Wednesday, July 25, 2012

Goldman's bullish call on China may be premature

So far markets' reaction to the latest increase in China's manufacturing PMI has been quite muted (h/t Avi Cohen). Here are four market indicators as well as two other factors demonstrating that it's way too early to call for a bottom in China's economic activity.

1. SHIBOR 1-year swap rate declined last night and is hovering near the recent lows. As discussed before, this swap rate is a measure of short term rate expectoration going out to 1 year. Just as in teh US, expectations of material improvements in economic growth would have resulted in the swap rate increase.

1-year SHIBOR rate swap

2. The Renminbi (CNY) continues to weaken. Clearly Bejing has the ability to control it but the government is allowing the currency to float within some range. This weakness may be an indication of some capital outflows.

CNY (per 1 dollar)

3. China's equity market hit another recent low, showing lack of confidence in corporate profit growth.

Shanghai Stock Exchange Composite Index

4. Imported iron ore prices (discussed earlier) are experiencing a sharp decline as well and are now nearing the three-year support level. A good indicator of demand decline for industrial commodities in China would be a breach of this support level the next few days.

China import Iron Ore 62% Fe spot (CFR Tianjin port)
USD/metric tonne (Bloomberg, Steel Business Briefing)

A couple of other indicators also support the slowdown thesis, negating the jump in the manufacturing PMI. One is the ISI Company Survey Index of China Sales, which is now at 2009 levels and is not showing signs of bottoming out.

Source: ISI Group
Another is today's Caterpillar (CAT) call which hinted that the firm is continuing to see soft machinery demand in China. CAT announced that they have no intentions of bung back stock at least in part due to lack of confidence in China's growth. The stock sold off in response.

CAT shares intraday

These indicators clearly tell us that yesterday's Goldman bullish call on China, based on the July flash PMI reading, may be premature.
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