In this Vaughan Nelson podcast, CEO and CIO Chris Wallis discusses his 2025 outlook, including the prospects for inflation and interest rate cuts. He believes investors should move beyond ‘narrative-oriented investing’ as, while there isn’t a specific sector or region that is materially undervalued, he believes there are attractive opportunities everywhere for discriminating investors.

Podcast released on 11 December, 2024

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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 good to be here, Dan.

Dan: All right, Chris, well, here we are middle of December, and it’s looking like this is probably our last podcast of 2024. And as we get into this, one of the questions that’s popping up is, do you think that the market’s starting to show signs of comfort with regards to inflation? And if that’s the case, do you think that we’ve seen the last of the rate cuts for the foreseeable future?

Chris Wallis: Yeah, look, I think, and certainly with the evidence we saw today with the CPI release, inflation’s bottomed, and it’s starting to tick higher. There will be enough air cover for the Fed to cut rates in December if they so choose. But certainly going forward, it’s going to be more difficult for them to cut into rising inflation. So if anything, I think the market’s already started taking some of those future rate cuts out of equity valuations, and we’ll see, more cuts may need to be taken out. But I suspect that we’ll get the cut in December, and then that may be it for the first half of next year.

Dan: Yeah. And speaking about the first half of next year, I know difficult to ask, but any themes or general outlook that you can share with us?

Chris Wallis: Look, I think as we move into ’25, we’re going to see a re-acceleration of economic activity. There was certainly some pent-up demand for small and mid-sized businesses, and we’re going to get more kind of pro-business initiatives out of Washington. And then at the same time, there’s a reason why inflationary pressures are ticking higher, and that is because we’re going to see a bit of a re-acceleration. That just means the broadening of economic activity as much as anything else. The market’s already started discounting some of that. We’ve seen broader participation with small caps and broader participation with cyclicals.

We’ve seen a broadening of the participation within the financial sector, so it’s not new information to the market. But for the first half of next year, I think the market’s done a pretty good job of discounting some of this pickup in activity. The real key is as we’re moving through the first half, is to see what policy initiatives are underway or able to be implemented. What, if any, additional stimulus measures via industrial policy come to fruition, and then what the countervailing reaction is from both allies and adversaries overseas.

Dan: One more question for you today. So given the overexposure, the outside influence that we see from the Mag 7 names, we’re hearing the talking heads, right? They’re suggesting that we start looking at down cap, right? And as you’re looking out as you’re positioning the portfolio for 2025, do you think there’s opportunity to look at specific caps, or maybe a specific region, or potentially a specific sector?

Chris Wallis: Yeah, I really don’t. Look, I know intuitively everybody wants to harken back to what we saw at the end of the ’90s when you had very narrow market leadership and technology. And at that time, it really pulled liquidity from other areas of the market. So the other areas of the market were selling off as the internet bubble was being created and technology outperforming. So as that bubble unwound, naturally the rest of the market was beneficiaries of that unwind. This is a little different in the sense that, small caps have done fine. The only areas that haven’t done well are areas that excess reliance on cheap financing and real estate, or banks that had bad loans. But by and large, other areas of the market, not just small caps, but even small caps in the rest of the world have done really well.

So while we have very stretched valuations in North America large cap, only on a relative valuation basis do small caps look less expensive. From an absolute standpoint, they’re not trading at a discount to their history. And then when you look overseas at the developed and the developing world, the PEs clearly are much lower, but that’s driven by fundamental reasons. There’s real structural factors at work, most of it in and around both industrial policy, in and around their energy policy, and then in and around their underlying demographics. And so they’re justified. So I don’t know that those valuation disparities mean that there has to be a great mean reversion or anything of that fact.

And I think as we move through ’25 and beyond, we’re going to get away from this narrative-oriented investing, meaning, “Oh, do you buy large tech?” Or, “No, we need to go buy small value,” or “Oh no, you go own banks or go own this particular sector, or go buy Europe.” We’re going to get back to talking about individual securities, because while there isn’t any single sector or region that really stands out as materially undervalued, there are securities within every region and every sector, and every cap range that are incredibly attractive. And that is about consistent with where we are in the overall cycle, which is, we’re kind of two and a half plus years into the liquidity cycle. It’d probably be peaking over the next 12 months unless we ramp liquidity up again. So you should be at an environment where you have to just be a little bit more discriminating in what you’re willing to invest in.

Dan: All right, good. Well, I think that’s a good spot to stop for today. And barring anything crazy happening in the next couple of weeks, this might be the last one. So Chris, thank you again for all the insights across ’24, and look forward to having you back here soon.

Chris Wallis: Sounds good. Thanks, Dan.

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