Fidelity Investments Roundtable: Three Key Themes for 2015

leadership series           market perspectives

                                                                                                        First Quarter 2015

Fidelity Investments Roundtable:
Three Key Themes for 2015
The presidents, chief investment officers, and other leaders within the investment divisions at         key takeaways
Fidelity Investments gather regularly to discuss market conditions, significant risk factors, and
other dynamics driving the performance of the financial markets. In the Fidelity Investments            •   Slowing demand and rising
roundtable that took place in December 2014, our investment professionals discussed three                   supply could make oil prices
key factors shaping the outlook for the financial markets in 2015: oil prices, the strength of              stay within a lower price
the U.S. dollar, and the potential for higher interest rates. Brian Hogan, president of the Equity          range for much of 2015.
Group of Fidelity Investments, moderated the discussion. [Note: The following views represent           •   The U.S. consumer sector
those of one or more individuals, and should not be considered as the collective view of either             is likely to be a clear
Fidelity Investments or any particular investment division.]                                                beneficiary of lower oil
BRIAN HOGAN (Moderator): Let’s start off with what’s in the news lately. Oil prices have                •   The U.S. dollar may be
recently hit a cyclical low, and may go lower. Do you think these low prices are sustainable?               at the beginning of a
                                                                                                            strengthening cycle, which
TIM COHEN (Equities): Many people are expecting a strong price rebound in 2015, and that we’ll              could support U.S. large-cap
see oil climb back up toward $100 a barrel. I’m not in that camp, because underlying demand growth          and mega-cap stocks.
has been slowing while supply has been increasing. In the developed world, alternative sources and
                                                                                                        •   U.S. stocks are generally
energy efficiency have been flattening the need for oil. Most of the actual demand growth has come
                                                                                                            favored; however, European
from emerging markets, particularly China, but even that has been slowing down. On the supply side
                                                                                                            equities, which are starting
of the equation, the U.S. has added a tremendous amount of production in a short time due to the            from lower valuations, may
success of shale drilling—something like a million barrels a day, more than 10% of our total output.        reach a tipping point in
Saudi Arabia has decided not to cut production for now, and other OPEC nations may be cheating              2015 and show unexpectedly
a bit by overproducing on their quotas. With supply likely to remain greater than demand, I don’t           strong returns if the
envision seeing the price spike back up again in the near term.                                             consensus view is wrong.
                                                                                                        •   Despite a consensus that
BRIAN ENYEART (Global Asset Allocation): One of the things people were saying when OPEC did
                                                                                                            short-term interest rates
not cut production was that this could be a game-changer, and that we haven’t seen anything like            will rise around midyear, the
this before. But we actually have seen something similar, back in 1998. When OPEC chooses not               pace of later increases and
to cut, you get a temporary glut, prices stay low, and the high-cost producers are gradually driven         the impact on long-term
out of the market over the course of 12 to 18 months. That process eventually leads to supply               rates is less certain.
matching demand, which stabilizes prices. If that historical pattern holds, we could very well see
low oil prices throughout 2015 while the high-cost producers decide whether they really want to
continue making capital investments in the hopes that prices will rise.

COHEN (Equities): Shale oil could change that timing a little bit because the production cycle is
much faster—the time it takes to drill a well and start pumping oil from a shale formation is much
shorter than other U.S. production. Also, the wells deplete faster, so if companies stop drilling new
wells, production could drop more quickly. However, shale production may turn out to be economical
at the current price range, and many of the U.S. producers are already hedged through next year. So
they’ll likely continue to produce for a while, regardless of the current market price.
HOGAN: What would extended low energy prices mean for                   seeing some job growth. Historically, betting against the U.S.
    investment portfolios?                                                  consumer’s spending habits has never been easy.

