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China's April PMI stats just came out and were more or less flat compared to March. The official CFLP manufacturing PMI came in at 52.9 in April, down slightly from 53.4 in March, and below the Bloomberg consensus of 53.9. The preliminary HSBC/Markit reading was 51.8, the same as the March reading. The readings show the manufacturing sector in China still in expansionary mode, which bodes well for the Chinese economy. Paradoxically perhaps, in the short term it will likely mean further monetary policy tightening with an increasing likelihood of an additional interest rate hike as the economy proves relatively resilient to the inflation fighting efforts to date.

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So while the reading shows that the Chinese economy is still carying on, it also shows some signs of slowing. While the results weren't sharply negative, they weren't positive either. Also, the extent to which they are expansionary is somewhat lower. So while it gives the People's Bank of China some room to move in terms of additional hikes in the required reserve ratio (now at an average of 20.5% for the large banks) and the interest rate (now at 6.31%), it also highlights the rising presence of policy risk. In other words, China, as well as many other emerging markets, is fast approaching the point where the next bit of monetary policy tightening could end up being the proverbial straw that breaks the camel's back.

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Thus the stock market reaction to this result will likely be neutral at best, but will probably see a slip. On the positive side, any weakness in stock prices should be taken as a buying opportunity for the "inflation eases theme", where inflation peaks in H2, and monetary policy tightening ceases. There is a narrow band where the monetary policy tightening cycle wraps up- but where it doesn't cause a hard-landing- for money to be made in Chinese equities.

This scenario is probably one where inflation peaks early, and most likely one where inflation is bought under control without crashing the property market. If the property market crashes, then the resultant recession would likely also see a decent sell-off in equities, which would also present buying opportunities. That is, if the recession ended up being mostly cyclical rather than structural. So keep an eye on general inflation in China, and especially property prices, and watch out for the next policy tightening move.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: China PMI Heralds Further Policy Tightening and Possible Opportunities