Has AI changed the outlook for 2024?

Lukasz De Pourbaix  
Hello, welcome to Sound Bites. Fidelity's monthly podcast where we talk about all things investments, and welcome to 2024. Hopefully everyone's had an relaxing break and feeling rejuvenated. And I'm pleased to be joined here by our illustrious equities team - Aussie equities team. To my left here, I've got Paul Taylor across from me, I've got James Abela and Casey McLean Thank you gents for for joining the podcast this month. 

Paul, James, Casey
Good to be here. 

Lukasz de Pourbaix
And so this month, we'll be really focused on what the year ahead might bring us, so a bit of an outlook. But before we get to the investment piece, I guess any bold predictions for this year? could be anything, whether it's sporting, any bold predictions and what we'll do at the 12 month point at the end of the year, we'll reflect on those and see whether any of them came true, but maybe I'll start with you, Paul?

Paul Taylor 
Broncos will definitely win the NRL grand final

James Abela
Queenslander

Paul Taylor 
They had a disappointing end to 2023. So I think 2024 is going to be much better for the Broncos. Brisbane Lions probably also I think will go one better in 2024. And the women's Brisbane Lions will stay on top. So one will stay at the top, and two will get to the top.

Lukasz De Pourbaix 
So there's a common theme there. Something to do with Queensland I think?

Paul Taylor
These are the easiest predictions I’ve ever made.

Lukasz De Pourbaix
Casey?

Casey Mclean 
Well, on the sporting ones, I'm pretty sure New South Wales will win the State of Origin. But broader than that, I think it's gonna be a year of surprises in elections. There’s about 40% of the global population has an election this year. And I wouldn't expect all of them to go with the odds. Expect some surprises there.

Lukasz De Pourbaix  
Absolutely. And James,

James Abela  
I think inflation is probably the big one that's on everyone's head right now. And the US and the UK have come down to towards 3%. And can Australia do the same as the is the thing? so that for me, I mean, if we are following the UK in the US, and we're six months behind, inflation should be below 3% in Australia within the next six months. 

Lukasz De Pourbaix
Wow. 

James Abela
That will be that will be a surprise. But yeah, that's what that's probably a prediction that I think is an interesting one.

Lukasz De Pourbaix    
Okay, so I've got a mixed bag of predictions there. Basically Queensland's gonna dominate everything

Paul Taylor
Except state of origin

Lukasz De Pourbaix
And inflation. We might kick off with these if we reflect on on last year. And sort of thinking ahead. Last year very much was a market focused by macro, big thematics. James, you mentioned inflation. If we're heading into the next sort of 12 months, do you think those big macro factors will continue to play as big a role as they did last year? Or are we maybe heading into a different environment? For 2024?

Paul Taylor  
Yeah. So my prediction is to move into a different environment, I think it will be about bottom up stock selection. I just think as some of those variables start to stabilise, I think people will move away from trying to predict, you know, as interest rates going up or whatever, and actually focus down on the company. And that's in the long run. That's what drives value. That's what drives wealth creation. It's, you know, is their company going to sell more products? What's their strategy like? How are they rolling out around Australia around the world. People will focus back on bottom up issues that are very company specific, because you get some stability in those macro factors. I think that's just where, you know, where attention moves. And, you know, I can definitely see that. I think there will be a change of approach in, you know, in 2024. And it will be all about, I think it will be all about the bottom up 

Lukasz De Pourbaix  
the bottom up. Yeah. Casey?

Casey Mclean    
I think, you know, the headlines are writing themselves already that, you know, 2023 was the year of interest rate rises, 2024 of interest rate declines. But you know, what that means for markets is still uncertain, because about half the time when they were in the interest rate cutting environment, market goes up, the other half goes down. The key differentiator really is whether we're in a recession or not. And if we look at the predictions at the moment, the median of economists it's about it's 50% in the US and 40%, for Australia. So yeah, hopefully, yeah, those predictions, the probabilities come down and the markets rally and, and I think the best sort of environment is more of a less directionless market so we're in 2023 and more trending sort of market where we can go down and find the best stocks that outperform in those environments. 

Lukasz De Pourbaix   
And James, your perspective because obviously you cover Aussie and global equities. Any other sort of observations? 

James Abela  5:18  
At the moment, the US market has really been leading the world back into recovery. But then unemployment was, you know, a bit different So, the economics is still a bit uncertain. But the big thing is definitely the bond market and refinancing risk in small caps is definitely globally and domestically still a significant focus. So if the bond markets, you know, can lead us into better times and have less risk, then probably, the recovery will continue on. Will the cyclical recovery continue? The last few months has been industrials, financials, consumer tech has all been pretty positive, its earnings, but it definitely will be more bottom up, as Paul mentioned. So therefore, what you do is you move to duration, and that means you can move out and valuation dispersion. And that's probably what 2024 is likely to be if the bottom up is fine, and we don't have the recession or the slowdown as Casey’s referenced, bond markets are positive, then I think durations and valuations start to expand. And then that'll all come together in 24.