    PAM HOLDING (Pyramis Global Advisors): When it comes                    HOGAN: The consensus certainly seems to be that the U.S.
    to the energy sector, many of our portfolios have lately been           dollar will stay strong and likely get stronger in 2015. Anyone
    relatively defensively positioned, either underweight the sector        want to differ from that consensus?
    or, in funds that are sector neutral, very carefully positioned.
    In addition, we’re thinking defensively on industrials as well,         DEREK YOUNG (Global Asset Allocation): If you look at
    because a lot of industrial manufacturers’ revenues are tied to         central bank policy, with the U.S. tightening while other major
    the capital expenditures of the energy industry. Many of those          economies are doing the reverse, it suggests we’ll have a
    manufacturers built up large inventories in anticipation of a           stronger dollar for an extended period. We’re only two or three
    spending boom driven by shale production. So even though                years into this strengthening cycle. Although past performance
    lower energy prices might be good for industrial production             may not be indicative of the future, the last one lasted much
    outside the energy industry by lowering input costs, we may see         longer, from 1994 to 2001.
    some real dislocation within the sector if energy companies cut
    capital spending.                                                       DESANTIS (Equities): At that time, the U.S. benefited from
                                                                            a wave of globalization. Companies were able to drive costs
    JOSEPH DESANTIS (Equities): There are always second-                    down while revenues went up due to increased U.S. demand,
    derivative impacts around such an energy price move,                    which created a huge tailwind for their earnings and the equity
    whether it’s production of pumps, or compressors, or even the           market. What makes the current dollar’s position seem even
    demand for steel itself. Lower energy prices can increase the           more unique is that last time this happened, the Germans (euro)
    differentiation of performance within certain sectors, which            were also trying to maintain the strength of their currency. Now,
    may improve the environment for active stock-pickers. For               virtually no currency union or country is really trying to do that.
    example, industrial producers of energy-related equipment               Hence, I think the surprise might not be that consensus is
    may have been facing challenges, as Pam said, but then the              wrong, but that the dollar strengthening cycle goes further, or
    transportation industry, which is in the same sector, has been          lasts longer, than most people expect.
    greatly benefiting from lower fuel prices. Another question
    is, if the job growth that has been coming from energy and              TOM HENSE (Equities and High Yield): If so, that could be a
    industrials slows, will it shift someplace else? I think we’ll likely   big issue for emerging-market (EM) corporate debt in particular,
    see a shift to job creation on the consumer side.                       because a lot of big EM companies, especially investment-grade
                                                                            or near-investment-grade, have borrowed in dollars but generate
    BRUCE HERRING (Global Asset Allocation): I agree—and I’d                their revenues in local currency. A strengthening dollar makes it
    add that lower energy prices directly translate to a significant        hard to keep up. Sovereign debt may be challenged by a strong
    transfer of wealth from producers to consumers, which is a              dollar also, but to a lesser extent than corporate debt, because
    huge boon for the U.S. consumer. In particular, lower energy            sovereigns can usually reduce spending, draw upon reserves, or
    prices tend to be very helpful for the middle class, who then           sell assets to keep up.
    tend to channel that money back into the economy through
    increased consumption. So the U.S. consumer discretionary               COHEN (Equities): It’s always a little worrying to be part of the
    sector is likely to benefit from lower energy prices.                   consensus view, but I have to admit I see a lot of reasons for
                                                                            the dollar to continue appreciating and very few for it to go the
    MELISSA REILLY (Equities): You can come up with a scenario              other way. That makes me wonder about the implications from a
    in which the U.S. consumer sector accelerates greatly, which            portfolio standpoint. The last time we had a strong dollar for an
    usually helps out Europe as well. European companies that               extended period, large-cap stocks tended to outperform small-
    export to us typically end up following closely behind as               caps. And not only did large-caps beat small, but mega-caps
    the consumer sector improves. We haven’t seen that rapid                beat large-caps. This outperformance for large-cap stocks was
    acceleration just yet, and there’s even an argument that the            driven mainly by an increase in the price-to-earnings (P/E) ratio
    cycle may have changed because in the U.S., spending and                for mega-caps, perhaps because investors looking for exposure
    saving patterns for the generations after the baby boomers              to a strong U.S. dollar were attracted to the strong liquidity and
    might be very different from what we have seen in the past.             well-known global brands of many mega-cap companies.
    But I think it’s more likely that we’ve been observing a period
    of U.S. consumers paying off debt and saving as a response              HOLDING (Pyramis Global Advisors): One of my biggest
    to the recession, rather than a demographic shift in habits.            concerns for the year—and this conversation is heightening
    People may be ready to return to spending, now that we’re               it—is what if consensus is wrong for 2015, as it was about rate

