China March PMIs are Slow but Steady

4/03/2018

Written by:

Rich Farr, Chief Market Strategist, Bluestone Capital Management

Jim McGovern, Market Strategist, Bluestone Capital Management

 

FAST FACTS ABOUT TODAY’S ECONOMIC DATA:

* China PMI’s are mixed, but show slow and steady growth in March.

* South Korean exports to Europe and China surged in March.

* U.S. ISM Manufacturing Index Slips from 14 year high.

* U.S. Constructing Spending slows further, maybe we do need that wall funding.

FIRST POST-CHINESE NEW YEAR DATA SUGGEST CHINA REMAINS ON SLOW AND STEADY COURSE:

The ‘official’ China Manufacturing PMI rebounded +1.5 points to 51.5 in March, which suggests slow growth.  In the month, there were small improvements in nearly all subcategories, including: Output (+2.4 points to 53.1), New Orders (+2.3 points to 53.3), Exports (+2.3 points to 51.3), Backlogs (+1.1 points to 46.0), and Employment (+1.0 points to 49.1).  Furthermore, the ‘official’ China Services PMI increased +0.2 points to 54.6 in March; however, New Service Orders fell -0.4 points to 50.1 and Services Business Expectations fell -0.1 points but remains at a lofty 61.1 (you have to stay positive in China or else you might negatively impact that dreaded ‘social score’.

 

MEANWHILE, CAIXIN CHINA MANUFACTURING PMI WORSENED IN MARCH:

The Caixin China Manufacturing PMI fell to its worst level in four months, -0.6 points M/M to 51.0 in March.  In the month, both Output and New Orders also hit their lowest levels in four months.

 

SOUTH KOREA TRADE SURPLUS EXPANDED IN MARCH ON EXPORTS TO EUROPE AND CHINA:

South Korea’s trade surplus jumped +$3.66 billion to +$6.9 billion in March, according to the Ministry of Trade, Industry, and Energy.  In the month, exports increased +15% M/M and accelerated to +6.1% Y/Y versus +3.9% Y/Y prior.  Imports also jumped +7.4% M/M but slowed to +5.0% Y/Y versus +15.1% Y/Y prior (Olympics are over and now comes the hangover?).  Note that exports to the EU and China posted double-digit growths of 24.2% and 16.6%, respectively.

 

U.S. ISM MANUFACTURING INDEX SLIPS FROM HIGHEST LEVEL SINCE 2004:

The ISM Manufacturing Index slipped -1.5 points to 59.3 in February, but January’s reading of 60.8 was a 14 year high.  In the month, Employment fell -2.4 points to 57.3, Inventories fell -1.2 to 55.5, New Orders slipped -2.3 points to 61.9, Production fell -1 point to 61, but Backlogs were flat at 59.8.  Note that Prices Paid increased +3.9 points to 78.1 which is the highest level since April 2011.

 

U.S. CONSTRUCTION SPENDING INCREASED SLIGHTLY IN FEBRUARY, BUT SLOWS ON Y/Y BASIS:

According to the Census Bureau, U.S. Construction Spending increased +0.1% M/M in February to a total value of $1,273.09 billion SAAR.  On a Y/Y basis, construction spending continues to slow and is up just +3.0% Y/Y (versus +4.2% Y/Y just two months ago … maybe we need more funding for “the wall”).  Residential Construction increased +0.1% M/M and +5.4% Y/Y (+6.3% Y/Y prior) and Nonresidential Construction increased +0.1% M/M but slowed to +1.3% Y/Y (+2.4% Y/Y prior).  Lastly, Private Construction increased +0.7% M/M and slowed to +3.4% Y/Y (+3% Y/Y prior) but Public Construction fell -2.1% M/M to +1.6% Y/Y (+7.3% Y/Y prior).

AMERICAS:

U.S. GDP:  Our GDP model points toward stronger growth in the quarters ahead (+3% Real GDP growth through Q4 2018) and our model doesn’t even factor in potential stimulus from tax reform or other policy proposals.  We are still highly optimistic on stimulative economic effects for 2018 due to tax reform and we are encouraged by the recent drop in interest rates.   As such, we still believe a good base case estimate for 2018 Real GDP is for +3% growth.

U.S. Inflation:  U.S. inflation is still in a slight upward trend, but CPI has leveled off since September.  We continue to believe that wage inflation should turn higher as labor slack (particularly in prime working age groups) continues to decline.    Note that the Fed’s preferred inflation metric, the Core PCE Deflator, increased to the Fed’s 2% inflation target in January (when viewed as a 3 month annualized rate of change).

U.S. Federal Reserve:  Although everyone seems to believe that the FOMC will hike rates 3-4 times in 2018, we believe they will become increasingly more data-dependent for the rest of the year.  We believe it is now necessary for inflation and economic growth to accelerate in order for the Fed to remain hawkish.  For now, we still believe two additional rate hikes will happen in 2018.

U.S. Treasuries:  With inflationary pressures slowly building, and Real GDP improving to +3.0%, we believe 10-year U.S. Treasury Yields will continue to trend higher and will likely exceed 3% by year end 2018.