Lukasz De Pourbaix  
So very much seems like it's potentially going to be much more of a company specific bottom up, driven market than what we maybe had last year. If we think about the year ahead, I mean, every year brings us sort of the unexpected things that we don't really anticipate. Last year, obviously there are geopolitical tensions, we have the conflict in the Middle East kickoff, and so forth. So it's there's there's always that that sort of X Factor, if you sort of think about the year ahead. And I know Casey, you've sort of alluded a little bit in terms of you know, there's a lot of elections happening, notably the US, whether we do or don't see Trump maybe get back into power. I mean, all of these things, obviously can have an impact. What are some of the things that in your mind, the key things to look out for in 2024?

Casey McLean 
Yeah, I think yeah, elections is definitely going to be a big one. US is one, and if Trump comes in he’s said, he's going to tear up the IRA, which would have big impacts on the whole electric vehicle value chain, if that does happen, and really shift the landscape there quite a bit. I think, you know, Taiwan elections, probably a smaller economy, but just as critical for the whole geopolitical tensions around the world that takes place this year, as well. And India, you know, the world's biggest democracy there, they've got one as well. So they are going to be interesting, and I don't think it's all going to go to script. But I think one thing that we have to be sort of wary of is that the consumer and businesses have been really resilient over the course of 22 and 23. Given they built up lots of cash reserves, cash buffers from fiscal handouts, you know, they locked in low interest rates with 30 year mortgages in the US and extended their debt with the corporates. But yeah, a lot of these defences are weakening, you know, they've run through a lot of those excess savings. You know, a lot of companies are reaching bond maturities, need to refinance need to refinance at higher rates. So, you know, mightn’t  be a recession. But, you know, there could be, you know, an impact on growth and  it's a long elongated period of slower growth, and slower consumption as well. But yeah, I think that's  one area of potential negativity. But at the same time, there's some cyclical type companies and sectors that have been in a downturn for a long time they've had they've had their recession, their earnings are at trough and they look much more attractive than some other segments.

Lukasz De Pourbaix  
James ?

James Abela   
Yeah, it's, yeah I don’t know, it's just the hard one. Yeah, whether the trends can continue is really just the key question. So the industrials property strength  has just  been a real surprise. So Seven, Boral. CSR. All of these had really strong results, really strong AGM updates. And that just signals, you wouldn't expect them to have pricing power. But I do think during the year, it's going to go back to these fundamental things of pricing power, and the market structures of businesses because they're the things that valuation dispersion is kind of extending. But whether that can continue on and market structures will allow you to continue on to push through prices. So I think competition will probably rear its ugly head in 2024 a bit more because it hasn't been very competitive in 23, because it's been very patchy. But I do think if the economy does strengthen, then competition will probably start to contain that enthusiasm for just margin expansion and recovery and everything's kind of good environment. So that's what you know, something I'll be looking out for definitely in 24.

Lukasz De Pourbaix   
Just interested to explore a little bit the concept, you know, the notion of recession. Because, you know, from  a global perspective, probably Fidelity has a 60% probability on a, what we call a cyclical recession, about 20%, soft landing type of scenario. If we do head into potentially a, let's call it a cyclical recession, what does that actually mean for markets? What does what does that type of environment mean for markets and stocks?

Paul Taylor  
Well, I mean, obviously, a recession is not good for stocks, although the market does look ahead well ahead of the economy. So if you should go into it, the markets already expecting it. Actually, once you go into a recession actually could be, it could be a reversal. So it sort of depends. So the there's a couple different factors, well, what's priced in? What are people expectin?, so if we're, if we're not expecting a cyclical recession, you get a cyclical recession, it will be negative. If we are expecting a cyclical recession, and it's probably already priced in. Are we expecting a deep cyclical recession or just a very shallow recession? And I would also put, I mean, I guess the point to bring out on that is also Australia relative to the rest of the world. So in that, that probabilities is maybe referring to the sort of bigger markets of the US and Europe, and maybe less so Australia, I think our  base case is still very much not recession in Australia. But yeah, so to me, it's all about, you know, expectations going into that as well, you know, where does it come out relative to those expectations?

Lukasz De Pourbaix
Casey, James, anything to add? 

Casey Mclean 
Yeah I just think, regardless of whether we do have this cyclical recession, or soft landing or not, what I think is definitely off the table is a deep sort of balance sheet type recession that was around the GFC. Yeah, households in general, around the world are in pretty good shape. corporate balance sheets, financial companies, balance sheets, they're all in good shape, there's no distress there. So if it is a cyclical recession, I think it's relatively shallow compared to previous cycles. And yeah, it does, like Paul says, come down to expectations and when price to that point, and, and how the market reacts to that. But it should be a relatively benign compared to some other cycles.

