Fidelity's Mark Schmehl | Portfolio Manager Commentary - May 2022

May 09, 2022 | Vito Finucci


Notes from FidelityConnects - May 3, 2022. Updates from Mark on tech, Tesla, energy and everything in between.

Let’s begin with your strategy. You did have a bit of a barbell between growth and value when we last spoke. Is this still the case?

  • Positioning has not changed much in the 6 months
  • A lot of resource cyclical and defence: utilities, staples, boring companies that people don't own
  • It is very different 2 years ago, but it is consistent with the way I see the world evolving
  • It looks like the portfolio will really work as the market moves into in late cycle

How you see those areas are having legs in late cycle?

  • I always like to go where things are getting better
  • Resource land is getting better: Devon and Nutrien reported a massive quarter. Meanwhile, Amazon had a terrible quarter, and the outlook is also terrible.
  • You've got this whole swing in the market from parts of the market that used to be great and are now less great
  • There are tons of cheap stocks with great earnings, so the market is not dying. It is a great time for active stock pickers

Can you please explain how to make a lot of money in late cycle given the right place?

  • This cycle is very similar to 2000 when tech coming off a super peak.
  • Similar to 2000, I own a lot of agriculture because of the same basic drivers - scarcity
  • The Fed is raising rates now, but it takes a long time to slow or speed up an economy. All of these things happen with a lag.
  • The economy is still growing in the next 12-18 months regardless what the Fed does
  • The tightness you're seeing in whole sections of the economy are going to remain or get worse, which is classic late cycle but very volatile
  • Stick with the names that are working. The market is much narrower, and you must be brave in your positioning

You talked about tech giants. We understand the Fed, we understand they’re longer duration stocks, share your outlook for tech.

  • Tech is never dead. The biggest part of the revaluation in Technology and is mostly behind us. The pandemic winners are all back to where they were in 2018.
  • The question you have to ask yourself is ‘do I buy it here’
    • Is Apple or Microsoft a buy right now? For me, I don’t think so because things aren’t getting better. They’re very much the same.
    • The fundamentals are good but not getting better and the estimates are pretty high.
  • The Fed is going to raise rates so your multiples aren’t going to expand. The tech sector is not going to be worse and I only like to invest things are getting better.
  • There are always bits and pieces. Tesla is better off from high energy scarcity but Microsoft, Apple and Amazon are boring
  • I can call any one of the 20 cyclical names in the portfolio and walk through the math and go wow, you’re going to make a lot more money than you think.
  • You speak to these management teams and they all say the same thing: they’re worried about the macro, because the headlines are awful
    • Then we ask them ‘what about your business? Are you seeing any weakness’ and the answer is always ‘God no, we’re so busy we can’t meet demand’.
  • So many investors invested in growth in the past 10 years and have no idea about a lot of these cyclical companies. There's a lot of portfolio managers and investors who just haven't been around long enough to remember this stuff from 15 years ago

Traditionally you invested in private companies where it was appropriate. And that was a lot of innovation. Where is that standing within the portfolio? Is that an area that you're looking to?

  • Private companies have raised enormous amount of capital near the end of last year. So there is tons of money trapped in the private world
  • The start-up market is not behaving rationally
  • I’m not investing in private market because they are too expensive. I can buy really great public software company 70% cheaper than some start-up company that may or may not work.

How does Metaverse pan out these days?

  • It is going to really matter. There are various companies you can invest in that are related to Metaverse
  • But you need pay attention to the price
  • It is hard to invest in those companies because it is hard to find the earnings and growth. It’s a lot easier to invest in a company like Nutrien (Fertilizer company, trades at 5x earnings and they’re buying back 20% of the shares and it’s incredibly cheap and estimates are too low) where you do not need to worry about the Fed
  • Metaverse is very interesting but hard to understand how these companies make money in the future and what I should pay for them today

Healthcare fits in defensive areas of the market. Tell us your view on healthcare and Biotech.

