January 02,2013

China's First PMI in 2013: Disappointing or Intentionally Conservative for Rainy Days Coming?

By Lu Ting

China's govt-backed NBS PMI came in at 50.6 in Dec, unchanged from Nov. It's below market consensus at 51.0 and our slightly more conservative forecast at 50.9. Though the 50.6 NBS PMI reading is below consensus and thus could be a bit disappointing, we expect markets won't turn bearish (see below). Simply put, we believe the Chinese economy and its asset markets will remain in a sweet spot in 1H13. However, as the street's China GDP growth consensus has been increasingly ratcheted up by exuberant forecasters, investors should be wary of getting too optimistic in coming months.



 Why markets may remain bullish despite the "disappointing" PMI?


First, most data points, especially the industrial earnings, have been pointing to an impressive recovery. Second, the private HSBC PMI for Dec, which was released yesterday, jumped to 51.5 in Dec from 50.5 in Nov, helping trigger a rally of China' stock prices yesterday. Third, PMI data are heavily seasonally adjusted, especially during the year ends and beginnings. It's likely that the NBS statisticians intentionally reported a conservative estimate within the allowable range to save better data for rainy days. Finally, the relatively muted official NBS PMI, especially a decline of exporter orders to 50 in Dec from 50.2 in Nov, means that the Chinese government will continue its pro-growth policy stance at the moment to withstand weak external demand. 


 Markets have turned decisively positive on China, the new questions is ?


Feedback from our global marketing in the past two months suggests that even those die-hard perpetual China bears believe in a soft-landing now. Investors are no longer interested in verifying China's green shoots. Instead, they are asking how sustainable the current recovery and when macro indicators will once again turn negative to markets as they are wondering when to take profit. In this regard, we have a concise answer. In 2012, macro environment was anemic to asset prices in 1H but turned increasingly supportive in 2H. In 2013, we expect the exactly the opposite. Macro environment could remain supportive of asset prices in 1H, but will likely turn less supportive or even negative in 2H as GDP/IP/earnings growth slows and inflation rises. Markets are now in honeymoon with China's new leaders by putting too high expectations on reforms, but investors could turn more realistic reforms in 2H. And, Beijing may have to take measures in 2H to prevent over-investment by China's new local officials. Finally, with macro indicators turning less supportive in 2H13, investors will increasingly shift attention to China's structural issues such as shadow banking, government debt and property bubble.


 Details: Domestic demand is the main growth driver


In Dec, new orders came in flat at 51.2 and production dropped to 52.0 from 52.5 in Nov. New orders was negatively impacted by the moderation of export orders, which declined to 50.0 in Dec from 50.2 in Nov. It suggests that domestic demand was still the main driver for growth, in line with our view that manufacturers have started restocking on rebounding commodity prices and improved economic outlook. HSBC PMI, released on 31 Dec, also shows the same pattern. New orders in HSBC PMI rose to 52.9 in Dec from 50.8 in Nov, but new export orders drooped to 49.2 in Dec from 52.1 in Nov.


Inventory of finished goods rose to 49.4 in Dec from 48.8 in Nov, while raw materials dropped to 47.3 from 47.9. Combined with other information, we believe the decline of raw materials inventory is a good signal in the current inventory cycle, mainly due to the pickup of production and investment demand, rather than to the destocking behaviour by the manufacturers.


Employment picked up slightly to 49.0 in Dec from 48.7 in Nov, but still lower than the average of 49.1 in 2H12. Note the adjustment in labor market usually lags behind economic conditions as firms are reluctant to cut payrolls in the early stage of a slowdown, and also slow to increase hiring in a recovery. We expect that the current labour market could ensure that Beijing keeps policy easing/stimulus to support growth.


Purchase prices rose to 53.3 in Dec from 50.1 in Nov. At this stage, inflation of both consumer and factory-gate prices remains subdued, providing room for Beijing

to sustain the current pro-growth policy stance. That said, current low inflation sows the seeds of higher inflation a year later in 2H13. We expect CPI inflation to slightly rise to 2.3% in Dec and we forecast 3.0% CPI inflation in 2013.


(Mr. Lu Ting is the Chief China economist with BAML )


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