manageable on the long side. And you have pockets of hard asset price inflation going on, where if we continue You'll kind of live secularly in this. Digital regime building a hard asset regime, the value of those assets goes up. So it's not a bad environment. There's going to be a lot of hiccups along the way because you don't have the benefit of I would say much multiple expansion. So anytime you get worried about corporate profits, you'll probably see some volatility show up on the market.

Pamela Ritchie [00:28:28] So put your seatbelt on, but you could fly on here. Andrew Marchese, CIO and Portfolio Manager. Thank you for joining us.