  • Covid destroyed hospitals/care. The volume at hospitals is down and may not recover for years.
  • There was this belief that it would bounce back but everyone’s exhausted and they’re just not bouncing.
  • Biotech is a mess because they raise capital all the time to fund their science projects. And we are in a market where capital is getting scarcer. Biotech is not a place you want to be.
  • Big Pharma looks great because they are not expensive; have nice portfolio and free cash flows. If you can generate free cash flow, you become instantly more valuable in a market where cashflow is being restricted by the Fed

The story of supply chain is related to geopolitical tensions. How is China lockdown affecting commodity prices?

  • China’s Covid Zero policy has reduced global demand by 20%.
  • China lockdown is a terrible news for the people in China but good news for market because we have a scarcity issue worldwide
  • Other commodities will pick up again because we don’t have any stuff

Could you explain what the differences are in terms of positioning for Special Situations and Global Innovators?

  • Global Innovators is a global growth fund whose benchmark is NASDAQ, whereas Special Situations fund and Canadian Growth Company fund are much more resource heavy
    • 60% of the Global Innovator’s benchmark is five stocks
    • Global Innovators will always have more technology and growth
    • Global Innovator is a go-anywhere mandate and find the best ideas
  • Global Innovators, Special Situations, and Canadian Growth Company should move very similar in general going forward

How do you see older world financials?

  • I don’t own a lot of financials because it is the wrong time to own it
  • The yield curve starts to flatten and financials suffer. I’m generally not a big owner of banks but there are a few times in the cycle where I own banks and this is not one of them.
  • My portfolio is mainly resources, staples and a little bit of growth around the edges
  • Eg: P&G

When you talk to management team, very smart people go into industries where they can make lots of money. Do you see people change in terms of hiring? Do you see people hire into resource industry?

  • We are so early in this cycle and no one believes this cycle
  • The management teams aren’t adding production
  • Nobody wants to work or invest in energy companies
  • This issue will be a multi-year (4-5 year) problem and people will realize that we actually need a lot of energy and we are not there yet

How do resources work through recession?

  • If you have recession you probably do not want to own these stocks.
  • But it takes a long time to slow economy down and we don’t have anything
  • Demand for houses is 100, supply is 8. If the demand drops to 80 and supply increase to 10, then the gap will still last

When will people start to invest in those resources?

  • It takes years to go through financing, building the plants etc
  • To bring on a new copper mine takes 10 years, to build a lumber mill in the middle of Georgia takes 3 years, to build up energy capacity we can all see peak energy coming in the future.
  • Who’s going to go out and spend $20B to grow a giant energy field? Nobody.
  • Even we have recession, they will still do well because there is no supply
  • Investment community is not there

What is your outlook on alternative energies?

  • It will get more and more investment
  • People are going to need them, especially for European who need to get off Russian oil and gas
  • It's one of the few growth areas of the market I think is going to win in this world of scarcity
  • If companies are cutting their budget when they have a lot of demand, then tech is not going to do well because people are going to cut advertisement budget. Facebook and Google will not do well

Why does tech do well in areas where there is a onshoring theme? Is that an area for growth?

  • There’s always somewhere you can invest in technology
  • Still secular themes: moving to the cloud, software demands etc.
  • Fed is taking the toys away by raising interest rates so you have to be very careful in this kind of market

How do you feel better positioned for the next cycle?

  • The next cycle is never led by the same things that lead the previous cycle
  • Leadership will likely not be tech, would likely be resources due to scarcity

You don’t have a lot of portfolio turnover in the last 6 months. Could you please tell us about your sell discipline?

  • I like to sell stocks that are getting worse and buy stocks that are getting better
  • I was way too slow to sell technology
  • It was a 10-year bull market, and it is very difficult to get off all your favourite stocks
  • How I like to sell the stocks is I like to own them over the cliff
  • I never want to try and pick a point and say it's over. Because then you tend to miss a lot of upside
  • I am very nimble and aggressive when it comes to selling. Getting out of things that are getting worse is a very good way to save people money
  • It helped me a lot compared to my peers like ARKK

Do you have a plan for the volatility?

  • I absolutely have a plan. I have a strategy and I know what worked last time. I feel confident in the way I build portfolio because it worked last time
  • This year I am playing more offense whereas I was playing a lot of defence last year. My vision is much clearer.
  • My vision is much clearer than it was six months ago. It feels good to be finding a ton of ideas and playing offense again.