Chris Wallis, CEO and CIO at Vaughan Nelson, joins the podcast with recent views on inflation, the inflation connected market correction, and how he’s deploying capital.

May 5th, 2024

Lightly edited transcript

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

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

Dan: All right, Chris, let’s get right into it here and talk about a little bit of economic data. So you’ve seen some recent economic data that’s really started to call into question whether or not inflation will continue to decline and to decline down to that Fed’s 2% target. Any update to share about your inflation outlook?

Chris: Yeah. As we’ve talked about for a while, we’re moving into a period where the point in time for the weakest data was really in the first quarter of this year and then into the second quarter of this year. And from there it’s going to strengthen. And I think unfortunately for the Fed specifically, we’re really not going to approach their 2% target. We’re going to end up at around 3% over the near term. But ultimately it looks like, based on the most recent data releases, that as we move into Q1 of 2025, we are in fact going to be three and a half to maybe it’s over 4%. So unfortunately by the back half of this year, inflation is going to be going the wrong direction for the Fed. So not a material shift in our forecast, just further confirmation that inflation is going to remain an issue. It doesn’t mean the Fed’s not going to cut rates, but it may mean they’re going to do it into an even firmer inflationary environment, which could prove a bit of an issue from a reputational standpoint for the Fed.

Dan: All right, Chris, follow up question. As we’re thinking about inflation, so an increase in inflationary concerns, right? This is seen and has led to the market increasing their rate expectations and what we’ve seen as a result is it’s triggered a broad equity market correction. Do you think that this equity market pullback is justified? And secondary question here is do you think it represents a good buying opportunity for you?

Chris: Yeah. Look, it shouldn’t be surprising that we pulled back, we had a significant easing in financial conditions in the fourth quarter of last year, and that led to a very powerful rally in cyclicals financials and small caps and really a high beta rally, not only in the fourth quarter, but it really did continue into the first quarter. And even if we didn’t have a big shift in inflationary expectations in the market, increasing interest rate expectations, I would’ve expected some sort of a shake out or a digestion period. So that’s clearly what we’re going through right now. Is it possible this could manifest into a larger correction? Of course. As we’ve said, the easy money was going to be made last year when you went from bad economic data to less bad and then you had an easing of financial conditions that’s always going to be the most powerful and broadest rally because you’re moving off the bottom. 24 is always going to be a narrower element of performance because valuations are higher and at the end of the day that inflation was some company’s revenues and other companies it was a headwind.

So we’re going to see this chop moving forward as we continue to, I think, digest company-specific performance rather than broad sector performance. And you can even see that in the large cap space where you had fairly weak earnings out of Meta, but you actually had strength out of Google and others. Look, we’re just going to be in a narrowing market environment. So yes, the correction is justified because we’ve raised interest rate expectations, we’ve tightened financial conditions from where they were in the fourth quarter and first quarter. And yes, at the same time it is going to present buying opportunities. But I think ultimately as we continue to move forward, investors are going to continue to discover that the opportunity set is going to be very, very company-specific. It is not going to be cap-specific. It is not going to be sector-specific.

Dan: So as you’re thinking about this, and I guess the question really is now is the time are you beginning to deploy capital? And I know you mentioned it’s really company-specific, but is there any type of sector or themes that you start to look in through and then start buying those companies?

Chris: Yeah. We definitely are putting capital work in this pullback. Earlier in the correction we actually added to some existing positions. Some of those were in the industrial sector, but again, it was more reflection of the company specifics than any broad industrial theme. I think what you’re going to see is us taking advantage of the pullback when we’re building new positions. You’re going to see shifts in overall weightings, meaning you may see tech allocations come down despite the strength and the secular opportunities there. The valuations aren’t nearly as attractive as they are in other areas of the market, but it’s going to continue to be very company-specific. And I do think investors need to and will begin to start positioning for a post-election world. So as we’ve talked about, Janet Yellen’s going to ramp up her checking account, it turns out she’s going to have to borrow a bit more than she anticipated, and so they’re going to provide the liquidity and the strength in the economy going into the election.

That’s just always the MO, but post that, as we think about moving into potentially a four-plus inflationary world in ’25, as we start to contemplate that maybe we see some of the tax cuts reverse and expire at the end of ’25 and we start to see more company specific strength and weakness, whether sector strength and weakness, I think it’s going to present real opportunities to take some unique positions as we move through it. Again, I just think we’re going to see ongoing shifts in leadership as we’ve talked about. We’re still in my mind and I’ve called it a longer bear market, but that’s probably the wrong description. It’s really a longer-term rebalancing and we’re still early in that. Time to put money to work, be very company specific, expect a lot of chop for the rest of ’24 with underlying economic strength and farming inflationary pressures as we move through the year. And then ’25 promises to be a lot of fun.

Dan: All right, we’ll hold you to it. Perfect. Well, thanks. Let’s wrap up there and we’ll catch you here soon.

Chris: Sounds good, Dan.

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