increases in 2014? I know consensus is always in flux, but the           curves for Treasuries and high-quality municipal bonds are still
    market seems to agree for now that the U.S. is still the best            remarkably steep. Often, when the Fed has started on the path
    place to invest. I don’t necessarily disagree, with the strong           of tightening, it has continued down that path for a while, which
    dollar and the likely higher rate environment. But perhaps               has prompted a dramatic flattening of the curve, bringing short-
    those factors are already accounted for by the market. Perhaps           term and long-term rates closer together. For the most part, our
    the focus on the favorable U.S. backdrop is taking attention             view is that while short-term rates will likely go higher around
    away from other regions that might have an even more positive            midyear, we are not convinced that the first move will be a
    inflection over the course of the year. For example, P/E ratios          harbinger of hundreds of basis-point increases to follow, or that
    have been more attractive in Europe for some time, and it                the yield curve will flatten out as quickly as it has in the past. So
    seemed like we would see a positive tipping point last year,             the challenge we face is in positioning well for the volatility we
    at least until the geopolitical unrest in Ukraine. We may see            expect as the market reacts or overreacts to policy signals.
    European equities achieve unexpectedly strong returns this
    year, thus providing even better opportunities for investors.            HOGAN: Do you think we’ve entered a new rate environment,
                                                                             where investors can expect to see many years of rising rates?
    COHEN (Equities): A year ago, valuations were pretty level across        Or should we expect a more gradual type of tightening?
    the board—the U.S., Europe, and Japan all looked similar, at
    prices around 15 to 16 times earnings, and EM markets looked             THOMPSON (Bonds): Overall, we don’t yet see the kinds of
    cheaper, at 13 times earnings or so. The spread has definitely           conditions that would set us up for a multiyear, secular cycle
    widened, with the U.S. increasing a little, EMs decreasing a little,     of rising rates. Part of our skepticism may be because we are
    and Europe and Japan relatively flat. That’s overall, though. When       at the lower end of the Fed’s target range for inflation. Combine
    you look at valuations on a company-by-company basis, and find           that with the U.S. market’s strength relative to the global
    a good company with strong growth prospects in an emerging               economy, and it’s hard to justify raising rates over a
    economy like India or China, it’s not 15 or 16 times earnings.           sustained period.
    It’s more like 18, 20, 25 times earnings. Valuations are lower in
    domestic-focused European companies, but I think that reflects a         HERRING (Global Asset Allocation): I worry more about the
    sentiment that the economy there will remain depressed. So the           global rate structure, and the pull of U.S. rates downward
    question becomes whether European industries will remain below           toward global rates rather than the other way around. Look at
    their long-term trends, and for how long.                                rates across Europe, and it’s clear that even as low as we are, the
                                                                             U.S. is still the most attractive developed market for bond yields.
    HOGAN: In 2014, the Federal Reserve (Fed) ended the U.S.
    quantitative easing program. The Fed has lately signalled a              HUYCK (Money Markets): I think part of the issue is the
    willingness to raise rates in 2015, and the market seems to              similarity in monetary policy across the globe, as major central
    expect this rate “liftoff” in the middle of the year. What do you        banks are aggressively easing and putting downward pressure
    think the implications of higher interest rates will be for investors?   on rates. With structural and regulatory issues in Europe, China,
                                                                             and Japan that might take decades to resolve, I think we are
    TIM HUYCK (Money Markets): I think the potential for higher              going to see a very challenging environment for sustaining high
    rates, and for some volatility of rate expectations, will be good        interest rates over the next five years or so.
    for money market investors. If you look at the Fed funds futures
    market, you can see that the market generally expects the first          LISA EMSBO-MATTINGLY (Asset Allocation Research): I agree
    rate hike to be in the July to August 2015 time frame. However,          that changes are likely to be gradual, and I’d add that the size of
    there’s much less consensus about the pace of tightening after           the Fed’s balance sheet might make it difficult to follow the usual
    that, with the futures market suggesting a much slower increase          playbook, so raising rates might not be an easy task. There is a
    through 2017 than the actual Fed Open Market Committee                   lot of market complacency around the idea of liftoff, a sense that
    predictions. Right now, the market seems to believe the Fed              the Fed is going to raise rates a little bit and it won’t be a big deal.
    will tighten slowly because headline inflation is low, but the           But don’t forget that from a global perspective, changes can have
    Fed has been clear that it plans to look at the economy overall,         an effect way out on the peripheries, and sometimes things can
    which includes ignoring the effect of falling energy prices on the       break unexpectedly when U.S. rates go up. Russia might be a
    inflation numbers. Given these circumstances, I think we should          good example—it’s very difficult to predict the full ramifications of
    expect to see some volatility around expectations for shorter-term       even a small rate increase, and that’s something we’ll be watching
    rates while they gradually rise.                                         closely in the coming year.

