“You have to keep an eye on these rolling bear markets, across all regions, industries, sectors and sub-sectors,” he says. “There will be fits and people will have to figure out when and how to allocate capital. It’s just the world we live in.”
The contrast between Wallis' perspective and the endless talk about bubbles is stark. But the Houston-based market veteran, whose focus is small- and mid-cap stocks, says the brutal adjustment to a world of higher interest rates is playing out in a similar way to the multiyear realignment of the global economy in the late 1980s and early 1990s Years.
The regional banking crisis in the US last March was a prominent example of this, says Wallis, and banks as far away as Germany and Japan have more recently been rocked by exposure to the US commercial real estate sector. European manufacturers are under intense pressure due to a combination of unsupportive industrial policies at home and competition from U.S. rivals fueled by government stimulus measures. The Chinese stock market tells the story of a painful economic adjustment there.
Wallis argues that the rebalancing process will take some time, with a wall of corporate debt coming due in 2025 and then really rising in 2026.
Small and mid-cap indices are likely to continue to struggle, but Wallis argues that investors can pick good companies with “gun shots” and build a portfolio that will outperform. The Vaughan Nelson Global Equity SMID Fund returned 14.1 percent last year, beating the MSCI Small and Mid-Cap Index's return of 11.7 percent.
“As we go through and reassess capital and figure out which management teams are disciplined in capital allocation decisions, have the right incentives, and have the right capital structure, you see real differences in winners and losers, even in similar industries. ”
This was also a theme of the local ASX reporting season. Consider the disparity between major and regional banks, or even between discount department stores Kmart, which delivered impressive results, and Big W, which did not.
Return on investment is Wallis' most important investment criterion. Its portfolio has a return on assets of about 9.5 percent, compared to a return of about 5 percent for its benchmark. The focus on companies that reinvest and are therefore less cyclical means the portfolio has less volatility in returns, says Wallis.
While North America and Western Europe dominate the portfolio, there are also some Australian names, including insurance broker Steadfast and laboratory services group ALS. Technology holdings include US groups Insight Enterprises, Monolithic Power Systems and Fabrinet, while Wallis has recently moved into the energy sector, betting that a long period of underinvestment will deliver strong returns.
“Politics cannot change physics,” he says. He's looking for the next group of AI winners who can use AI to dramatically reduce costs.
As a proponent of rolling bear markets, Wallis is actually very optimistic about the economic environment for the rest of the year, with economic growth gaining momentum in the US and Europe, while Asia is not far behind; He says nominal U.S. GDP could grow a staggering 7 percent through the December quarter.
That will lead to inflationary pressures, but Wallis expects the Federal Reserve to cut interest rates and the U.S. Treasury to continue spending in an election year. His biggest shock? Normalizing interest rates in Japan would result in Japanese capital being repatriated from foreign markets in a way that would send shockwaves.
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