Market/Economy Analysis: China

China has been one of the primary economic drivers of the last 10-15 years; it is the primary force in the "south-south" trade, where raw material exporters (Australia, Canada, most of South America) sell their raw materials to China who then converts them into final products for shipment to the west.  However, China's growth is slowing.  Consider the following data points released since June 1:

Manufacturing

After adjusting for seasonal factors, the HSBC Purchasing Managers’ Index™ (PMI™) – a composite indicator designed to provide a single-figure snapshot of operating conditions in the manufacturing economy – posted at 49.2 in May, down from 50.4 in April. This signalled the first deterioration in operating conditions in seven months, albeit at only a marginal pace.

Despite operating conditions worsening, manufacturing output rose for the seventh month in a row during May, albeit marginally. Behind the meagre expansion of output, total new orders declined modestly and for the first time since last September. Demand from abroad also weakened over the month, with new export orders falling for the second month in a row. A number of panellists suggested reduced client demand, particularly in the US,

Here's a chart of the relevant data:

Note that the index spent most of 2012 below 50, indicating contraction.  Now traders are concerned we're seeing that trend start again.

Services:

Output continued to expand across both the manufacturing and service sectors for the seventh consecutive month in May. However, production at manufacturing plants rose at the weakest pace since October 2012 and business activity at service providers increased at a modest pace. The latter was signalled by the HSBC China Services Business Activity Index, which posted 51.2 in May. This was broadly unchanged from April’s 51.1 and was one of the lowest readings in the series history.

Total new orders were relatively unchanged in May at the composite level, with sector data indicating differing trends. New work intake at manufacturing plants fell modestly over the month and for the first time since last September, while new business increased at service providers. However, the rate of growth was modest and remained historically weak in the service sector.

Here's a chart of the data:

While still positive,  we've seen a few months of lower prints.  This is hardly fatal, as this sector hasn't meaningfully contracted in over two years.  But it is something to keep your eye on.

Other recent data prints have also disappointed.  From Bloomberg:

China’s trade, inflation and lending data for May all trailed estimates, signaling weaker global and domestic demand that will test the nation’s leaders’ resolve to forgo short-term stimulus for slower, more-sustainable growth. 

Industrial production rose a less-than-forecast 9.2 percent from a year earlier and factory-gate prices fell for a 15th month, National Bureau of Statistics data showed today in Beijing. Export gains were at a 10-month low and imports dropped after a crackdown on fake trade invoices while fixed-asset investment growth slowed and new yuan loans declined. 
.....

Industrial production compared with the median estimate for a 9.4 percent increase, with growth the weakest for a January-May period since 2009. Fixed-asset investment excluding rural areas rose 20.4 percent in the first five months from a year earlier, down from a 20.6 percent pace in January-April, statistics bureau data showed. May’s retail-sales growth of 12.9 percent matched the median projection of analysts.

May exports rose 1 percent from a year earlier, down from 14.7 percent in April, while imports dropped 0.3 percent from a year earlier. The median estimates of analysts were for 7.4 percent export growth and 6.6 percent import gains. The $20.4 billion trade surplus compared with forecasts for $20 billion.

“This shows the real state of the Chinese export situation,” said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong. The data give a “pretty depressed” picture, with weak external demand and a yuan that has appreciated substantially against a trade-weighted basket of currencies, said Shen, who previously worked at the European Central Bank. 

Bear in mind that China needs rapid growth because of two inter-related factors: the world's largest population and its GDP per capita.  In order to create a large enough economic "pie" to spread out over its population and thereby raise people out of poverty, we need to see strong growth figures.  That's why industrial production prints of 9.4% are concerning to economists.  Now, let's also stipulate the Chinese slowdown is "relative" and no one is predicting a crash. These are still good numbers; they just indicate things are slowing relative to what we've seen.

But most importantly is that the traditional policy avenues to increase growth aren't there.  From the Financial Times:

The concern about China’s slowdown is grounded partly in the speed with which credit is growing in China. The figure for total lending, which includes the non-banks as well as the banks, hit nearly Rmb8tn ($1.3tn) in the first four months of the year, significantly higher than the Rmb4.85tn for the same period a year ago, according to JPMorgan. Today, China’s total credit is almost double its gross domestic product.

But more worrying is the declining efficacy of that credit. The amount of capital being put to work is swelling, but the productivity of that capital is plummeting. Five years ago, a dollar invested produced a dollar of GDP growth. But today it takes $3 to $4 of investment to produce a dollar of output – and the quality of that output is suspect. There is overcapacity across many Chinese industries, from shipbuilding to solar.

The decreasing efficacy of Chinese lending is a policy problem, because this is the preferred method for the Chinese government to goose economic growth.

The short version of the above data points is it is becoming more and more apparent that the Chinese growth story is changing.  And that has tremendous ramifications for the rest of the world.

The Chinese market is consolidating in a descending triangle formation, with the top part of the triangle connecting the early February and last May highs and the lows established on the 38.2% Fib level.  A break of the 2150 level would indicated a move lower.  Also note that prices are below the 200 day EMA with the shorter EMAs moving lower.

The beginning of a sea change in household deleveraging

- by New Deal democrat

The Federal Reserve's report on household debt burdens was released earlier this week covering the January - March quarter. I have been watching these series since before the Great Recession. Indeed, when household debt burdens started to decline, that was one of the final signs that the Recession was about to start. Further, I long suspected that, before this cycle was over, households would set new all time lows for debt service. With the exception of one quarter in 1980 (as to total financial obligations), that happened in the final quarter of last year.

