Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Helen Zhu, Head of China Equities for BlackRock.
Hi, Helen.
Helen Zhu: Good morning.
Wall: So, next week, we have quite an important political event in China. What is it and why should investors care?
Zhu: Well, on October 16th we are having a once-in-five-years plenum. This is going to be the 19th plenum of the Communist Party and it's the event at which we are going to see the unveiling of the new leadership. So, we already know that Xi Jinping and his team will be there. What we don't know is who else fills out the Politburo, who else fills out the Politburo Standing Committee and the top positions within the Communist Party.
Obviously, this is going to have a lot of implications in terms of who are the leadership of the next five years and potentially also identifying who will be the successors after the five years as well. So, on the back of that, we will see ministers and other types of positions filled out over the coming months.
Wall: And in China, in emerging markets, politics and stock markets are much more linked than they are in developed markets.
Zhu: Absolutely.
Wall: So, who is running the country will obviously have an impact on policies and policies will have an impact on stocks. I know that you are particularly keen at the moment on financial stocks because policy have been supportive of that sector, haven't they?
Zhu: Well, I think, you look for opportunities where you think that there are certain things that are underappreciated. So, there are many aspects of China that are very exciting and changing dynamically. But certainly, one area that investors have been less positive on or more skeptical towards has been financials, largely because of concerns regarding nonperforming loan (NPL) cycle as well as the interest rate margin type of concerns.
But what we're starting to see is that China's economy is now doing much better as a combination of domestic policies, like supply-side reform to control overcapacity, as well as very buoyant export demand in this first-time-in-many-years synchronized global recovery. So, on the back of that NPL cycle is improving and we're actually starting to see that the NIM (net interest margin) cycle is starting to stabilise if not slightly improve as well, which we think we will start to observe in the third quarter results.
And in terms of policy, I think, the government has been relatively clear in terms of wanting to support certain types of lending over other types of lending. But the biggest policy support to the banking sector certainly has been this push towards supply-side reform to phase out the really poor zombie companies gradually and to actually, kind of, return profitability to the rest of the manufacturing industries and a lot of the upstream industries where the perceived NPLs were in the past years.
Wall: And you mentioned that China's growth is looking a lot more robust now. There were some concerns about China making this transition from being this sort of the factory of the world into a lot more developed market model for its economic structure. And along with that a lot of the sort of low-level manufacturing has moved out to neighbouring countries. But rather than that being a negative, you see that as an opportunity, don't you?
Zhu: Well, I think, that's basically the sustainable future for China, right? So, if the economy is purely dependent on, let's say, just property investment or just cheap labour advantages, I don't think global investors are ever going to really give it proper credit for the sustainability of the growth. It's never really been about the pace of growth for China or Chinese equities. I mean, GDP has surprised positively; earnings have been great. But over the last – basically from the 2010 through 2015-2016 period, valuations kept going down because people thought growth is great, earnings are great, but it's not sustainable.
But now, China has gotten lucky in that export demand is getting better. Actually, the reliance on property and fixed asset investment has been going down and China is starting to show that it can somewhat gradually albeit just initial steps in a very, very long journey, shift towards the more sustainable aspects of the economy, which goes into, for example, higher-end manufacturing and more higher-value-add type of exports.
Wall: And to the original point, the government is being supportive of this, aren't they?
Zhu: Absolutely. I think the government has a very grandiose five-to-10-year plan [that] was laid out many years ago in terms of improving overall wages, improving overall income and GDP per capita. A lot of that means that cheap labour manufacturing will not be sustainable. The focus – and a lot of different policies, you see them working together towards the same objectives.
So, whether it's One Belt One Road in terms of improving connectivity with overseas and having emerging markets export services and capital goods, too, or this Made in China 2025 agenda of subsidizing R&D for domestic companies, helping them get up the learning curve to try to compete more in the global arena in terms of slightly higher-end type of products, supply-side reform, getting rid of zombie companies and making sure that overall industries' profitability and returns enhance so that people have some incentive to start not just invest in property speculation but rather to actually put money into the real economy. All of these things are supposed to work together synergistically.
Wall: Helen, thank you very much.
Zhu: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
