Fidelity Equity-Income Fund Q3 2024 Review (undefined:FEQIX)

Performance Review

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For the quarter, the fund gained 8.35%, underperforming the 9.47% advance of the benchmark, the Russell 3000® Value Index.

U.S. value stocks rose in the third quarter due to resilient corporate profits, the promise of generative artificial intelligence and the Federal Reserve’s long-anticipated pivot to cutting interest rates. Amid this favorable backdrop for higher-risk assets, the index continued its late-2023 momentum and ended September just shy of its all-time closing high. In a reversal from last quarter, value stocks outperformed the Russell 3000® Growth Index, which gained 3.42% in Q3. Meanwhile smaller-cap shares outpaced large-caps in what was a broad rally.

The shift toward global monetary easing gained steam when the Fed lowered its benchmark federal funds rate after a historic hiking cycle that began in March 2022 to combat persistently high inflation. On September 18, the central bank cut rates by 0.50 percentage points, opting for a bolder start in making its first rate reduction since March 2020. The Fed’s stated goal is to achieve a soft landing for the economy: bring down inflation while preventing a gradual cooling in the labor market and neither spurring nor slowing economic activity. The Fed has projected the equivalent of two more quarter-point cuts this year.

The Russell 3000® Value Index gained 5.46% in July, as investors rotated into small-cap, value and cyclical shares due to concern about a recession in the U.S. Volatility spiked, but the index rallied as August (+2.44%) unfolded. In September, stocks rose in anticipation of the Fed’s mid-month meeting and continued to climb after the rate cut. The 1.32% advance for the month bumped the index’s year-to-date gain to 16.23%.

By sector within the index, AI’s influence was reflected in the 18% advance for the utilities sector, which is sensitive to interest rates and benefited from its key role in providing the electricity needed to power massive data centers used for AI. Real estate, also sensitive to interest rates, was another standout, advancing 17% on the potential for lower borrowing costs. Conversely, energy (-3%) struggled as oil prices dipped on worries about the global demand outlook.

As always, the fund was positioned with a value-oriented and defensive tilt. The fund’s conservatism has historically led to outperformance during times of market volatility and moderate underperformance in “risk-on” market climates. This was largely true for its performance the past three months, as the fund lagged its benchmark when the index was up the most in July. However, we were pleased the fund performed roughly in line with the index in August and September, when the index advanced.

Both security selection and industry positioning detracted from the fund’s performance versus the benchmark in Q3. Stock picking and an overweight in information technology weighed the most on relative performance, followed by choices in financials and an underweight in real estate. A cash position of roughly 3%, on average, also detracted amid the rising market backdrop.

In terms of individual relative detractors, non-benchmark positions in technology stocks Samsung Electronics (OTCPK:SSNLF, -21%) and NXP Semiconductors (NXPI, -10%) hurt the most. Samsung is a South Korea- based electronics conglomerate, while NXP is a Netherlands-based provider of diversified semiconductor solutions. Both stocks were hampered by the cyclical downturn that affected semiconductor firms the past quarter, as spending for non-AI-related chips fell on an industrywide basis.

It also hurt to overweight Wells Fargo (WFC) because the stock returned about -5% the past three months. In July, the financial services firm reported second-quarter results that modestly outperformed consensus expectations but showed a marked decline in net interest income. In its guidance, Wells Fargo projected that interest income would be hampered for the remainder of 2024, given the anticipated easing of monetary policy by the Fed. We trimmed our stake in Wells Fargo during the quarter.

Conversely, it helped most to avoid Micron Technology (MU, -21%) and Intel (INTC, -24%) – two benchmark components and underperforming semiconductor stocks that were hampered along with other non-AI- related chipmakers in Q3.

An overweight in GE Vernova (GEV, +49%) also helped, as the power- generation business that split from General Electric on April 2 continued to fare well as a stand-alone entity.

LARGEST CONTRIBUTORS VS. BENCHMARK

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LARGEST DETRACTORS VS. BENCHMARK

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Outlook and Positioning

At the end of September, the economy appears generally stable against a backdrop of moderating inflation. The Fed has projected the equivalent of two more quarter-point cuts this year, which should be a positive for many stocks.

However, geopolitical risk remains. The Russia-Ukraine and Israel- Hamas wars could broaden, threatening to bring the U.S. and/or other countries into a wider conflict. Upcoming elections in the U.S. and globally could also create some volatility. Also, we’ve seen some signs of strain among lower-end consumers in the U.S. Although Walmart (WMT) recently reported strong quarterly financial results, dollar stores and other major retailers and restaurant chains have reported signs of consumers cutting back on spending.

Looking ahead, we will continue to use dispersion (spreads) as a signal for where alpha odds may be rising, then target our stock picking in those areas. We also plan to continue focusing on large price/value disconnects in quality companies to pursue our three main investment goals: investment return, minimizing downside capture, and yield.

Overall, we think an investment landscape with an increasingly short- term focus is an enduring competitive advantage for patient investors with a long-term perspective.

This quarter we exited some small positions across several sectors, notably in information technology. We also established a number of small positions in areas such as energy (Shell, SHEL), consumer discretionary (Starbucks,SBUX), industrials (Rolls-Royce Holdings, OTCPK:RYCEY) and financials (Apollo Global Management, APO).

The largest sector overweight at quarter end was communications services. We increased our position in this sector during the past three months by establishing an out-of-benchmark stake in Quebecor (OTCPK:QBCRF), a Canadian diversified telecommunication and media company serving Quebec.

In consumer staples– another sector overweight – we favor high- quality companies that we think can pass along rising costs. In addition, stocks in this category typically perform well in a recession. Here, some of the fund’s key positions include big box retailers Walmart and Target (TGT), the latter of which we increased our position in this period. We also held a stake in consumer product giant Procter & Gamble (PG) and Alimentation Couche-Tard (OTCPK:ANCTF), a Canadian operator of convenience stores with an attractive valuation and underestimated cash-flow potential. This quarter we established a position in food and beverage manufacturer J.M. Smucker (SJM) and exited stakes in global food business Bunge (BG) and cosmetics company Estee Lauder (EL). Notably, Walmart and P&G were the fund’s No. 6 and No. 8 holdings, respectively, at the end of September.

In contrast, the fund was underweight real estate and financials, though financials was the fund’s biggest absolute weight at quarter end, making up 19% of assets. Here, notable positions included JPMorgan Chase (JPM) and Bank of America (BAC), the fund’s largest and ninth- largest holdings at quarter end. Both stocks are market-share gainers executing well at reasonable valuations. We also held sizable stakes in PNC Financial Services Group (PNC), a well-executing regional bank, and Wells Fargo, a turnaround story. Looking ahead, we may consider adding to what we consider safer regional banks when we see indiscriminate market fear.