China's Unsustainable PMI

The last two nights we have been bombarded with headline data on manufacturing in China - one good and getting better and one bad and consistently contracting. Credit Suisse digs into the reality underlying these indices and notes three reasons why they feel the positive PMI trend is unsustainable as cutting through the "baffle-'em-with-bullshit" macro data is critical in understanding the sad reality we face.

First, PMI New Orders have been sustaining the recent strength but seasonally (thanks to Chinese New Year) it is all downhill from here (and in fact this month's data dropped modestly)...

Second, the divergence between NBS and HSBC is almost as wide as it has ever been and has proved entirely unsustainable in the past (with NBS PMI tending to drop to HSBC in most cases). This dislocation may be due to some selective government projects that are a) not a reflection of the broad economy; and b) likely unsustainable also...

and third, the divergence between PMI New Orders (down) and PMI Output (dramatic rise) is entirely unsustainable. For this year, the movement in new orders in April is counter to its usual seasonal pattern, reflecting the weakness in the underlying demand from the private sector. This is a point we have been warning over the past two months.

As Credit Suisse concludes:

The latest trend in PMI fits with the scenario we have been talking about – the economy has bottomed but not out. While the resumption of local government infrastructure projects would help remove the risk of a hard landing, we do not think it would help the economy to rebound quickly and strongly. In our view, Beijing’s tolerance towards slightly more lending is assuring, while the pick-up in some infrastructure investments has also provided a floor to how slow growth can be. However, the underlying demand from the private sector is missing at this moment and that cannot be addressed by simply making monetary policy less restrictive, in our view. Without the involvement of real private businesses and with continued restrictions on lending to developers, we suspect banks will soon run out of qualified borrowers to undertake projects and drive economic activities forward. We think that this data set would cool off the market’s optimism about a quick rebound in Chinese demand.

Yet, the economy is not doing that bad, hence a substantial stimulus is not likely in the near future. We reiterate our core view for the medium term outlook that the Chinese economy has entered a multiple-year period of subdued growth, featuring a weak credit cycle, a weak export cycle, a weak property cycle, and a weak SME cycle.