Tuesday, December 6, 2011

Global PMI Warning: Which Country Can Save the World?

We, Mr China, issue our first global PMI warning in this website. It should be our second official warning since our previous Inflation Warning issued in November 2010.

Last Thursday, the China Federation of Logistics and Purchasing (CFLP) reported that China official PMI (Purchasing Managers Index) reading dropped to 49 in November. Manufacturing PMI (Purchasing Managers Index), by definition, is a leading indicator of manufacturing activities of a country. A reading above 50 signals an expansion of the manufacturing sector, while a reading below 50 means a contraction. The above data in November represented the first contraction (below the 50-neutral line) of China manufacturing activities since March 2009.

What is the basic calculation method for a Purchasing Managers Index? The Purchasing Managers Index (PMI) is in fact a composite index calculated by five individual sub-indexes according to different weights: New Orders (30%), Output (25%), Employment (20%), Suppliers Delivery Times (15%), Stock of Items Purchased (10%), in which the Delivery Times sub-index is inverted for comparison purpose. The below graph shows the current trend of China Manufacturing PMI (mPMI) in red color v.s. Non-manufacturing PMI (nPMI) in green color:

China Manufacturing PMI chart

Current China Manufacturing PMI chart

As China is still an export-oriented country, the market unavoidably puts more focus on mPMI than nPMI. For your reference, China nPMI dropped to 49.7 in November, also below the 50-neutral line that divides expansion from contraction.

What did the mPMI data of 49 in November actually mean? Let us have a closer look into the CFLP's sub-indexes. Sub-index for inventories (stock of items purchased) hit a record high of 53.1 in November, a sharp increase from October's 50.3. Sub-index for new orders in November was 47.8, representing a 2.7% drop from October. Sub-index for purchase prices was 44.4, representing a 1.8% drop from October. Sub-index for export orders was 45.6, a sharp drop from October's 48.6, signaling that the weak U.S. economic growth and the spreading European debt crisis were really affecting the Chinese economy. In November, 10 out of 20 manufacturing industries in China including oil refining and transport facility manufacturing, reported a reading above 50, while the remaining 10 industries including electronic facility manufacturing, food production and non-ferrous metal smelting, reported a reading under 50. The CFLP's PMI reading is calculated by the monthly data from questionnaires to purchasing managers in over 800 large companies in 20 Chinese industries as per GB/T4754-2002 classification.

Hong Kong and Shanghai Banking Corporation (HSBC), another key organization to monitor China manufacturing activities, also reported that its China manufacturing Purchasing Managers Index (compiled by Markit) reading was under 50 in November. The HSBC's reading actually dropped significantly to a 32-month low of 47.7 in November (was 51 in October). HSBC's PMI is calculated by the monthly data from questionnaires to purchasing managers in more than 400 companies, which focus on more Chinese SMEs (Small-and-Medium-sized Enterprises) than that of the CFLP's PMI. Therefore it is fair to say that HSBC's PMI data has a higher SME weighting, while the official CFLP's PMI has a higher SOE (State-owned Enterprise) weighting.

In any case, all the above PMI data suggest that China economy is really slowing down. The pace of slowdown, however, is determined by 3 key factors: Chinese government macro-economic intervention, speed of inventory de-stocking, as well as the demand drop from overseas markets. As the government intervention still favors long-term economic growth and the momentum of domestic consumption and domestic investment remain strong, it is believed that the slowdown should be steady and the risk of a hard landing should still be relatively low.

How about the demand drop from overseas markets? This factor is perhaps the most difficult one that we can stay optimistic globally. While the U.S. economy has been weak in recent years, the Euro-zone economy also starts to worsen in recent months. In November, the Markit Euro-zone manufacturing Purchasing Managers Index (mPMI) dropped to 46.4 (final value), the lowest reading since July 2009. This has been the 4th consecutive month below the so-called 50-neutral line that divides expansion from contraction. More importantly, it was also the first month since mid-2009 that all Euro-zone countries suffered from output drop. The euro-zone sub-index for output dropped to 45.7 in November from 46.6 in October, the lowest level since June 2009. Even worse, the weak euro-zone sub-index for employment showed that manufacturers are again cutting their headcounts for darkening sales and economic outlook.

Germany economy, which is used to outperform its euro-zone peers, can no longer keep growing under the euro-zone sovereign-debt crisis. Germany Markit/BME manufacturing purchasing managers index (mPMI) dropped to 47.9 (final value) in November, the lowest reading since July 2009. This has been the the second consecutive month of contraction and also the 7th consecutive month of decline. Germany sub-index for new orders dropped to 43.2, the lowest reading since the June 2009, signaling the darkening economic outlook. For the other large euro-zone countries, France mPMI dropped to its lowest level since June 2009, Italy mPMI experienced the 4th consecutive month of contraction, and Spain's mPMI even contracted for 7th consecutive month.

While all the Purchasing Managers Index data indicate that the entire world including China is heading towards an economic contraction, up to this moment there is virtually no country can save the world this time as China still hesitates to fully unfreeze its monetary policy due to inflationary concerns. The risk of further global PMI deterioration remains and that is why we feel we need to issue this Global PMI Warning.


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