VSP CIO on Bloomberg: Mindful of Impact by A Potential Fed Policy Mistake; Constructive on China Equities for 2022

Vanessa Xu, Managing Partner and Chief Investment Officer of VS Partners, returned to Bloomberg Markets: China Open again on December 23. She shared her latest readings about recent market evolvement and outlook for next year.

?Click below to watch the video.

Main points discussed in the interview are as follow:

Q1 How are you approaching the virus? To what extent might this affect your assumptions going into next year?

• ?Some contrarian thinking vis-à-vis the two market consensuses that’re going on. One is that the Fed is behind the inflation curve, and it has to do something to control the price expectations. Risk in the US risk assets is that they come at the time that inflation is peaking if it hasn’t already peaked. Inventory and the supply bottleneck have peaked as well as the growth trajectory outlook is perhaps on the downside. We are very mindful of potentially a Fed policy mistake. So it's a bigger risk than Omicron.
• ?Earnings growth outlook has been revised up a lot in 2021. At the same time, the fiscal drag instead of fiscal stimulus comes in at the time of a new strand of virus. Therefore, the risk asset is very vulnerable right now and the market breath has become thinner. There's nearly one out of five S&P companies that has experienced that 20% correction in the last 100 days. which is not a good sign.

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Q2 A lot of people have tried to kind of telegraph a top for the S&P and it's just been such a grueling task this year. And you're willing to stick your neck out to say look, there is some kind of risk of a policy mistake from the Federal Reserve. You talk a little bit more about the violent rotation that we could be seeing here in China, and what exactly that you're talking about for next year? What sort of leadership are we gonna be seeing?

• Potentially the risk of a violent rotation is not just gonna be in China. That kind of volatility is also perhaps gonna be seen in the US market as well.
• But back to China, if we're looking at Shenwan classification for sectors, there are 28 of them. Beneath the dispersion of the market, 21 out of 28 sectors actually experienced valuation contraction instead of expansion.
• Out of the seven sectors that have experienced both outsize earnings growth and the multiple expansion of a very low base of 2020, those are the sectors that we need to be mindful of the rotation. Upstream sectors, electrical equipment and defense for example.

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Q3 You still hold about a third of your portfolio in Chinese asset. Just walk us through what that makes an allocation looks like right now. Just give it a divergence when it comes to Hong Kong and the rest of the world at the moment.

• China equity particularly within the A-share equity is a long-term strategic location. But for 2021, we are heavier on the local currency denominated credit which has done very well. Earlier on your show, I said that the credit event particularly driven by the property sector, gave the active managers a very good opportunity to price discovery which has panned out well for us. ?
• For next year we've turned more constructive on the Chinese equity. Given valuation has corrected so much and the bad news of economy as well as policy headwinds has been priced more or less into the valuation now.

Q4 When you say Chinese equity, do you mean more offshore or onshore? What sectors have you been looking at?

• We look at it holistically as China equities but relatively more onshore. In Hong Kong, although the evaluation has corrected more but Hong Kong is susceptible to both the US risks and the China risks. And the domestic market has abundant domestic liquidity to support.

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Q5 In terms of the risk that you're seeing right now, you mentioned about the Fed policy mistake. What would be a Fed policy mistake? I mean, they plotted it out at this point that we could be seeing eight hikes in the next three years or so. Are you saying that that's just not gonna happen? What would be that area where it's actually okay, and markets can withstand it, and where it's a little bit too much?

• Next year, the plot chart has shown the expectation of three hikes. But as I said, if it comes at the time of both inflation and economic marginal growth on the downside with Omicron impact and fiscal withdrawal, it could be a risk. The market can take the Omicron impact but challenging to take the Omicron impact and fiscal and monetary tightening together at the same time.
• We might see a dip. And how long and the magnitude of that the dip is by and large driven by the mega cap tech stocks. But I'm not overall very pessimistic about the US equity market. I think after the dip, it will recover.
• The Fed has also learned from the 2017- 2018 autopilot debacle. If it sees the pain points of the risk assets, it might ease or reverse its policy stance.

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Q6 What's the best argument that the US bull market continues and what's the best argument against it?

• I would not argue that it continues because there are a lot of signals that point to some sort of correction. But again, I think the US market on a yearly outlook will still register a positive return. It's just within the year there are some volatilities to manage through.