China has been a major contributor to global growth, and its economic activity tends to have significant repercussions for the global economy. To understand where the Chinese economy is in its growth cycle, we highlight several key charts below, which may also provide context for the impact of the coronavirus. China-related political and geopolitical headlines are grabbing the most attention lately. However, China remains an important economic bellwether for countries that have started to reopen following the COVID-19 epidemic.
Chinese Economy Health Check: PMIs
Source: Bloomberg. Data as of September 30, 2020. Past performance is no guarantee of future results. Chart is for illustrative purposes only.
China’s manufacturing Purchasing Managers Indices (PMIs)1—both official and Caixin—looked solid in September, but the non-manufacturing activity gauge stole the limelight. The official services PMI rose to 55.9, surprising to the upside and indicating that the recovery is not only gaining speed but also becoming more balanced (smaller supply-demand gap).
There were several other bright spots as well:
The new orders gauge improved further to 52.8.
The new export orders PMI finally moved into expansion territory (50.8), suggesting that global growth headwinds are subsiding.
The large companies PMI continues to do well (up to 52.5), as large companies and state-owned enterprises (SOEs) are convenient conduits for kick-starting the economy. However, the activity gauge for small companies finally left contraction zone, improving quite sharply in September (from 47.7 to 50.1). One conclusion is that the transmission mechanism might be working better, and that authorities made the right choice not flooding the system with cheap credit (similar to past crises), focusing on the targeted (“drip”) stimulus instead.
Understanding the Credit Cycle: Non-SOE Borrowing Costs
Source: Wind, UBS. Data as of September 24, 2020. Past performance is no guarantee of future results. Chart is for illustrative purposes only. Spreads are measured relative to average yield of 1, 3, 5, and 10 year bonds issued by the China Development Bank.
As with any economy, central bank policy is very important in China. In this chart, we can see that interest rates for the private sector fluctuate, whereas the interest rates paid by SOEs are pretty stable. Therefore, to understand the credit cycle, we point your attention to this private sector, or non-SOE, interest rate.
One issue that remains unresolved, despite numerous calls and pledges, is the higher cost of funding for China’s small and privately-owned companies. There are legitimate reasons why this is the case (a lack of information to assess credit risks, etc.), so the recent initiatives to use financial technologies and new products to support small enterprises look promising.
China SOE and Non-SOE Real Yields, %
Source: VanEck Research; UBS; Bloomberg LP. Data as of September 24, 2020. Past performance is no guarantee of future results. Chart is for illustrative purposes only.
An interesting aspect of the post-COVID recovery is that Chinese authorities seem to be okay with local real and nominal yields grinding higher—and this applies to both corporate yields and government bond yields. From an investor’s perspective, this made China’s fixed income valuations look more attractive compared to several months ago. And this happened right before FTSE Russell’s recent decision to add China to its benchmark World Government Bond Index—ending September on a high note!
DEFINITIONS AND DISCLOSURES
1Purchasing managers index (PMI) is an economic indicator derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction. We believe PMIs are a better indicator of the health of the Chinese economy than the gross domestic product (GDP) number, which is politicized and is a composite in any case. The manufacturing and non-manufacturing, or service, PMIs have been separated in order to understand the different sectors of the economy. These days, we believe the manufacturing PMI is the number to watch for cyclicality.
Please note that Van Eck Securities Corporation (an affiliated broker-dealer of Van Eck Associates Corporation) offer investment products that invest in the asset classes discussed in this commentary.
FTSE World Government Bond Index tracks the performance of fixed-rate, local currency, investment-grade sovereign bonds.
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