Lukasz De Pourbaix  
So when you're sort of, I guess, because you've got the luxury of actually meeting a lot of the companies meeting the on the ground sort of operations, and so you're really close to the market. And from that perspective, if any of you sort of feeling that, you know, across the companies that you cover that that from a management perspective, they're sensing a recession or not, because that bottom up is really the thing that will drive  the market

James Abela  
Yeah not in my world. It's mean, the ones that have been really affected have been the ones that are labour constrained and cost constrained. They've had very big downgrades. So things like healthcare services and industrial services, where they're very labour intensive, they've had, you know, very poor profit warnings, it's been a very, very difficult environment. But that's, you know, a small portion of the market. But overall, things are kind of still okay, like we mentioned, it's still been okay. And for the portfolio, it's how much you want to expose yourself to beta or the recovery. If it's going to be a shallow recession, and valuations are attractive, then you do go through to consumer, financials, tech and industrials. But if it is, you know, if it is a recession, or it is a smaller slowdown there, maybe you want to go through to something like staples or through real estate. And the last in a little while real estate has kind of taken on the positive market sentiment shift. And it's actually rallied pretty well, because it is affected by capex, it's affected by labour, it's affected by cost of capital. And it's affected by discount rates and valuations. So if you do have peak rates, peak inflation, all of those become, you know, less bad for real estate, and a lot of them are trading at a 0.75 - 2.8 x Book or NTA. So that kind of may be more interesting then if we are in a different kind of environment. But I think it's a matter of how much you want to, I guess expose yourself to the betaand the recovery if the recession isn't, as Casey mentioned, as deep as you think or is expected.

Casey Mclean  
I’ll also just add, I think sort of differentiate the risks based on goods versus services as well and, and I think goods exposed companies have probably already seen their recession. You look at Germany, very much a goods exposed companies, with a huge auto market,  export markets and you know, they've had PMIs in the 30s, which signals a deep recession. But now there's there's probably most of the way through that. China is getting less bad. It's still not good, but getting less bad in their macro conditions as well. Whereas services exposed economies, companies have been doing much better in Australia, the US as well. And that, yeah, potentially they see a slowdown, but still be more resilient and type exposed companies can recover.

Paul Taylor  
Yeah, yeah. I'd also say, Look, I'm probably fit when we meet with companies, I'm probably focused on slightly different factors. So I'm not sure I mean, some are better than others. But I don't know whether companies themselves are good at predicting demand., I mean, they'll see it when it happens, They're like everybody else we know when we're fearful or excited. And I just don't think, I didn't necessarily put a lot of stock when I talked to the management team. And you know, our approach is waterfront coverage, we were meeting with the, you know, pretty much the entire market every quarter, and updating our earnings, cash flow valuation model, balance sheet model every quarter. So it's an important part of it. But I don't know whether the companies themselves always see that. I guess, where I'm more focused is sort of what their intentions are. And I think that's always the interesting thing. So companies will have as, as conditions stabilise, and they get a little bit more certainly they'll often, they'll have a better assessment of projects. So they'll start doing things. So they'll, what I'm normally trying to get at them as what their intentions are, what is their capex? What are they going to be doing? How are they going to be expanding? You know, I think, a really interesting topic and 24 is also going to be things like artificial intelligence. How are companies integrating artificial intelligence in their process? That's  really interesting. Now, that's not going to tell you, you know, what the demand is, but it's telling you about their cost base, it’s telling you about how they're meeting the market. It's telling you about their strategy, how good the management team is, as well. You know, automation on some of their production. So, yeah, well, when I talk to the company, they're the things I'm always interested in. Because I don't I don't know whether they have a really good read on predicting what's going to happen over the next year. But they obviously do have a very good read on what they're going to do capex, artificial intelligence, automation projects.

Lukasz De Pourbaix 
Great, we might, we might sort of get a bit of bit of predictions bit of sort of, I guess, views on the next 12 months from a stock perspective. And I guess what it'd be interesting to explore is, you know, maybe one or two stocks that you're most excited about for the next coming 12 months, and why.

