China News, China Noise

by Paul Goodwin on October 23, 2014

This is an excerpt from Cabot China & Emerging Markets Report, which seeks to capitalize on the big boom in China and other emerging market countries. Editor Paul Goodwin, Cabot’s international investing guru, provides your passport to profits.

This week’s release of China’s HSBC manufacturing purchasing manager’s index (PMI) revealed that manufacturing activity has strengthened slightly. The index edged up from 50.2 in September to 50.4 this month. (Any reading over 50 indicates expansion.)

You might think that any strengthening in the Chinese manufacturing sector would be a good sign, but you might be wrong.

The release of any hard data about the state of the Chinese economy is always the opening bell of a 10-round boxing match over what it all means. When one combatant points out that the PMI results were better than analysts had predicted (the consensus estimate was for no change at 50.2), another will respond that 50.4 is still pretty weak in absolute terms.

One analyst will point out that the Chinese government has been trying to slow its economy and that this mild growth is a sign of successful moderation. Another will observe that there are still portions of the Chinese economy that are stagnant and will require selective stimulation to keep growth going.

In other words, the consensus reaction to the October PMI is that it is/isn’t good news and that the government will/won’t need to resort to further stimulus and that the outlook for the Chinese economy is/isn’t bright.

It will come as no surprise to those of you who have been subscribers for a while to learn that we are completely agnostic about the implications and outcomes of the October PMI.

While it’s sometimes an interesting intellectual exercise to wonder why the markets for emerging markets stocks move the way they do, the only thing we care about is the movement itself.

The movement of the PowerShares Golden Dragon Halter USX China ETF (PGJ) sums up the collective wisdom of everyone who’s interested in buying American Depositary Receipts (ADRs) of Chinese stocks. When people are buying, the Golden Dragon will top its 25- and 50-day moving averages and we will follow that trend by putting more money into stocks. When investors are discouraged or afraid about the future of Chinese stocks, PGJ will fall below its moving averages and we will reduce our buying and tighten up our loss limits.

Right now, PGJ has bounced strongly from the correction that began on September 9. The recovery started on October 14 and the eight-day rally has pushed the ETF back above its 25-day moving average. If that average also turns up, we will get a new buy signal.

But the 25-day moving average is also below its 50- and 200-day moving averages, indicating that the correction we have been through was a significant one, and may require some time to return to real health. We’ll keep watching.

One other thing. Recent economic news out of Europe has indicated that the European Union may be in danger of sliding into a period of extremely slow growth or even another recession.

We’ve remarked before that a healthy EU is as essential to Chinese growth as the development of a domestic Chinese consumer culture (which is what the government is trying to encourage). Collectively, Europe is China’s biggest trading partner, and until demand from Europe picks up, keeping the Chinese economy in steady, healthy growth will be an exercise in trial-and-error management by the government.

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