In this Vaughan Nelson podcast, CEO and CIO Chris Wallis, evaluates President Trump’s economic policies, market liquidity, and the AI disruption resulting from DeepSeek.

Podcast released on 27 January, 2025

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Lightly edited transcript

Dan: Welcome to the Vaughan Nelson podcast. With me today is CEO and CIO Chris Wallis. Welcome Chris.

Chris Wallis: It’s great to be here, Dan.

Dan: All right, Chris, welcome to 2025, our first official podcast outside the Strategy Podcast and we’ve got a lot to talk about today I think. Looking forward to this one, so we’ll jump right into it. We are now just about a week or so into President Trump’s second presidency, and he’s already creating quite the stir. So we’ve seen him focus a lot of attention on securing the borders, tariffs, reshoring, cutting federal spending, tax cuts. So we’ll open up today, first question, how do you think these initiatives will impact the equity markets?

Chris Wallis: Yeah, we thought there would be more volatility in 2025, and that’s certainly been the case here in the last couple of weeks of January. I guess what I’d highlight, Trump’s slogan is make America great again, but I think the irony is Trump’s policies and his politics are better for risk assets outside of the United States than for the risk assets in the United States. And the reason I say that is what influences stock prices and asset prices is on the margin. What’s the change on the margin? Are things getting marginally better or marginally worse? And the US equity markets have performed so well for so long and the dollar has been incredibly strong that we need to see almost a re-acceleration from what has been kind of record growth relative to the rest of the world. And while there’s some shorter term pinup demand, and we’re going to see that in the first two quarters, we’re going to see, like we’ve talked about, a little bit of tick-up in inflation, but it should remain somewhat right around or just below 3%.

We’re going to start to see some pick-up in industrial activity that’s been in a recession, but it’s going to be fairly muted. But what’s interesting is his policies and his platform is driving significant shifts in the rest of the world. And you can look at his interaction with Europe where he ignores Brussels and goes straight to the country-level leadership, meaning let’s get away from the poor policies and industrial policies coming out of Brussels. Let me go bully the leadership of the individual countries. And we’re seeing incrementally more populist policies being adopted in the rest of the world, which means you’re going to see a little bit better growth out of the rest of the world than what was probably priced into risk assets.

At the same time in the US, look, I think his policies on the margin are going to be a net negative for economic activity. And the reason I say that is if you want to cut cost as an example, we’re recording this on the 28th, overnight he announced that they’re going to freeze distributions for grant and aid. Well, that’s about $3 trillion and they know they need to go hard after spending cuts. Those spending cuts aren’t easy to come by. And so I think what he’s trying to do is see if he can encourage a lawsuit to validate or invalidate the implications of the Impoundment Act, which just says, hey look, if Congress allocated the dollars executive branch, you have to spend them. I think what he’s going to try to do is really test that legal theory, which does mean we’re going to see a lack of distributions and a lack of activity or a pause in this first quarter. At the same time we know his view on tariffs.

Look, if we’re going to address our deficits, it means cuts and spending and increases in taxes, and he doesn’t want to increase taxes on the American public through the tax code. He wants to do it through tariffs or ultimately just like a VAT tax. And so a combination of those probably means on the margin a little bit weaker data than people think, a little bit higher inflation than people think and maybe a little bit less liquidity at a time when US equity prices are extremely stretched from a performance and valuation level for the rest of the world. So again, I think it’s going to be ironic. I think make America great again may actually make non-US equity markets great again.

Dan: All right, I think that’s a good recap as we get through week one. I can’t wait to see what we see by the end of week two. And shifting over a little bit, in a couple of our prior podcasts, you mentioned liquidity growth and how it’s muted and that might drive volatility and risk assets over the near term. Any updates? And I guess it may spin off what you just went through, but any updates in that view?