U.S. Equities and Earnings:  S&P 500 operating earnings will rise materially yet again in 2018 and 2019, but the question remains, will the market put a 20 P/E multiple on forward earnings?  We think a 20 forward multiple is aggressive, but a 19 P/E may not be.   Our new SPX target is for a 19x P/E on 2019 forward earnings of $160, bringing our 2018 SPX target to 3,000).  We continue to favor the homebuilders, given the demographic tailwind and lack of inventory.   We also prefer financials given expectations for economic growth.

Argentina:  Argentina’s economic data continued to improve in February:  Industrial Production was up 5.3% Y/Y, Construction was up +16.6% Y/Y, and Exports were up +10.1% Y/Y.   Argentina finished 2017 on a strong note as GDP accelerated to +3.9% Y/Y in Q4, the Unemployment Rate fell to 7.2% in Q4, and Retail Sales were up +20.2% Y/Y in December (and increased further to +21.2% in January).  However, inflation remains a problem at +26% Y/Y (far better than 45% from a year ago though), and Consumer Confidence has turned lower (43.8 in March).

Brazil:  The macro data in Brazil continue to improve.  GDP continues to improve (+2.1% Y/Y in Q4), PMI’s have turn notably higher in 2018, Industrial Production is up +5.7% Y/Y, Retail Sales are up +3.2% Y/Y, tax receipts are growing, Exports are up +7.6% Y/Y, and inflation remains below trend (+2.9% Y/Y in January) – which allowed the central bank to cut rates once again.  However, Unemployment remains persistently high at 12.2%.   Of all the major global bond markets, Brazilian 10-year bond yields are the richest in the world at 9.5%.  As the economy improves, and inflation cools, we would expect to see investors reach for yield in Brazil.   As such, we remain bullish on Brazil 10-Year Sovereign Bonds.

Canada: Despite worries about Canada’s housing market, so far Canada’s economic data remain healthy.  Consumer Confidence remains at high levels, manufacturing PMI’s remain strong (March increased slightly to 55.7 from 55.6), unemployment has been sub-6% for four months in a row (5.8% in February), retail sales are elevated (+3.6% Y/Y in January), CPI has accelerated to +2.2% Y/Y in February, and Canada’s monthly GDP remains at a healthy 3.5% Y/Y.

Mexico: Mexico’s GDP has been in a slowing trend since Q1 2017 (+3.3% then, now +1.5% Y/Y) – and Mexico is now on our macro risk watch.  The Mexican Central Bank has been increasing interest rates since late 2015 (mainly because of fear of dollar weakness).   Consumer Confidence has been trending slightly downward since September.  However, PMI’s and New Orders remain in an up-trend, Exports are up +12.5% Y/Y, Industrial Production turned positive on a Y/Y basis, Retail Sales are now up +0.5% Y/Y, and unemployment is still low at 3.4%.

Venezuela: We will leave this as a placeholder in the event that Venezuela ever becomes an investible market again.  We are hopeful …

EMEA: 

United Kingdom:  The U.K. economy has been reasonably resilient throughout the BREXIT process.   Unemployment remains steady, Retail Sales increased +1.1% Y/Y in February, Industrial Production increased +1.6% Y/Y in January, and PMI’s continue to indicate growth.  However, Consumer Confidence has remained negative, home prices have begun to turn lower in London, while inflation remains elevated.  In fact, the Bank of England raised rates due to higher inflation (CPI now at 3.0%), despite recent weakness in economic data.

European Union:  The stronger Euro may now be a problem for Mario Draghi as CPI has been in a slowing trend for several months.   Not to mention, Industrial Production slowed to +2.7% Y/Y, Economic Sentiment is turning lower, and PMI’s have turned back from recent highs.   We think the idea of an ECB hike within the next year is basically out the window, and as such we remain bullish on the Euro STOXX 50 Index, as well as European Financials.

European Central Banks:  The ECB is slowly removing accommodation and will likely end its asset purchases by year end.  But Mario Draghi has given no indication about raising rates and the recent decline in CPI will give them even further pause for doing so.  We will watch to see if current ECB tapering has any meaningful impact on the economic outlook.

Eastern Europe: We continue to believe risks remain for Eastern Europe given high Debt/GDP levels, most notably Cyprus (104%), Croatia (88%, up from 66% at the end of 2013), and Slovenia (81%).   Yet, economic data have been robust this year across most of Eastern Europe.

South Africa:  Now that Zuma’s out, Business Confidence appears to be on a slight up-swing, PMI’s have turned further positive in February, Exports increased +8.7% Y/Y in Q4, and Retail Sales were up +3.1% Y/Y in January.  But these subtle improvements are going to need to get significantly stronger to crush unemployment (26.7% in Q4).

Turkey:  The Lira is weakening again, along with Turkey’s economy (mfg PMI fell nearly 4 points in March and Consumer Confidence is starting to weaken).  Let’s not forget that CPI is already +10.3% Y/Y.   Despite the chaotic political situation, the macro backdrop had been strong, as Real GDP was +7.3% Y/Y in Q4, Industrial Production accelerated to +12.9% Y/Y in January, Business Confidence had improved throughout Q1, and exports accelerated to +10.7% Y/Y in January.