    CHRISTINE THOMPSON (Bonds): For bond investors, we’re                    YOUNG (Global Asset Allocation): I don’t think you can
    looking at the whole yield curve, at both short-term and long-           underestimate the importance of U.S. Treasury debt as the
    term interest rates. Even after some flattening in 2014, the yield       “flight to quality” investment choice. So whenever you have a

global crisis or concerns, you start to see U.S. yields supported           economy’s continuing mid-cycle expansion, while Treasuries
    by foreign investment.                                                      rise due to very low bond yields in Europe and elsewhere.

    HOGAN: How do equities fit into this dynamic?                               HOGAN: Thank you all for sharing your thoughts. To summarize:
                                                                                It seems as though as a group, we expect oil prices to stay
    ANGELO MANIOUDAKIS (Global Asset Allocation): I think                       relatively low, the U.S. dollar to remain strong, and short-term
    the recent relationship between Treasuries and equities has                 interest rates to rise gradually in the U.S., but with some market
    been very interesting, and different from what we have come to              volatility as rate expectations adjust. Although none of these
    expect. A couple of years ago, it was more of an either/or choice           themes suggests obvious market upheavals, careful positioning
    for investors, “risk on” versus “risk off”—buy equities versus              in energy, industrials, emerging markets, and bonds may be
    buy Treasuries. With so many foreign buyers of Treasuries,                  prudent. Equities in the U.S. and in developed Europe, and the
    that market dynamic seems to have shifted a little. So we may               U.S. consumer sector in particular, might benefit most from
    see a situation where U.S. equities continue to rise due to the             these themes in 2015.

    Fidelity Thought Leadership Vice President and Senior Investment Writer Vic Tulli provided editorial direction for this article.

    The following are regular participants in Fidelity Investments’ roundtable sessions:

    Bob Brown                                                                   Jeffrey Lagarce
    President, Bonds                                                            President, Pyramis Global Advisors

    Tim Cohen                                                                   Angelo Manioudakis
    Chief Investment Officer, Equities                                          Chief Investment Officer, Global Asset Allocation

    Joseph DeSantis                                                             Jeffrey Mitchell
    Chief Investment Officer, Equities                                          Head of Research, Global Asset Allocation

    Lisa Emsbo-Mattingly                                                        Charlie Morrison
    Director, Asset Allocation Research                                         President, Asset Management

    Brian Enyeart                                                               Stephanie Pierce
    Chief Investment Officer, Global Asset Allocation                           Executive Vice President, Investment Product Development

    Tom Hense                                                                   Nancy Prior
    Group Chief Investment Officer, High Yield and Equities                     President, Fixed Income

    Bruce Herring                                                               Melissa Reilly
    Group Chief Investment Officer, Global Asset Allocation                     Chief Investment Officer, Equities

    Brian Hogan                                                                 Chris Sheldon
    President, Equity Group                                                     Chief Investment Officer, Private Wealth Management

    Pam Holding                                                                 Christine Thompson
    Chief Investment Officer, Pyramis Global Advisors                           Chief Investment Officer, Bonds

    Tim Huyck                                                                   Derek Young
    Chief Investment Officer, Money Markets                                     President, Global Asset Allocation

Past performance is no guarantee of future results.                          update any of the information. Fidelity cannot be held responsible for
    Generally, among asset classes, stocks are more volatile than bonds          any direct or incidental loss incurred by applying any of the information
    or short-term instruments and can decline significantly in response to       offered. An individual’s investment decisions should take into account
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    including leveraged loans, generally offer higher yields compared to         situation.
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    be more volatile than those of larger companies. Foreign markets can be
                                                                                 Pyramis Global Advisors LLC is a division of Fidelity Investments.
    more volatile than U.S. markets due to increased risks of adverse issuer,
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    Views expressed are based on the information available as of
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    There is no guarantee that the trends discussed will continue.               & Workplace Investing (PWI), Fidelity Family Office Services (FFOS), or
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