China manufacturing back in expansion

The official Purchasing Managers’ Index, which primarily tracks large companies and SOEs, rebounded to 50.5 in March, rising from a three-year low of 49.2 in February, according to data released by the National Bureau of Statistics on Sunday. The new export orders component picked up from last month but remained in contractionary territory, signalling external pressures on China’s economy remain pertaining to weak global demand impacted by both the trade war and the slowdown evident in the global economy.

Small businesses continue to be hit harder than larger firms, remaining in contraction, but there was improvement as the subindex rose to 49.3. This is encouraging because the private sector now contributes more than 80% of China’s employment and accounts for most new jobs created each year.

The Caixin Manufacturing Purchasing Managers’ Index, which primarily tracks small companies, also expanded in March picking up to 50.8, the strongest pace in eight months. Because the Caixin PMI tracks smaller firms, it is much more volatile and more prone to seasonal effects. The strong rebound in the output and the employment components may simply reflect factory activity picking up after the holiday season.

The severe, deleveraging-driven tightening of credit has had a big impact on economic growth since the focus on financial stability adopted after the 19th Communist Party congress in October 2017. Since late last year, we have seen an uptick in credit growth, and the fragility in domestic economic indicators means this is likely to continue. Continued policy support, both fiscal and monetary, will be required to stabilise growth and promote a self-sustaining trajectory for growth. On that basis we expect more RRR cuts and continued support for private firms as this sector continues to drive job creation, accounting for 80% of jobs and more than 90% of new jobs, according to the National Development and Reform Commission of the People's Republic of China.

This pro-growth bias has been confirmed by Chinese president Xi Jinping, who has indicated that Beijing is committed to supporting economic growth. Ultimately, credit growth and easing policies may have turned a corner generating potential green shoots in the real economy, but Chinese growth may not have bottomed out just yet. 

The improvement in manufacturing will support Chinese equity markets, which have so far rallied strongly off the back of trade optimism, central bank U-turns and policy support. Providing trade talks continue, the green shoots of manufacturing sector improvement provides some fundamental basis for stocks to continue higher given that so far momentum has largely driven the move, particularly as foreign ownership continues to pick up following MSCI’s increased weighting of Chinese stocks.

Margin debt is also exploding on the mainland as traders chase the market higher, increasing more than 14% in March, the largest monthly rise since 2015. Looking at previous increases from 2015, however, the boost is small in comparison. Regulators will be monitoring leverage to avoid another 2015 style boom/bust bubble, but for now, market sentiment has far from reached bubble territory and the recovery is still in early stages. On that basis regulators will continue to monitor leverage whilst walking a fine line to balance a continued recovery in the stock market without blowing another bubble.