Manager Insight

Fidelity's Patrice Quirion has been selling positions that he considers most vulnerable at this late point in the cycle.
By Michael Ryval | 05/07/18

With economies in a growth phase since 2009, markets have been generally trending upwards, with a few blips here and there. Yet Patrice Quirion, a portfolio manager at Toronto-based Fidelity Investments, cautions that there are signs that economies are in the late stages and it's time to de-risk, or minimize riskier exposures, in global portfolios.

About the Author
Michael Ryval, a regular contributor to Morningstar, is a Toronto-based freelance writer who specializes in business and investing.

The first concern revolves around inflation, which has been slowly surfacing, especially in strong economies such as the United States. "What characterizes the late cycle is that you slowly start to run out of excess capacity -- be it labour, manufacturing or commodity capacity. And as demand continues to grow, it puts pressure on prices," says Quirion, who oversees about $2 billion in assets, including the 4-star rated $590.9-million Fidelity Global Concentrated Equity.

Quirion notes that he meets between 600 and 800 companies a year, and over the past year he's heard an increasing number of corporations raising the point that labour inflation is becoming more of a factor. "Just look at the U.S., where unemployment is around 3.8%. There is not a lot of slack," says Quirion.

"As a result of these mounting inflationary pressures central banks are forced to react and increase interest rates, which means that at the margin growth becomes more difficult," says Quirion.

"In spite of that, confidence remains very high on the corporate and consumer side. Consumers are more willing to borrow to subsidize their spending, and companies are more willing to spend on capital expenditures and acquisitions. All of that is great. But you need to keep in mind that, at some point, those big-ticket spending categories reach a level where it's no longer sustainable."

One telling sign, Quirion notes, is when consumers replace cars or homes more often than the long-term averages. "You start to see excesses, which eventually need to revert to the mean. You don't know how long it will last. All this says that you are probably at an unsustainable level of spending," says Quirion, a native of Coaticook, QC, and a 13-year industry veteran who joined Fidelity in 2005 after completing a master's degree at Queen's University.

A case in point is housing in the U.S. Normally, the market can absorb 1.4 to 1.6 million units a year. "But we were building well in excess of two million in 2006," says Quirion. "You can't build two million units a year forever because there will be too many homes. The same applies to cars. You can build 15 million cars a year and at the peak of the market you produce 18 million. But it can't go on for 10 years because you will have too many cars on the market."

Quirion is not necessarily calling for an imminent end of this global economic cycle. "But we are getting above trend in quite a few areas, automobiles being one of those," Quirion adds. "However, we have to express some nuances on a geographic basis. For example, housing in the U.S. is not at unsustainably high levels. But in China it is. So we are starting to get signs that this [trend of moving to excesses] is starting to happen."

But when it comes to determining when markets are riskier, Quirion admits it is more of an art than a science. "Valuations are not massively high, aside from a few pockets of high-growth momentum stocks. We need to focus on the risk to earnings, as opposed to valuations. Since the choppiness we had at the beginning of this year, valuations are actually fair," says Quirion, adding that the benchmark S&P 500 Index is trading at 17 times forward earnings, which is not too far from historical averages. "The risk in the market is the risk tied to the economy that will eventually impact corporate earnings. Because we are nearing the end [of the cycle] markets are becoming riskier as a result of an economic cycle that is becoming stretched."

Given this perspective, Quirion has been gradually de-risking four portfolios under his management and selling positions that he considers most vulnerable at this point in the cycle. "Basically, I am out of the banking sector. Over the past year or so we have sold  JPMorgan Chase (JPM) and  Citigroup (C). The banks will be the most at-risk sector," says Quirion, who also manages the $197.2 million Fidelity International Concentrated Equity.

Similarly, he has sold semi-conductor makers such as  Taiwan Semiconductor Manufacturing (TSM) and Samsung Electronics, and industrial firms such as  Eaton Corp. (ETN) and Sweden-based Indutrade. Quirion has also sold holdings such as Chinese spirits manufacturer Wuliangye Yibin and gas distributor ENN Energy Holdings. "It's a relatively defensive business," Quirion says, referring to ENN. "But sentiment on China has turned so positive that valuations have doubled, although ENN's business has not changed that much."

Fully invested and running portfolios with about 55 names, Quirion has acquired more defensive, non-cyclical names. One example is U.S.-based ServiceMaster Global Holdings (SERV), a leading provider of pest control services to businesses and homes. "Restaurants still need to get permits and demonstrate there are no mice in the kitchens, regardless of whether the economy is good or not," says Quirion.

"It's pretty much a non-cyclical business. But they should be able to expand margins over time." Based on a combination of organic growth of about 5% a year and 5.5% free cash flow yield, Quirion believes the stock will compound at around 10% to 11% a year. While the firm does not pay dividends it uses its excess cash flow for acquisitions or share buybacks.

"In many cases, I'd rather see the company reinvest the capital in the business. Most of them can generate better returns doing that than giving me back the money [in dividends]," says Quirion. "I'm contrarian. But I am also very long-term focused. I think of investing as buying a stake in a company and owning it for a long time."

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