ASIA / PACIFIC:

Australia: We’ll get some big data out of Australia tonight with PMI’s, Home Prices and Job Advertisement trends that we’ll want to watch.   As backdrop, the RBA has cut rates twice in the past year and Australian data is mixed.  So far, PMIs indicate solid growth, Auto Sales are up +6.7% Y/Y in December, and business and consumer confidence have been strong.    Conversely, the Unemployment Rate increased slightly to 5.6% in February, Retail Sales slowed to +2.1% Y/Y in January, and we are starting to see weakness in the housing market (private sales down -6.1% M/M and building approvals are up just +0.9% Y/Y).  We remain neutral on Australia at this time, on concerns about China exposure but so far China is still posting strong data.

China:   With China cracking down on shadow banking, pollution, industrial overcapacity, and removing migrant workers from its cities, we expect China GDP to continue to trend lower and we are monitoring the situation closely.   PMI’s continue to indicate growth, but are now in a clear slowing trend as backlogs and new orders weaken (see above), Industrial Profits slowed to +16% in February, and Durable Goods Orders fell 12% M/M in February.  Home Prices are up +5.4% Y/Y (half the rate of change from a year ago). CPI accelerated to +2.9% Y/Y in February and Industrial Production is up +7.2% Y/Y thus far in 2018.  We are watching for further signs of stress within China’s credit and housing markets.

India:  Indian economic activity appears to have recovered nicely since the new Goods and Services Tax (GST) was implemented as Industrial Production accelerated to +7.5% Y/Y in January, Commercial Credit accelerated to +11.5% Y/Y, and inflation appears to have turned lower (+4.4% Y/Y in February).  However, note that PMI’s indicated contraction in February and Exports slowed to +4.5% Y/Y in February.

Indonesia:  Indonesia’s GDP and Private Consumption Expenditures have been stable at 5% Y/Y, Consumer Confidence has been stable, PMI rebounded to 51.4 in February, Retail Sales rebounded +1.0% Y/Y in February, and Exports accelerated to +11.8% Y/Y in February.  However, Industrial Production declined -0.4% Y/Y in January and CPI ticked higher in March.  Our best guess is that the central bank’s dovish policy stance may revert to a more neutral stance going forward (they declined to cut rates again in December).

Japan:  Overall, we remain bullish on Japan given Japan’s economic activity remains in an improving trend: unemployment continues to improve (2.4% in January), Industrial Production is up +2.5% Y/Y, Retail Trade is up +1.6% Y/Y, and Bank lending is up +2.1% Y/Y.  Conversely, Exports are now down -2.1% Y/Y, whereas Imports accelerated to +11.7% Y/Y (thanks to higher oil prices).

RussiaThe Russian economy isn’t setting the world afire, but GDP came in at 1.5% in 2017, despite Q4 being weaker than expected at +0.9% Y/Y, and March’s manufacturing PMI increased a hair to 50.6 (from 50.2).  Overall, economic data continue to suggest economic growth, as Retail Sales were up +4.0% Y/Y in February, Real Wages are up +6.2% Y/Y, the Unemployment rate improved to 5.0% in February, Industrial Production is up +1.5% Y/Y, and exports were up +31.3% Y/Y in January.  Meanwhile, Core CPI slowed to +1.9% Y/Y in February, which allowed the Bank of Russia to continue to cut rates.   However, it should be noted that Consumer Confidence remains negative.  Nonetheless, Russian equities remain among the cheapest in the industrialized world and we remain bullish.

South Korea:  We are keeping an eye on trade data into China, which improved in March.   Overall, SK is beginning to show signs of slowing post-Olympics (imports are slowing and the Nikkei South Korea PMI slipped below 50 in March).

MACRO TRADE IDEAS:

 

GLOBAL CENTRAL BANK SCORECARD:

 

WEEK IN REVIEW – BEST & WORST PERFORMERS:

S&P 500 SECTOR PERFORMANCE:

Source: Bloomberg

 

BEST/WORST PERFORMING WORLD BOND MARKETS:

Source: Bloomberg

 

BEST/WORST PERFORMING GLOBAL STOCK MARKETS:

Source: Bloomberg

 

CURRENCIES PERFORMANCE:

Source: Bloomberg

 

COMMODITIES MARKET PERFORMANCE:

Source: Bloomberg

 

MAJOR GLOBAL STOCK MARKETS:

Source: Bloomberg

 

MAJOR GLOBAL BOND MARKETS:

Source: Bloomberg

 

DISCLOSURE APPENDIX

This publication is for Institutional Investor use only and not for distribution to the general public. The comments herein are based on the author’s opinion at a particular point in time and may change at any time without notice. Merion Capital Group does not guarantee the accuracy or completeness of the information contained herein. Merion Capital Group is a FINRA-registered broker-dealer. Merion Capital Group shares in the commissions for trades that are executed through Tourmaline Partners, LLC, a FINRA-registered broker-dealer. This report is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. It does not constitute a general or personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors. Past performance is not a guarantee of future performance. All investments involve risk, including the loss of all of the original capital invested.