Chris Wallis, chief executive officer and chief investment officer at Texas-based investment manager Vaughan Nelson, spoke exclusively to InvestorDaily during his whistlestop roadshow for the group’s ASX-listed fund of global small and mid-cap (SMID) stocks.
Mr Wallis believes investors still trying to buy the index are in for a rude awakening as the global economy continues to deleverage from years of easy money.
“Investors have been lulled into this state of mind where there is zero cost of capital and unlimited liquidity, and everybody gets a participation ribbon. That’s just not going to be the case anymore,” he said.
“We have reached a point globally of instability and a lack of balance. The Fed effectively created a banking crisis to feed the political need of fighting inflation.”
From an Australian perspective, it is easy to think the collapse of a handful of US regional banks is old news now. But according to Houston-based Wallis, the crisis is far from over.
“It is not contained by any stretch of the imagination,” he said. “All you have to do is spend a little bit of time looking at the balance sheets of banks and their cash flows.”
Vaughan Nelson, which is an affiliate manager of French investment group Natixis, was established in 1970 and now manages more than $14 billion in assets. The group was expecting unrealised losses to begin impacting US banks in the second half of this year. What it didn’t account for was a run on Silicon Valley Bank (SVB) and First Republic.
Mr Wallis, who describes SVB as “a hedge fund with a banking charter”, says there is a misconception among investors that only small banks are at risk.
“You can look at the Bank of America and the unrealised losses on those balance sheets. It can fester long enough that it starts to impact banks of that size. That won’t happen, but we are going to have more bank failures, there is no doubt about it.”
He believes the Fed will need to slash rates by 200 basis and stop quantitative tightening (QT) to avoid a major issue. And while this won’t prevent cash-strapped lenders from collapsing, it will allow them to reprice their loan books.
However, he says even a 2 per cent rate cut would still lead to commercial real estate defaults and substantially lower mortgage lending in the US.
“We are going to see more banks fail,” Mr Wallis warned.
With a hawkish central bank ready to slay inflation at all costs, the chief investment officer says many investors are waiting for a recession and a crash to begin buying undervalued stocks.
“Investors need to look at 2023 as the year they capture their alpha,” Mr Wallis said. “You’re not trying to generate a return this year. You’re trying to rotate capital into the areas that are going to be deeply oversold. It’s a transition year,” he said.
US banks have sold off by around 40 per cent, but Vaughan Nelson is still not buying just yet. One thing Mr Wallis is confident about is the role of active management in the current climate.“For me, I love it. I like volatility. Give me a banking crisis and we can have some fun. We’re going to make money. We’re going to generate a lot of alpha. Our goal is to compound at 15 per cent. It is easier today to reach that than it was when we launched in 2020.”
The Vaughan Nelson Global SMID Cap Equity Fund (ASX: VNGS) is an active ETF that aims to outperform the MSCI ACWI SMID Cap Index (after fees and expenses and before taxes) on a rolling five-year basis.
The fund is currently overweight US small and mid-cap stocks and favours industrials, technology, and financial services.
Japanese equities are its second largest position (11.3 per cent), while Aussie equities make up 2.6 per cent of total holdings.
The fund owns 73 companies including IT group Insight Enterprises, Cboe Global Markets, and Florida-based insurer Brown & Brown.