Paul Taylor  
Yeah, so for me, it is, you know, so like I said, I'm it is very much focused back on individual stock selection, I think, you know, that will be, you know, that will be an exciting prospect.  I'd also be very focused on the broadening of the market. So, if you go back to 2023, was a very narrow market. You know, we talked about the Magnificent Seven, there was a few stocks that really …technology was the best performer in, you know, in 2023, as well. So, look to me, first of all, I think there will be a much more broadening as things stabilise, but very much on individual, an individual rollout as well. You know, some of the companies that are the biggest in the in the portfolio, for me, anyway, are companies like companies like SEEK, which I think as a great long term, so once again, these are not, when I look at these companies, I'm not thinking about 2024, I'm actually thinking about the next five to seven years. Right. So that is to put it in that context. So I think SEEK has a fantastic model, they dominate the recruitment space, I think learning will be an important, you know, they're sort of online learning will be an important part of it as well. A way to train people because I think, if you think about the big thematics, probably, as I was growing up, a lot of people were still in a job for life. Now, I think the young ones realise that industry is going to get disrupted. People will change jobs multiple times. So all of a sudden if you if you've gone from a job for life to now 10 jobs, that's that's they've just multiplied their revenue by 10 times. And you have to get retrained each time. So to me there's a few different questions that come out of that, which is you know, so how does change education for a start? So you get, you know, does that, you know, you might go to university or r whatever training you do, which is more general. And then you have to retrain as you as industries get disrupted, and you move from industry and you move jobs, there's a whole lot. And so they think about that from a sort of adult, ongoing education that there's going to be an interesting dynamic, and just the rotation of rotation of jobs will be will be important as well. So to me, it's those sorts of, but like I said, I'm not focused on them for 2024. I'm focused on them for the next five to seven years on those some of those bigger trends. I talked about artificial intelligence, I think that's going to be really important in you know, sites like SEEK as well.

Casey Mclean    
Okay, so yeah, I don't say preface my stock selection here with that same longer term view that Paul has as well, but once I think you can do well, both longer term and potentially in the in the in the near term, as well is, is SiteMinder. Who do software for hotels channel management software, which allows smaller hotels, you know mum and dad type hotels, to plug into the 400 Plus online travel agents, so the Bookings, the Expedia’s of the world. And it's really about efficiency for them. Firstly, and this is taking away from a manual process of pricing rooms, managing inventory that they do in Excel. But it also means that they can have better pricing, they can see what's ,going on in the market and maximise their revenue. And if you think if travel has had a great period, revenge travel coming out of COVID, and if that slows down, you know, the emphasis is going to be on cutting costs maximising revenue. So in the short term, it could be well supported as well. And they're adding a lot of hotels in what's a really quite low, lowly penetrated industry at this point. But longer term as well, I think they have really good prospects in your first year, that penetration is going to grow. But secondly, their ability to monetise, is increasing, they've got such a wealth of data, some of the best data in the travel industry, or the hotel industry, that they can use to do AI, predictive pricing based if you got a state of origin, for instance, and the demand around you know, Homebush is going to increase on these periods that you should price up accordingly. And, and they're changing their model slightly to be taking a cut a small, very small cut of the revenue that the hotels,  make out of their system as well. So it's a company that's it's a loss making currently it should in on their guidance, reached breakeven... So I think they've got a really quite a good long term and short term runway

Lukasz De Pourbaix  
James, for yourself.

James Abela 
Yeah, I'll stick with one that I've had for many years over the decade of the fund have held it for a very long period of time, which is Altium, ALU.  It's in that Internet of Things and artificial intelligence environment, it's the software that designs, PCB boards. It'll be in everything, it touches, so many different things that we have in the world in terms of technology. And it'll be around for many, many years, it's been a huge success story for 10-20 years. It has great financials a very high return profile, very high cash flow, had 15 - 20% growth for the last, you know, many, many, many years and the next few years expected. The market structure that it's in is very tight. There's only three or four players in the world that actually does what it does. There was a takeover offer from Autodesk towards Altium. In the last couple of years. The CEO mentioned he spoke to Google as a takeover 10 years ago, it is in a great space. And provides a great service for the world, to design a PCB board with multiple countries, multiple engineers for a product that might be made in different country, but it's designed for chips designed all around the world. So Altium is for me. Yeah, probably the most exciting and interesting one that I've had for many years and will have hopefully for many years as well.

Lukasz De Pourbaix  
Fantastic. So we might sort of leave it there. But I think what I really got out of this conversation was a couple of things. And one is that we may be, in 2024 maybe will be an environment of where the macro dominates less, where we're possibly back into a really bottom up stocks specific market environment, which is really exciting for active managers 

James Abela
Stock pickers

Lukasz De Pourbaix
Yeah - such as Fidelity. And I guess, some of the other things is the breadth of the market again, and if we sort of cast our minds back to 2023, there were very narrow parts of the market that did well. And the more breadth of the market in terms of what could do well, again is a real, real interesting opportunity for long term investors. 

So thank you very much. I think that was the A great discussion in terms of what the year ahead may bring, and we'll definitely keep an eye out on the Broncos to see if they do win that premiership. So, thank you gents, thank you for joining us and for the listeners out there. Thank you for taking the time. If you like what you hear, please hit subscribe on whichever podcast platform you are using. And if you would like to get any more information regarding Fidelity, please have a look at our website www.fidelity.com.au