Chinese PMI – Looking Like Slowing Growth

For the first time in seven months the Chinese Purchasing Managers Index (PMI) fell as the HSBC PMI (Flash) fell to 49.6. Any number below 50 indicates that the economy is contracting instead of expanding as the final HSBC PMI measured 50.4 in April. The contracting manufacturing industry in China shows that the country will have a difficult time reaching its 7.5% target growth rate for 2013 and additionally it implies that the global economic recovery is stalling after several months of positive data.

Internally, the government has to decide whether or not to change their monetary policy in an attempt to stabilize manufacturing activity or allow the slowdown to continue and focus their efforts on boosting domestic demand for goods. Currently, China generates the majority of their GDP growth by attracting foreign investment and exporting a wide array of goods. Globally, the slowing of the Chinese economy has massive ramifications throughout the world economy as many commodity prices are tied to the demand from China which will drive their prices higher or lower, several currencies are tied to their country’s ability to export to China (i.e. Australian dollar), and the pace of Chinese economic growth is an important barometer to measuring the growth of the global economy.

As part of the PMI measurement, the sub-index of New Orders fell to 49.5 which shows that there are not enough new orders being placed to push the country’s economic expansion higher. This sub-index is extremely important to watch because it shows future potential growth and when this sub-index begins to contract, the PMI will most likely follow suit (and vice versa). With the falling New Orders sub-index and falling PMI, Chinese domestic demand is weak and unable to make up the slack given by the global economy. This is the dilemma that the Chinese government faces, do they focus on continuing to grow their export markets or do they focus on strengthening domestic demand. If the country wants to generate long term success, they will focus on strengthening the Chinese consumer, but, with the markets irrationality and the need to please investors, the government will have to strike a balance between generating higher levels of growth and creating long term sustainability.

In order for the global economy and many advanced economies to create and sustain growth (including Canada), the Chinese economy must find its footing and stabilize its growth rates. The historical phase of expansion which saw the Chinese economy produce double digit growth rates may be over as the country is transitioning into a different phase of wealth and growth. However, the market is looking for stable and expanding growth, if China is able to create consistent positive growth, the markets will respond in kind.

Chinese PMI Chart - April 2013

Chart was captured from: http://www.bloomberg.com/quote/CPMINDX:IND

Sources:

• http://uk.reuters.com/article/2013/05/23/uk-china-economy-flash-pmi-idUKBRE94M02R20130523
• http://business.financialpost.com/2013/05/23/warning-signs-for-china-as-factory-activity-shrinks-for-first-time-in-7-months/

Weekly TA for May 13-17th

Here is a brief look at the TSX, Focus 5 and several ETF’s on how they performed over the week.

European Financial Crisis Explained

Here’s a quick youtube video explaining why Europe is in trouble. Enjoy!

‘Over 50% chance for Iran conflict in coming year’: David Gergen

Interesting article in the Jerusalem Post regarding some comments made by CNN political wonk David Gergen regarding Iran (click here to read article). [Hat tip: Global Macro Monitor]

Key points:

• Mr. Gergan believes that there is a greater than 50% chance of a conflict with Iran occurring in the next 2-24 months. According to some estimates, the odds are over 90%.
• Key quote: “In my 30 years in and out of politics, this is the toughest problem I have ever seen.”

Oil has been trending lower over the past couple of months primarily due to the fact that sluggish global oil demand has replaced Iran as the central talking point. Here is a reminder that Iran hasn’t gone away; it is merely on the back burner.

Earnings Cliff

Much has been written about the potential “fiscal cliff” faced by the US (click here to read article), but it seems that US equities are currently driving off an earnings cliff (click here to view video).  As of last Friday, only 42% of the 98 companies in the S&P 500 who have already reported their earnings, reported sales figures that beat the market estimate. If this continues, this will be one of the  weakest quarters for sales growth since the depths of the great recession in late 2008/early 2009. Over the past couple of years companies have been able to beat earnings estimates by cutting costs, but you can’t hide from sales declines forever. Europe in a near depression and a slowing China are starting to take its toll on corporate results.

Some of the companies that have reported disappointing results are some of the global economy’s bellweathers:IBM, DuPont, and 3M are just a few of the companies missing sales targest. DuPont also announced job cuts of 1,500, while Dow Chemical said it would cut 2,400 jobs (click here to read article). From the FT article:

                             US corporate earnings have so far been in line with forecasts that quarterly  profits and revenues will fall for the first time since 2009.

                         Jack Ablin, chief investment officer at Harris Private Bank, said: “I give  more weight to fundamentals than liquidity from the Fed.

                             The fact that we are  seeing a 2 per cent drop in profits for the first time since  2009 . . . represents a directional change in the market.”

It is still early, but if this is a sign of things to come out of the US, then Mr. Ablin is probably right in that we are witnessing a major directional change in the makret. In Canada, the earnings season for the TSX 60 is just getting underway, with CN Rail announcing on Monday decent earnings (click here to read article) along with a cautious outlook for the rest of the year. Tomorrow we get a handfull of TSX 60 companies reporting their results. We are likely to see a number of Canadian companies across the commodity landscape report poor results. Keep a watchful eye on your companies.