More than meets the eye: Chinese manufacturers overstocked!

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China’s CFLP manufacturing PMI for April came in at 52.9, down from 53.4 in March.

Index: ManufacturingSeasonally adjusted indexCompared to previous monthDirection
PMI52.9LowerExpanding
Output55.3LowerExpanding
New Orders53.8LowerExpanding
New Export Orders51.3LowerExpanding
Backlogs of Orders50.7LowerExpanding
Stocks of Finished Goods50.8LowerExpanding
Purchases of Inputs53.8LowerExpanding
Imports50.6LowerExpanding
Input Prices66.2LowerExpanding
Stocks of Major Inputs52.0HigherExpanding
Employment51.8UnchangedExpanding
Suppliers’ Delivery Time50.6HigherQuickening

Source: Li & Fung

While the figure still indicates further expansion in the Chinese manufacturing sector, it surprised on the downside as it was significantly lower compared to the apparent historical seasonal patterns where April is normally a bumper month.

Sources: Li & Fung; CFLP; Plexus Asset Management.

Sources: Li & Fung; CFLP; Plexus Asset Management.

Although most commentators ascribe the lower-than-expected PMI to the action taken by the Chinese authorities to tighten credit conditions and reign in the property sector, my analysis indicates that the external sector and especially the fallout of Japan’s twin disaster played a major role in the weak PMI number. The new export orders PMI registered a paltry 51.3, whereas in normal circumstances it would have been in excess of 54, given the historical seasonal pattern.

Sources: Li & Fung; CFLP; Plexus Asset Management.

The same is evident in the import PMI that came in at a barely growing 50.6, whereas in normal circumstances it would have been in excess of 53, given the historical seasonal pattern.

Sources: Li & Fung; CFLP; Plexus Asset Management.

In contrast, the stocks of major inputs PMI followed the historical seasonal pattern and the 52.0 was in fact somewhat stronger than what would  otherwise have been expected.

Sources: Li & Fung; CFLP; Plexus Asset Management.

But where does that leave China’s manufacturing industry, you may ask. In short: “Overstocked!” The ratio between the stocks of major inputs PMI and the new orders PMI is approaching high levels similar to that of mid-2008 during the commodity frenzy that lasted until July that year. (Please note that the axis is in reverse order). We all know what happened afterwards! Where the ratio between the stocks of major inputs and new orders normally follow the same pattern, it is evident that Chinese manufacturers have changed tack since the start of last year.

Sources: Li & Fung; CFLP; Plexus Asset Management.

A relatively high stock to orders ratio is followed by a weaker manufacturing PMI a month later and vice versa. The stock to orders ratio therefore leads the PMI by one month. It seems to me that the Chinese manufacturers are much  more inventory conscious than in the past, because their monthly responses to the PMI questions are highly influenced by the ratio of stocks to new orders of the previous month.

Sources: Li & Fung; CFLP; Plexus Asset Management.

The said pattern that has emerged is not limited to stocks of major inputs, though. A similar pattern is evident in the ratio of stocks of finished goods to new orders (please note the reverse axis).

Sources: Li & Fung; CFLP; Plexus Asset Management.

Sources: Li & Fung; CFLP; Plexus Asset Management.

My conclusion is that Chinese manufacturers are currently overstocked given April’s PMI for new orders. The PMI ratio for stocks of major inputs to new orders indicates that the manufacturing PMI in May could fall to below 51.0, while the PMI ratio for stocks of finished goods to new orders indicates a drop to below 52.0.  That corresponds to the seasonal lull that starts to set in from May to July.

It certainly does not bode well for the Baltic Dry Index in coming months.

Sources: Li & Fung; CFLP; I-Net Bridge; Plexus Asset Management.

With the Chinese as the driving force behind commodity prices, the high stocks to orders ratio raises questions about the sustainability of high commodity prices in coming months.

Sources: Li & Fung; CFLP; I-Net Bridge; Plexus Asset Management.

The significant gap that has opened between China’s new export orders PMI and metal prices specifically is most worrying.

Sources: Li & Fung; CFLP; I-Net Bridge; Plexus Asset Management.

Although China’s Shanghai Composite Index pulled back to be more or less in line with the PMI, I think that there is still downside ahead and will bide my time before venturing into that market.

Sources: Li & Fung; CFLP; I-Net Bridge; Plexus Asset Management.

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