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Chris Wallis, CEO and CIO at Vaughan Nelson, examines the disparities between the US and ex-US markets and expectations stemming from CPI numbers.

February 28, 2024

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, we’re really chugging along here with the markets. We started to begin to see some global equity markets hitting the all-time highs. Most notably, we’ve seen Japan, a handful of Western European countries. A question, do you think this is indicative of investors beginning to move away from the US because it’s become overvalued? Or if I said this another way, do you think that the valuation gap between the US and non-US has become overly stretched?

Chris Wallis: Yeah, it’s interesting. If you look at the underlying data, the valuation disparity between large and small in any geography or US and rest of the world on geography, it would look like there’s big valuation gaps. And that’s simply not the case. That when you really get in and look at the underlying securities and the valuations, the disparities that exist are justified based on the underlying rate of growth and rate of profitability and return on capital of the individual securities.

So the market has done a good job of allocating capital and determining who deserves higher and lower multiples. And so I don’t think it’s indicative of a rotation out of expensive securities into less expensive securities. I think what it’s reflecting is the rest of the world is coming to the end of its economic malaise. The industrial recession that’s lasted for many quarters is coming to an end in the US, and it’s coming to an end outside of the US. Every major central bank has ramped up liquidity over the last couple of quarters and it’s finally starting to hit the market.

So I think it’s more reflection of improvement in fundamentals and an increase in liquidity and less to do with valuation disparity. And the one thing I want to highlight is we’re leaving a period where it was easy just to compare US to rest of world or emerging markets to developed or large to small. And I really think we got to get away from those type of comparisons. And it gets back to what we’ve said is that, look, the world is still out of balance and there’s great opportunities in every sector, in every asset class and every region. You’ve just got to be very specific about what you’re investing in and get away from some of the style box orientation of reallocation and you can see it.

I mean, you look at our global SMID strategy last year, it’s North American allocation outperformed the S&P 500 by several hundred basis points and it’s not large cap tech, right? There’s really good opportunities across the board. You’ve just got to take a more targeted approach to it. And that’s why we’ve said I think active is going to continue to outpace passive until we get to and get through the rebalancing. We’re going to see more of that this year is inflation expectations change and yield curves change and cost of capital changes. It’s going to remain dynamic for a while.

Dan: Another question, CPI data that’s coming out later this week. Any expectations, anything that you think that is potentially disruptive and particularly on the heels of what you just described?

Chris Wallis: Look, I think the US Fed is the window to be able to rely on the data to cut rates is rapidly closing. I mean, we really have economic weakness in Q1 right now, and we’ll have a little bit in Q2. Then it gets stronger and base effects within the CPI calculation are going to start working against them. So look, we’ve gotten a little bit hotter inflationary prints recently. It’s not just a US phenomenon. This is happening in all over the globe ex-China, and it’s going to continue to simmer through the end of the year.

So I’m not expecting any significant surprises one way or the other, but I’m not expecting it to decline dramatically unless there’s some nuance within some of the calculations. Inflation’s going to firm, it’s going to be 3% ish in and around there, plus or minus a little bit. And we’re already starting to see it start to simmer such that when we get into Q4 of this year, there’s that chance it’s going to be moving higher. So I don’t think there’s going to be anything incredibly disruptive.

Fed’s going to cut rates. They need to cut rates. They’ll get it down four or four and a half percent. I think what may surprise people is if they wait too long and they’re doing it in an accelerating economic environment, when inflationary pressures are firming, you may actually see the long end of the yield curve move higher Anytime it’s poked up, the US 10 years poked up over 5%, it sends Janet Yellen into a bit of a panic. So it promises to be interesting for sure.

Dan: Good. All right, well we got a pretty quick one today. Not too much action happening out there, but good to have you. Thanks for your thoughts and we’ll see you real soon. You bet.

Chris Wallis: Sounds good, Dan.

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