When Down is Up – In Global Markets (#60)

China’s ‘Purchasing Managers Index’ (PMI) registered its lowest number (48.1%) in eight (8) months and the Asian markets posted gains on the news, making for a few years of bizarre and unreal economic environment, both in the East and the West, where market response to the latest economic data is opposite to what it should be, in normal economic times. But since the unprecedented economic stimulus undertaken by the Central Banks, it has been anything but normal times.

HSBC Flash China Manufacturing PMI reading for March:

• 48.1 (vs. expected 48.7)

• prior was 48.5 (a 7-month low)

• 8 month low

The PMI is widely considered to be an important gauge in indicating the direction of a country’s economy. While we do not concern ourselves with the month to month change, the index hitting its lowest number in eight straight months is a trend.

China’s economy is slowing quite significantly, and while that in of itself may not be news of late, the Government of China is going to let it, and that certainly makes it news, as over the past almost three decades, the government has done everything in its power to continuously boost growth rates and prevent any slowdowns, whatever the cost.  

The general consensus among economists and analysts, globally, still seems to be that China’s government will not allow a significant slowdown of its economy, certainly not below the stated target of 7.5%.

In our latest Economic Report released on March 1st, 2014, we had disagreed with that consensus and projected lower growth than the set targets. We again disagree with the general consensus and anticipate a steadily declining GDP rate, eventually to numbers much below the target rate of 7.5%, perhaps in the range of 5% - eventually.

The Chinese and Asian markets responded to the lower PMI number with a moderate upswing, reflecting the anticipation of the markets that the slower growth is going to trigger a stimulative response from China’s government. And that brings attention to the upside down economic World that we now live in, where economic reality illicits a contrarian response from financial markets. Bad economic news only means one thing to the markets, and that is anticipation of more financial stimulus from governments and their Central Banks.

The analysts and financial markets in Asia expect China’s government to further ease fiscal and monetary stimulus, but we feel the government is going to be more inclined to let the economy slow without material stimulus being triggered.

As highlighted in our Economic Report, China’s economy is dangerously leveraged and the government knows it, and has decided to launch the re-balancing of its economy through the acceptance of slower growth rate, deleveraging and reforms. In that context it cannot afford the risk of adding further significant stimulus and debt to an already over-leveraged economy.

Our projection is that the Chinese government will accept further slowing of its economy, below its target rate, over time, because it cannot risk an uncontrolled implosion of its highly leveraged financial system.  

And that fact that China is going to slow materially is going to affect markets negatively – when the reality sets in that the World cannot continue to function indefinitely in an upside down economic environment.