Chris Wallis, CEO and CIO at Vaughan Nelson, explores the market broadening last week, bottoming of the industrial cycle and reacting to momentum surrounding a potential Trump presidency.

July 14th, 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 great to be here, Dan.

Dan: So Chris, over the past week or so we started to see a fairly significant correction in the narrow market leadership. We saw a powerful rally, both in small caps and other value sectors. The US dollar, that corrected meaningfully. The market rotation, it appeared to be triggered by a fairly benign CPI report so a question here for you this morning. Was last week’s market rotation a harbinger of broadening equity market rally, and do you think that the CPI report, did that change your view of the firming inflation for the fourth quarter of ’24?

Chris: Yeah. Now, we still expect firming inflation beginning in Q4 of ’24 and potentially into the early part of 2025. And I think it’s important when you look at the significant rotation we saw in the market last week, and there’s every expectation that it was driven by that CPI report. But when you actually look at the CPI report, was it much cooler than expected? No, not really. Did the details provide any indication that cyclicals or small cap or beta should be preferred? No, not really. Did the release provide any increased confidence that we’re going to hit the Fed’s 2% inflation target? No, not really.

And so, when I look at those rotations I think it was nothing more than the market had been trending in a very narrow fashion for a material amount of time. Investors get offsides and then there is a trigger that produces profit taking, and repositioning, and rebalancing. So the market got out of balance, they got too far to one side, and then we used the CPI report as the reason or a catalyst for repositioning the market but I don’t think that CPI report changed anything, and I don’t think necessarily the CPI report should lead to a broadening rally. We’ve talked about for some time that we’re going to see a bottoming in industrial activity and that the global industrial cycle is going to start to improve in late Q2 and Q3, and that may be a reason for rotation. But I don’t think the CPI was anything more than a catalyst for investors that were entirely positioned one way to begin rebalancing and bring balance back into the market. The market just had very unstable positioning going into last week in that CPI report.

Dan: And so, I’m going to just follow-up on something you said there as we hop into our second question, but you’re right. The last two quarters or so we’ve been discussing the bottom of the global industrial cycle. We’ve talked about the outlook for improved industrial growth. But you’re right, it does appear as though the bottoming process is well underway. We believe we should see some improved growth in the third quarter into the fourth quarter for the industrial sector. So do you have any update to the nature of the duration of that upturn, the broader economic outlook as we head into the second half of ’24 and first half of ’25?

Chris: Yeah. I think the most interesting development is there’s really long indicators that maybe nine, 12, as much as 15 months into the future, and then there’s medium term indicators and then short-term indicators. And while we know the industrial cycle’s getting better, we’re starting to get a signal from the longest indicators that there’s going to be an economic slowdown in 2025 in the US. So that would give us some indication that if we get an upturn it may be more muted or more short-lived, but we’re really going to need to see the data come out over the next, I’d say three to four months.

Because what we’re going to see in the back half of 2024 from the more medium term indicators, they’re either going to confirm the economic slowdown in the first half of 2025 or they’re going to dispel that. And as that data begins to come out and we get a little bit more granular information, that’ll give us the information we need to know whether this upturn in global industrial activity is going to be more muted or is it going to be on a more sustained basis, so time will tell. There’s going to be more to come on that.

Dan: And so, we’re recording this podcast here. It’s Monday, July 15th, and I think it’d be hard not to talk about the events over the weekend. Over the weekend, unfortunately, US experienced a violent tragedy with the attempted assassination of former President Trump, and it goes without saying that political violence in any form should be condemned and its impact does influence political outcomes. So do you think that the events of this past weekend, does that solidify Trump’s lead? And do you think the market will begin to react and start positioning more for a Trump victory?

Chris Wallis: I think that’s going to be a narrative in the market and I just caution investors not to try to extrapolate a Trump win or even a Republican sweep into market positioning or this benefits, and that doesn’t. And the reason is, well, just from the political reality, between now and November is an eternity in political time and narratives, and momentum, and emotions can shift on a daily or weekly basis. And we’re also going to see a response out of the Democratic Party. If they give up on Biden but let Biden-Harris ticket move forward, they’re going to redirect all their resources to defending their congressional seats. And so, maybe it’s a more balanced structure in Washington as we get the election results anyway.

But even if there’s a big Republican sweep, if you think you know what the economic implications of that are, I think it’s a bit naive. And the reason I say that is, it’s a very different environment where deficit spending has been driving inflation, and inflation is still the number one issue with households and the loss of real income. And if you think Trump’s going to cut taxes, are you really going to cut taxes to support deficit spending if inflation’s still a primary issue? That is a very significant political negative.

Or is it more politically expedient to allow the tax cuts to expire or modify them but allow corporate tax rates to increase modestly or allow individual tax rates to increase for the wealthy and then sustain some deficit spending? Redirect it. I think the clearest loser in all this would be some of the energy transitions. We’ve seen a lot within biofuels and other renewable projects where, quite frankly, the economics just don’t work and the projects are starting to fail, even without any shift in federal regulation.

So I would just caution investors don’t try to extrapolate too far, too fast, especially in and around campaign rhetoric, and the politics are likely to shift. And we also need to remember we’re in a period of populism because the economies are out of balance, because wealth creation and wealth disparity is out of balance and when you go back and look at the ’60s and ’70s, there was a lot of political violence during that period. And so, these are not going to be isolated events and they’re going to have real political outcomes and those are going to have economic outcomes, but there’s nothing to indicate that government’s role is going to shrink in investors’ lives, it’s just going to go different directions. Dollars will get allocated different ways.

So I would just caution investors, be patient, let it play out. Things could be quite different in another six to nine months.

Dan: Okay, good. Well, let’s put a wrap on it there, so thank you, Chris, and talk to you soon.

Chris Wallis: Sounds good.

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