Chris Wallis: Yeah, for sure. Look, I think this is the biggest threat near term for US equity markets and risk assets in general. Liquidity is not growing at a sufficient rate to fund economic activity and maintain equity prices. We’re seeing when you look at the level of funds available on the reverse repo where the treasury general account lies and the Fed’s kind of continuing quantitative tightening, there is not much liquidity left to push out into the economy and the market to support economic activity and asset prices. And so we need to get liquidity flowing again. And as I just mentioned, a lot of Trump’s initial attacks on federal distributions is not conducive to boosting liquidity. That’s actually going to take liquidity out of the system as well. I would anticipate that the Fed is going to have to stop quantitative tightening fairly soon and restart quantitative easing.

They may not call it quantitative easing, it may be under a different program or they may not say anything, they may just start doing it and we start seeing it in changes in the Fed’s balance sheet, but we’re getting to that point to where a combination of the disruption in the flow of distributions coming out of the federal budget in conjunction with tightening liquidity in and around the Fed’s balance sheet could start to present a real challenge to equity markets. And I think this is a natural part of the process. We should see weakness either in asset prices or the economy that then triggers lower interest rates. And we know Trump wants lower interest rates and so if he’s not going to get them by the Fed, maybe he can create a big enough economic slowdown that it’ll force the Fed’s hands, and then we need to wait and see what our new Treasury secretary is going to do as well. I’m sure he’s going to have some tricks up his sleeve.

Dan: All right, and then let’s shift over to maybe what the biggest story the last couple of days have been, maybe the biggest story so far of January, and this is talking about AI, right? So we experienced a real shock in the AI trade this week when we saw the release of DeepSeek’s shockingly efficient AI model. And we saw them got whacked across the board yesterday, right? So is this dip in AI related names, do you think that’s something that investors should buy? Do you think it’s time to look elsewhere for some other different equity market opportunities?

Chris Wallis: So here’s my view on the correction. The market was looking for a reason to correct and DeepSeek’s release of their efficient AI model was the excuse the market used to correct. And it has less to do with the fundamentals of the underlying businesses. And that doesn’t mean you just run out and buy them because the fundamentals haven’t changed because quite frankly, most of the rally didn’t have much to do with the underlying fundamentals as well, right? Momentum in the algorithmic trading and the trend following does feed on itself. And so while you get strong underlying fundamentals, the share price momentum just becomes self-reinforcing and kind of sets its own path. So I think a couple of things to take away. It just highlighted how crowded a trade it was, and when you get really crowded trades, they become very unstable. And at the same time, just given the momentum that the AI trade has had for the last couple of years, we’ve built up a lot of funds that were flowing into double and triple leverage ETFs.

There was a lot of support leading to the price action emanating out of the options market and a lot of these securities, and in a way from the primary poster children for AI like NVIDIA, but the peripheral bets were up 25, 35% year-to-date, and then just a few hours they gave all that back. That is endemic of a market that lacks liquidity and it’s endemic of a market that has real structural problems. There’s not breadth and depth to actually transact volume at any given price. And this is something we’ve talked about in the past. It has everything to do with passive, it has everything to do with the use of ETFs and when money comes in, they have to buy and when money leaves, they have to sell. And given the fact that index funds aren’t typical market makers, meaning if your 401K or your pension plan owns the S&P or the Triple Q, they’re not net sellers, right? They’re just net buyers every couple of weeks.

So there’s not a lot of liquidity, which means the marginal dollars flowing in and out really amplify the price moves. And so that’s really what we saw I think in the last day or so. Do I think we’ve fixed the crowding? No. It could continue to go. Now it’s a question of the funds that float into the Triple Q and the double and triple ETFs yesterday that were buyers of the securities that some of the institutions were selling, are those flows going to continue so that you can reignite some of the algorithmic trading and get more momentum and “it’ll be a great buying opportunity?” Or no, is it going to be a short-lived bounce? And in fact, those positions that were put on yesterday end up under water a week from now and then they start selling and you get another wave of selling and we just haven’t found balance yet. Only time will tell, but I think it has a lot less to do with the AI fundamentals and more just to do with the fragile nature of equity markets in a very crowded position.

Dan: All right, Chris, that’s great. So that’s a wrap for today. Good having you back. Thanks for all the insight and we’ll catch you soon.

Chris Wallis: Sounds good, Dan.

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