China’s growth down to 9.2%: Time to start nibbling on stocks?

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China’s CFLP non-manufacturing PMI of 61.9 for May was perfectly in line with the apparent seasonal trend experienced since the PMI survey started in 2008.

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

I think it is pretty obvious that June’s non-manufacturing PMI is likely to drop to around 57 from May’s 61.9 due to the seasonal lull in June. The financial markets will probably focus on the drop, though, and will view it as a signal that growth in the services sector is slowing sharply. Silly, isn’t it?

To get a clearer picture of the underlying trend in the services sector I decided to seasonally adjust the PMI time series. I concentrated on the trends in 2009 and 2010 and ignored 2008 due to the impact of the liquidity crisis. In the graph below, in which the seasonally adjusted PMI time series is depicted against the actual time series, it is evident that the seasonally adjusted PMI has trended down since January 2008 while the downtrend of the unadjusted PMI only manifested itself in November of that year. The same happened at the beginning of 2009 when the uptrend of the seasonally adjusted PMI appeared long before it was actually visible in the unadjusted PMI.

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

The steadiness of the seasonally adjusted PMI since March 2009, ranging between 55 and 60, is remarkable as it indicates that growth in the services (non-manufacturing) sector ranges between fast growth and robust growth.

Critics of China’s statistics almost always argue that the GDP growth numbers are manipulated to suit China’s government as there is no relationship between what is going on in the underlying economy and economic growth. I want to dispel that view. In the graph below I smoothed the seasonally adjusted non-manufacturing PMI by the three-month moving average and depicted it against the official China Consumer Confidence Index. It is evident that consumer confidence is the driving force behind the services sector. With the long time lag of the publication of the Consumer Confidence Index it is clear to me that the trend of the smoothed seasonally adjusted non-manufacturing PMI is an excellent indicator of consumer sentiment in China.

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

The jump in consumer sentiment in March should therefore have been expected, but perhaps not the extent of it. The continued rise of the smoothed seasonally adjusted PMI since March indicates that consumer sentiment has not stalled despite market comments pointing to the opposite. Just bear in mind that the services (non-manufacturing) sector of China’s economy constitutes roughly 40% of the total economy, with the rest made up by the manufacturing sector.

China’s CFLP manufacturing PMI dropped to 52.0 in May from 52.9 in April. The PMI was in line with what I expected on the basis of the seasonal pattern and what the stock-to-orders ratios pointed to in the previous month’s PMI.

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

The PMI is significantly lower than previous years’ seasonal patterns, though, indicating weakness in growth compared to other years (2008 and 2009 are excluded as a result of the global liquidity crisis).

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

To me Japan’s twin disasters in March are severely denting China’s manufacturing sector as the usual seasonal strength in new export orders in April and May was absent this time around.

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

In my previous coverage I commented that Chinese manufacturers found themselves in an overstocked position. Although the seasonal factors call for a somewhat weaker stocks of major inputs index reading, it plunged in May.

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

The new orders index fell less and resulted in an improved stocks of major-inputs-to-new-orders ratio situation (please note the reverse axis). With the said ratio leading the CFLP manufacturing PMI, May’s ratio is pointing to a slight rise in June’s PMI.

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

Finished goods at the factory level remain a problem as the ratio of the stocks of finished goods relative to new orders continued to decline in May and points to further weakness in the manufacturing PMI in June.

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

If I extrapolate the relative weakness of 2011’s PMI compared to that of other years through June, and taking into account the seasonal weakness during this month, it seems to me that a figure of between 51.0 and 51.5 should be expected in June. The trend is consistent with what the stock-to-orders ratios are indicating.

By seasonally adjusting the CFLP manufacturing PMI I was amazed to see the actual impact of the Japanese crisis on China’s manufacturing sector.

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

A closer look illustrates that the seasonally adjusted PMI fell from 53.1 in February to a barely expanding 50.1 in April. May’s figure rebounded to 52.0, though, and therefore indicates that the growth in the manufacturing sector actually accelerated in May from April’s low.

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

The impact of Japan’s twin disasters on China’s manufacturing sector can clearly be seen in the graph below where Japan’s manufacturing PMI (already seasonally adjusted when published) is depicted against my seasonally adjusted manufacturing PMI for China. Looking at the trade between the two countries and the interdependence between them, the close relationship since Japan’s twin disasters is no coincidence.

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

The stronger seasonally adjusted manufacturing PMI for China in May was therefore on the back of the recovery in Japan’s manufacturing sector. With the recovery in Japan’s manufacturing sector set to gain momentum it means that the Chinese economy is past the worst in the aftermath of Japan’s twin disasters. Even if June’s manufacturing PMI falls to 51 it will effectively mean that the seasonally adjusted manufacturing PMI for June will improve on May’s 52.0 and therefore means that growth in the manufacturing sector is accelerating. The slack in production as a result of Japan’s crisis is therefore being taken up, albeit slowly. In my view growth in China’s manufacturing sector is likely to surprise on the upside in the third quarter of this year on the back of the expected recovery in Japan.

The calculation of seasonally adjusted time series for China’s manufacturing and non-manufacturing sector PMIs enabled me to calculate a seasonally adjusted GDP-weighted Composite PMI. I was struck by the steadiness of the PMI and was amazed when I depicted it against China’s GDP growth on a year-ago basis.

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

From the graph it is clear to me that year-on-year GDP growth in China has slowed to approximately 9.2% in the second quarter from 9.7% in the first quarter. With the robust pace of growth in the services (non-manufacturing sector) maintained, the slump in the manufacturing sector of the economy on the back of the crisis in Japan is likely to be the sole fly in the ointment.

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

The significant slowdown in economic growth in the second quarter is also likely to take the heat off the PBoC with regard to tightening further.

Is that what the market expects? No, I do not think economists expect such a pull-back in growth, but the Chinese stock market players seems to have the edge on them. They are in fact fairly good anticipators of the underlying economy as illustrated below. At the end of April the market was slightly overoptimistic about May’s PMI but at the end of May it anticipated a lower PMI ahead.

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

Soon the market players will realize that the recovery in Japan is again lending support to China’s manufacturing sector. Furthermore, they will begin to anticipate seasonal strength in Q3.

Yes, in my opinion one can gradually start accumulating Chinese stocks on weakness. The Shanghai Composite Index looks particularly interesting after the knock of nearly 12% from its April highs.

Source: StockCharts.com

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2 comments to China’s growth down to 9.2%: Time to start nibbling on stocks?

  • Shailendra

    Its an excellent reading, very informative and brings straight and logical quantitative argument.

  • spragus

    the charts are good!
    but what I see is that the underlying momentum of the Chinese economy is still there. Coupled with a continued rise in inflation,the government is going to want to continue tightening (raising rates). That may not be so good for the stock market.

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