The state of the economy drives the stock market in the medium to long term. However, it’s hard for non-Chinese to understand which Chinese data are important and which are just noise. On top of that, a lot of Chinese economic data are fabricated, so it’s hard to know which data to trust.
We have separated the important data series from the unimportant for you. As you can see in the rest of this post, the Chinese economy is experiencing robust growth right now. Yes, a few of the numbers may have been “massaged” by the Chinese government, but on balance the trend points to an improving macro picture.
*You need to focus on the overall trend in the data and not the month-to-month changes because some of the month-to-month changes are purely random.
*China is important because it represents the emerging market world. As we said, the U.S. stock market is going up with all stock markets around the world right now. That is why the equities rally in the next few years will be especially powerful. This is the first time in 5 years in which all of the major stock markets in the world will go up together.
China’s economy completely relies on its manufacturing sector. If the manufacturing sector were to collapse, China’s economy would collapse as well (despite the much touted “shift from manufacturing to services”).
China’s Industrial Output has SOARED over the past 2 months, growing at almost 8% year-over-year in March 2017.
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Growth in Industrial Output will most likely continue to be robust in the next few months, although the growth rate might not be as high as that of March.
Here is a 10 year chart for Industrial Production in China. As you can see, China’s Industrial Production growth rate bottomed at 6% for 2015 and 2016. Only in recent months has the growth rate soared.
Producer prices represent one side of the inflation story in China. This index tends to move inline with the Industrial Output. As you can see in the chart below, Producer Prices have risen significantly throughout all of 2016. The last month saw no growth in the index, but this might just be a temporary 1 month blip.
Perhaps Producer Prices will decline a little in the next few months because this index is at the top end of its 20 year range.
After bottoming in early 2016, New Orders in China surged in October 2016. Since then, this index has risen very slowly. This means that Chinese manufacturers have seen healthy growth in the past 6 months.
Chinese Exports is not a good indicator because it is strongly impacted by seasonal factors (i.e. drops significantly every year after Christmas because shoppers are buying less). However, Export Prices is a very good indicator because it shows how strong foreign demand is for Chinese goods and whether or not there is a supply glut in China.
Like all the other indicators. Export Prices bottomed in the beginning of 2016. After going flat for most of 2016, Export Prices have soared consistently since December 2016. This shows that foreign demand (primarily from Europe) for Chinese products is surging.
The following is a 10 year chart for China’s Export Prices Index.
The initial surge in Chinese economic data since early-2016 is most likely over. China’s economy will continue to improve, but at a slower rate than the past year. This is still bullish for the Chinese stock market (e.g. the Shanghai Index) in the medium-long run.
Recently there have been fears of a slowdown in the services sector in the Chinese economy. This is true. The Services PMI has dropped over the past 3 months. See the 5 year Services PMI chart below.
However, this is irrelevant. China’s economy relies on manufacturing and not services. And not matter how much China wants to shift from being export-driven to consumption-driven, services will NEVER be the main engine of growth for China. As a country with 1.34 billion people, China really lacks raw materials and resources. It imports a ton of materials from the U.S., Canada, New Zealand, Australia, Russia, etc. It needs to make up for these imports by exporting manufactured goods. Otherwise, China would rack up a ton of debt in the long run (balance of trade deficit) and go bankrupt like Greece. And let’s not kid ourselves. Despite a few phone makers like Huawei and Xiaomi, Chinese innovation is still nonexistent.
Why has Chinese economic growth picked up in 2016 and 2017?
The Chinese government’s fiscal spending has soared over the past year (up by 25%). This increase in fiscal spending is essential a fiscal stimulus package, with China intending to spend more than $200 billion on new railways and subways from 2016-2020.
So as you can see, China’s economy is being kicked into high gear once again. This will cause problems in the long run (e.g. after 2020) because these infrastructure projects are mostly funded by local and state governments via debt. The local governments will eventually default in a few years after being crushed by mountains of debt.