Conclusion: We continue to see signs that inflation setup to moderate in China, whilst Chinese GDP growth looks to accelerate relative to the world and the US in particular. We remain bullish on Chinese equities as a result of these factors.
Position: Long Chinese equities (CAF); Long the Chinese yuan (CYB).
After ticking up to 53.4 in March, China’s Manufacturing PMI inflected once again, falling to 52.9 in April. Breaking down the subcomponents of the index, we see broad-based weakness across the board:
- New Export Orders ticked down: 51.3 vs. 52.5
- Backlogs of Orders ticked down: 50.7 vs. 51.4
- Output ticked down: 55.3 vs. 55.7
- Imports ticked down: 50.6 vs. 52
- Employment came in flat at 51.8; the relative “strength” here is confirmed by a recent Hudson Highland Group survey that showed 77% of Chinese firms intend to increase their staff in 2Q, up from 72% in 1Q.
While we’d generally greet a soft PMI reading like this with negative sentiment – particularly as it relates to investor’s appetites for equities, we actually receive this report in a positive fashion due to the Input Prices subcomponent falling (-2.1) percentage points MoM to 66.2. Late last week, HSBC’s unofficial PMI gauge confirmed this official deceleration, with its Input Prices subcomponent falling to 62.4 in April vs. 69.5 in March.
While still elevated on an absolute level, the slopes of these series continue to trend positively on a six-month basis, which augments our call for slower reported CPI in the back half of this year. As such, we remain bullish on Chinese equities as the PBOC reins in the pace and magnitude of tightening measures.
Shifting gears back to the growth side of the equation, there’s no confusing this weekend’s PMI report for something other than what it is: Slowing Growth. While generally, we want to be short equities/equity markets where growth is slowing, we think we are in a very unique and interesting situation with regard to our Chinese equity exposure.
On a relative basis to the US and the rest of the world, Chinese growth is decelerating at a slower pace, which increases the likelihood that international investors once again look to China as a place to buy growth. We maintain that China’s +9.7% 1Q11 GDP growth looks significantly more attractive when US GDP growth has a 1-handle on it. In addition, bearish sentiment around a confluence of known-knowns supports the mean reversion case – both from an absolute price perspective, as well as on a P/E basis. Relative to its historic valuations, China is quite “cheap”. We like it when our catalysts are supported by valuation.
This confluence of factors has us leaning more positive on Chinese equities than PIMCO, who was out this morning reminding the world that Chinese growth is slowing (known) and inflation is accelerating (also known). If their call for “higher than expected” inflation rates in China is predicated on an increase in the velocity of US dollar debasement/commodity inflation, then we’d just as soon be defensive towards any risk assets. A US Currency Crash is not structurally bullish for any of our long positions (except Gold) – particularly when the dust has settled.