Why Chinese Manufacturing Data Signals a Coming Collapse

China’s economy is going from bad to worse. The manufacturing sector, for so long the lifeblood of the economy, fell to its lowest point in over six years this month. It’s comes as further proof that the world’s second largest economy is sinking.

The decline in manufacturing is alarming for several reasons. For one, it affects confidence from within China itself. But just as important is the effect it has on global markets and the world economy at large.

Stock markets are reacting badly to any hint of negativity coming out of China. US stocks in particular are plunging because of all the uncertainty surrounding China at the moment. And it doesn’t get much bigger than manufacturing data. It only highlights that Chinese authorities are incapable of reversing the decline.

The one thing markets are clutching to instead is the belief that credit growth is rising. That’s creating the perception that the economy will pick up later in the year. But the markets have their bearings off on this one, as we’ll see later.

But let’s stick with the manufacturing figures for the moment. How bad were they? I’ll leave it to He Fan, an economist at Caixin Insight Group, to explain:

The PMI [manufacturing] for August has fallen further from July’s two-year low, indicating that the economy is still in the process of bottoming out’.

The PMI here refers to the Purchasing Managers Index. It’s essentially a reading measuring things like the number of new orders for various goods. Anything below 50 suggests that manufacturing is underperforming on a long term basis.

The PMI dropped to 47.1 in August, which was down on July’s 47.8 reading. Worse still, it defied expectations that predicted a rebound in the PMI. Instead, orders from domestic and foreign buyers declined for the month.

As you might expect, markets didn’t take the sobering news well.

Markets tumble on Chinese manufacturing, economic slowdown

The week-long selloffs on Chinese stock markets showed no signs of slowing yesterday.

The Shanghai Composite Index (SCI) fell another 3.4% to 3,664 on Thursday, capping off a torrid week for investors. Earlier in the week the SCI saw a single-day plunge of over 6% amid fears of capital flights. Investors worry that the yuan’s recent devaluations will lead to a flood of money leaving Chinese shores.

Meanwhile, global markets worry about what all this means for China’s economy. The longer its economic situation worsens, the likelier it is that global markets start to panic.

The US S&P500 shed 2.11% overnight, dropping to 2,035 points. In one fell swoop, the S&P wiped most of its gain for the year. Similarly, the Dow Jones plunged 2% to 16,990 points. The NASDAQ lost 2.82%, finishing on 4,877 points.

Closer to home, the ASX200 fell to 5,179 at 3pm AEST, down 2.1%. Banks led the selloffs, with the Big Four all down between 2.4–4.3% each in trade today.

The ASX200 is now down 9% for the month. It’s on course for its worst monthly performance since 2008.

What’s beyond any doubt is that China has global markets spooked. What we’re seeing now is an international response to China’s slowdown. It’s true that global markets have little exposure to Chinese stocks. But they have a lot of exposure to China’s economic problems.

The truism ‘when the US sneezes, the world catches a cold’ could apply here too. China is sneezing, and global markets are coming down with something.

And why wouldn’t they?

After all, most economies have a stake in the wellbeing of China. US trade with China is critical to the prosperity of both nations. As far as Australia’s concerned, our relations with China are paramount to our own wellbeing. Who’ll buy our minerals if China is too sick to spend? There’s no obvious alternative.

Not that everyone is concerned about China’s future. Some believe the big rebound is coming.

Credit growth in China a good omen…or is it?

One thing markets are pinning their hopes on for a Chinese recovery is down to rising credit growth. From the Australian Financial Review:

The Chinese economy is forecast to grow at 7% this year. [Markets fear] this number is unreachable without significant government stimulus.

One sign that Beijing is unwilling to let the economy slow significantly has been a recent pick-up in credit growth. [That’s regarded] as the single most important factor in China’s economy performance.

[Credit growth] hit a 31 month high in July and has increased by 20% over the last three months. [It suggests economic] activity will rebound later in the year’.

That would be fine, if any of it was true. But credit growth in China isn’t picking up — far from it. The markets may have convinced themselves of it, but what they’re seeing is nothing but an illusion.

The recent ‘credit growth’ in China is a stunt.

China announced that credit growth grew by 1.48 trillion yuan in July. But 60% of this ‘growth’ was a ruse. Why? Because it came from ‘non-banking financial institutions’. In other words, the Chinese loaned themselves 1.48 trillion yuan. They did so to support the stock market, which was plunging at the time. They then had the gall to register this as new credit growth.

Why does this matter? It’s because the Chinese economy got nothing from this cash injection. It didn’t increasing real activity in the real economy.

But here’s the kicker. If we just account for loans to the real, or actual, economy, July was a stinker.

Loans to the real economy grew by 1.32 trillion yuan in June. In July, however, that figure plunged to 589 billion yuan. That’s the lowest official figure since October 2014. In other words, loans that the economy benefits from fell by 735 billion yuan in July!

If markets are pinning their hopes on ‘healthy’ credit growth for China’s recovery, they’re in for a rude shock. Credit growth didn’t hit a 31 month low in July. It didn’t increase by 20% in the last three months. Nor does it suggest that economic activity will rebound later in the year.

If anything, it suggests the completely opposite. Both manufacturing and credit growth is declining. Things are bad, and they’re getting worse.  Once markets catch wind of this, market panic could reach fever pitch.

China is on a rollercoaster to the bottom. Global markets better prepare for what’s coming.

Mat Spasic,

Contributor, Markets and Money

PS: Chinese stock markets aren’t the only ones with clouds hanging over their future. The Aussie share market has a few dark clouds of its own.

Markets and Money’s Vern Gowdie believes the ASX is set for a catastrophic crash.

Vern is the award-winning Founder of the Gowdie Family Wealth advisory service. He’s ranked as one of Australia’s Top 50 financial planners. Vern’s convinced the ASX could lose as much as 90% of its $1.8 trillion market cap.  And that’s why he’s written ‘Five Fatal Stocks You Must Sell Now’ for you.

In this free report, Vern identifies the five companies which could destroy your wealth. It’ll surprise you to learn which blue chip stocks made his blacklist. And he’s identified one major commodity stock that could catch you by surprise. To find out how to download the report, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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