We know that China’s central government is worried about its nation’s economy. In early June, China’s central bank surprised markets by cutting interest rates for the first time since 2008 to combat faltering growth.
Policymakers also pushed a “Cash for Clunkers” program to boost car sales and offered incentives for consumers to buy more energy-efficient appliances, two more signs of economic weakness.
Would one interest-rate cut solve the problem? Or are things getting worse? Here are five things I’m watching, and I’ll also give you one idea to play the trend in China.
1. Expectations for Economic Growth Are Tumbling. In recent months, economic growth in China has not only slowed — it’s slowed faster than most people expected.
First, you should note that first-quarter GDP fell to 8.1%, which is A) lower than last year’s 9.25 growth, B) lower than expectations and C) way off the peak of 14% hit in 2007. Sure, that 14% was unsustainable — but expectations keep going lower and lower.
Deutsche Bank just lowered its forecast for China’s economic growth this year to 7.9% while Credit Suisse cut its estimate to 7.7%. And an adviser to the Chinese government, Zheng Xinli, deputy head of the China Center for International Economic Exchanges, said on Wednesday that China’s economic growth could drop below 7% in the second quarter.
That’s important because the last time China’s economic growth was that low was during the global financial crisis! For comparison purposes, China reported economic growth of just 6.6% in the first quarter of 2009.
2. Manufacturing Slumps. The HSBC China Manufacturing Purchasing Managers’ Index (PMI) has indicated contraction for the last eight months, falling to a seven-month low of 48.1 in June from a final reading of 48.4 in May.
Importantly, the new orders and export order sub-indices both declined. And both input and output prices dived to their lowest levels in over two years as a sub-index measuring output hit a three-month low.
Making things worse, the official PMI has also started to drop, falling to 50.4 in May from 53.3 in April. Analysts said the official reading was finally catching up with the flash PMI reading, which is intended to give an early signal to changing economic conditions.
Speaking of changing conditions, and dramatic ones at that …
3. Metals Manufacturers Turn from Pig Iron … to Pigs! China’s steel production fell 2.5% in May compared to April. Iron ore spot import prices fell 8% through most of May. And output of copper fell 1.4% month-on-month, its second-consecutive month of decline.
How anemic is steel demand in China? It’s SO BAD … Wuhan Iron & Steel is apparently venturing into pig farming, as the steel business is no longer profitable.
Hey, people always need to eat. They need pigs more than pig iron, Wuhan figures.
And it’s not the only one.
Shanxi Coking Coal Group, a leading coking coal producer, is venturing into the pig-slaughtering business with China’s biggest hog processor, Shuanghui Group. According to the report, the two companies will build a pig slaughterhouse with an annual output of 2 million pigs.
But will the slaughterhouse require as much energy as a steel plant? Probably not even close, which leads to our next sign that China’s economy is on the decline.
4. Energy Demand Is Weakening. Power output is linked to economic growth, so everyone has been freaking out over the following chart showing China’s power output and GDP. (The blue line shows power output year-over-year, while the red line represents GDP growth.)
It sure looks like power output is leading China’s GDP much lower.
Power-generation growth was sluggish at just 2.7% after its weakest pace in three years in April. Coal inventory in the five biggest power plants in Guangdong’s power grid now hits 20 days or more, way higher than the normal required level of 15 days.
And take a look at inventories of thermal coal at Qinhuangdao, one of the biggest ports in China.
Inventory level has reached 9.5 billion metric tons. That is even more than the previous record of 9.3 million tons, set in November 2008, near the bottom of the global financial downturn.
Warehouses are so full of coal, incoming trains can’t unload their cargoes, because it’s just more supply that needs a home in already-full storage spaces.
Why is there so much coal piling up in Qinhuangdao? Demand for coal falls as electricity production drops.
What about oil?
China’s crude oil imports rose 0.4% in May to a record 6 million barrels, but that’s because China is building up oil stockpiles. On the other hand, refinery run-rates in China fell 0.7% in May from a year earlier … and then fell another 2.5% in June.
5. Trade Numbers Are Weak. The pace of Chinese export growth fell to 4.9% year-over-year, down from 8.9% the previous month. Meanwhile, imports climbed just 0.3% year-over-year versus expectations of a 10.9% jump.
Import slowdown reflected weakening demand for both non-commodity ordinary imports and raw materials. And because import demand centers on investments, this also acts as an indicator for investment growth.
It’s also an indicator that the Chinese economy is in for a bumpy ride and maybe a hard landing.
China’s trade picture is looking even worse with Europe on the skids. Much to the surprise of many Americans, we aren’t the No. 1 market for Chinese-made junk — Europe is. And with Europe on the brink of its own economic meltdown, this is dragging on China’s economy.
Nearly 22% of China’s exports head to Europe, contributing nearly 6% to China’s GDP; only 17% of exports from China are shipped to the U.S.
So with Europe slumping into recession, how big of a bite will that take out of China’s GDP? I don’t know, but I’m glad not to be long China right now.
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Why Things Could Be Even Worse
Recently, mainstream media sources including The New York Times called out China for massaging its economic data to make it look better than it really is:
“Officials in some cities and provinces are also overstating economic output, corporate revenue, corporate profits and tax receipts, the corporate executives and economists said. The officials do so by urging businesses to keep separate sets of books, showing improving business results and tax payments that do not exist.
“The executives and economists roughly estimated that the effect of the inaccurate statistics was to falsely inflate a variety of economic indicators by 1 or 2 percentage points. That may be enough to make very bad economic news look merely bad.”
So is China headed for a hard landing? The last time China faced real economic troubles was in 2009, when economic growth fell to just 6.6% in the first quarter.
Growth hasn’t dipped to that level yet. But anecdotal evidence suggests China’s job market is just as bad as, or worse than, it was in the last crisis. That’s because smaller and mid-sized private firms are increasingly struggling with slackening orders, rapid wage increases and higher raw material costs.
This time around, the vast majority of market analysts expect Chinese economic growth to bottom this quarter — in other words, right now — or early next quarter. If that doesn’t happen, the bottom could fall out of Chinese stocks.
In Red-Hot Global Resources, we’ve taken steps to protect ourselves by buying a bearish fund that goes up twice as much as a leading basket of Chinese stocks goes down. It’s called the ProShares UltraShort FTSE China 25 (FXP). But we could sell at any time, so you shouldn’t buy it just because I like it right now.
If you’re investing on your own, do your own due diligence. Remember, especially with these leveraged funds, you have to use protective stops, and know when you’re getting out before you get in.
All the best,
Sean
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