China’s slowdown: Fed taper concerns not the only thing spooking markets

Fears abound of a patchy recovery

EUROPEAN and Asian bourses began June on a weaker footing, amid fears the US Federal Reserve will start to taper quantitative easing (QE) following better-than-expected US data last Friday. But while some of the blame for falling equity markets ironically lies with stronger US figures, mixed data on Chinese activity is also playing an important role. According to Saturday’s figures, China’s official manufacturing purchasing managers index (PMI) rose to 50.8 in May from 50.6 in April. But HSBC’s manufacturing PMI for May showed a slide in factory output from 50.4 to 49.2 – the first contraction since October 2012.

Commenting on the figures, HSBC’s chief China economist Hongbin Qu said “the downward revision of the final HSBC PMI suggests a marginal weakening of manufacturing activities towards the end of May, thanks to deteriorating domestic demand conditions.”

It has revived fears of a patchy recovery in the world’s second largest economy. China’s GDP annual economic growth slowed to an annualised 7.7 per cent in the first quarter, down from 7.9 per cent in the previous quarter. And the IMF and OECD have both cut their forecasts for 2013, with the IMF warning about China’s debt situation, which has left local governments leveraged up to the hilt. The drop in growth – that averaged 9.22 per cent between 1989 and 2013 with a high of 14.2 per cent in 1992 – is partly due to a shift to a more consumption-driven, services-based economy, away from a dependency on sluggish exports and investment.

Nonetheless, Berenberg Bank’s UK economist Robert Wood says that official PMI remaining within the 50-51 range – which it has been in since last October – points to more of the same. “Looking across the official and HSBC manufacturing PMI figures suggests little change to the recent trend of slightly slower Chinese growth than we’ve become used to. We don’t think growth will continue to slide, and the government target of 7.5 per cent growth this year supports this.”

But its impact has already been felt, with the Australian dollar and South African rand hit by the reduction in demand for metals by China due to slowing growth. Resources companies, which rely on Chinese consumption, “will see a further slide in share prices across the sector. The STOXX600 basic resource index has already fallen 20 per cent year-to-date. And with commodities prices on the slide due to the slowdown, resource companies will have to battle with lower consumption and higher costs,” warns Ishaq Siddiqi of ETX Capital.

Australian shares fell 0.6 per cent yesterday to a two-month low, and Japan’s Nikkei 225 index slid by over 3 per cent to a six-week low. Ricardo Evangelista of ActivTrades thinks it is fair to assume a slowdown in China is taking place, triggering a domino effect that he believes is already affecting some equities. There has been a drop in demand for industrial metals, like iron ore and copper.

Siddiqi warns that other sectors with high exposure to China – luxury retailers and consumer discretionary companies like Volkswagen or Audi – are also likely to suffer.

The slowdown could not be coming at a worse time for traders, already spooked by fears of the withdrawal of QE by the Fed. “Traders are now having to price-in the double whammy of reduction in liquidity in the global marketplace combined with a sharp slowdown in Chinese growth,” says Siddiqi.

It all reads risk-off to Siddiqi, and he thinks it could likely be the cause of a wider correction across global equities. But with markets now so dependent on central banks for sentiment, Mike van Dulken of Accendo Markets thinks a continuation of easy money means equities could eke out more gains.

So what should investors be weary of? “A deterioration in Chinese numbers will mark the fall of the world economy’s last standing man,” says Evangelista. It would be followed by a drop in commodities and equities – although such an event could give investors, who have been waiting for a drop in assets exposed to Chinese growth, a good opportunity should China then regain its strong momentum.

For those seeking more certainty, turning from emerging to developed markets could offer a solution. “There was a shift to emerging markets because they were yielding better returns, but more signs of a recovery in the Eurozone might lead people to move to developed markets to tap into that growth. Plus, they’re less volatile,” says van Dulken.