First, a refresher. According to the Federal Reserve,

The household debt service ratio (DSR) is an estimate of the ratio of debt payments to disposable personal income. Debt payments consist of the estimated required payments on outstanding mortgage and consumer debt.

The financial obligations ratio (FOR) adds automobile lease payments, rental payments on tenant-occupied property, homeowners' insurance, and property tax payments to the debt service ratio.

I've combined the two measures into a single graph. Total financial onligations are in blue and debt service payments are in red:



I have noted a number of times that refinancing increased in 2011 and 2012 with new record lows in mortgage rates, and probably played a major role in keeping the economy from tipping back into recession.

Now, for the first time in four years, household deleveraging has stopped. Whether we have already hit the absolute bottom or not is impossible to say, but it certainly appears that the bottoming process has begun.

It's also worth noting that the willingness of households to re-leverage, even slightly, bespeaks increasing confidence about the future. Recall that this has also shown up in recent consumer confidence readings, which have made 5 year highs, and in Gallup's consumer spending data, which has been strong ever since last December, even in the face of the payroll tax increase. This is also of a piece with the new post-recession lows in the savings rate.

I believe thie is the beginning of a very slow sea change.

A note about the CPI

. - by New Deal democrat

Consumer prices for May were reported on Tuesday as having risen +0.1%, in line with my prediction based on gas prices of +0.2% +/-0.1%.

I haven't been making these forecasts just as an exercise in crystal ball gazing (well, okay, maybe just a little), but also as a way of elaborating on a theme I've been writing about for a long time -- the major but largely unremarked impact of the secular increase in gas prices on the consumer economy.

What I've been trying to show, among other things, is that the relative change in gas prices has been the driving determinant in whether wages fall behind, keep up with, or increase vs. the general price level since gas prices bottomed in 1999. With gas prices finally plateauing or even declining slightly in the last year, real wages have started to increase again.I believe this is an important reason why the economic expansion has so far survived both the payroll tax increase and Sequestration.

Will Oil Finally Break Through the 98 Price Level?

The 98 price level has provided strong resistance for oil prices this year.  Yesterday prices closed at 98.58.  Let's see if the upward momentum continues today.

Condolences to Professor Thoma

Professor Thoma of Economists View just announced that his wife has passed away.  On behalf of all here at the Bonddad Blog, we want to extend our deepest sympathies.

US Industrial Production Slowdown

The latest contraction in the ISM manufacturing report indicates the US manufacturing sector is slowing.  There have been signs this was happening for the last few months.  First, we've seen weak readings from some of the regional manufacturing reports.  For example, here is the latest Empire State report:

The May 2013 Empire State Manufacturing Survey indicates that conditions for New York manufacturers declined marginally. The general business conditions index fell four points to -1.4, its first negative reading since January. The new orders index also edged into negative territory, and the shipments index fell to zero. The prices paid index declined eight points to 20.5, indicating a slowdown in selling price increases, while the prices received index was little changed at 4.6. Employment indexes were mixed, showing both a modest increase in the number of employees and a slight decline in the length of the average workweek. Indexes for the six-month outlook were generally lower, suggesting that optimism about future conditions had weakened.    

And  the latest Philadelphia Fed Report:

The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, decreased from 1.3 in April to -5.2 this month. The current activity index has shown no pattern of sustained growth over the past seven months, generally alternating between positive and negative readings (see Chart). The number of firms reporting decreased activity this month (29 percent) edged out those reporting increased activity (24 percent).

Richmond also shows a slowdown:

In May, the seasonally adjusted composite index of manufacturing activity — our broadest measure of manufacturing — gained four points settling at −2 from April's reading of −6. Among the index's components, shipments recouped seventeen points to 8, the gauge for new orders slipped two points to finish at −10, and the jobs index subtracted six points to end at −3.

 We also see this slowdown in the overall industrial production numbers coming from the Federal Reserve.

The above chart breaks the US down into market groups.  In 4 of the last 7 months we've seen weak readings from the final products and non-industrial supplies sector.    Non-durable goods have printed weak readings in 3 of the last 7 months, and non-energy has printed weak readings in 2 of the last 3 prints.

Let's look at the anecdotal reports from the latest ISM report to get some more insight into this section of the economy:

• "Customers are anticipating resin price decreases and holding back orders." (Plastics & Rubber Products)
• "Slight uptick in overall business but not substantial." (Textile Mills)
• "Government spending has tightened, which has moved out program awards and caused some reduction in force." (Computer & Electronic Products)
• "Market outlook is relatively flat, with some promise of raw materials inflation relaxing." (Electrical Equipment, Appliances & Components)
• "General economy seems sluggish and pensive. Buyers are not buying much beyond lead times." (Fabricated Metal Products)
• "Downturn in European and Chinese markets is having a negative effect on our business." (Machinery)
• "We are having a difficult time hiring skilled employees." (Transportation Equipment)
• "Business continues to increase, but over the past 20 days we have seen the trend flatten." (Furniture & Related Products)
• "Market was holding strong until mid-month — then softened." (Wood Products)
• "Decline in sales for FYQ2 over same period a year ago due to softer demand [in] both domestic and exports." (Chemical Products)

Summing up the information we get the following points:

• The overall domestic economy is "sluggish and pensive" with a "flat' outlook and some markets have recently "softened."  Cuts to government spending are having an impact.
• The international slowdown is also hurting.  

In addition, consider the excess capacity in the system:

In another sign of recent weakness in the manufacturing sector, capacity utilization in the US has stalled, as demand remains soft. US industries are producing significantly below their capacity and "5.5 percentage points below long-run average" according to the Fed. We are certainly far under the 82-85% level at which economists believe that the traditional measures of inflation are expected to rise.

The sky is not falling.  But things are definitely grinding lower.