Reading China's PMI

by: Zhong Jin

Today, China’s official manufacturing PMI (Purchase Manager Index) for November will be released. Given that markets have focused on the monetary tightening measures taken by Chinese policy makers (in addition to the EU debt crisis), investors will be watching closely.

After 2008, China’s PMI data shows that domestic demand is the main driver the manufacturing recovery in China. Especially for the past four months, the widening gap between the new order index and the new order index for exporting confirmed that the internal demand is rising faster than the external demand.

From the chart shown below, it is clear that the Shanghai stock price index is a reliable leading indicator of the input price index for manufacturers. In most cases, the Shanghai stock index is also a valuable indicator of China’s PMI and new order index. A large portion of China’s domestic demand comes from investment and governments, which are heavily influenced by the central government’s economic policy. China’s stock market is also sensitive to the government’s policy and reacts in a more timely manner than manufacturers.

As I pointed out in my previous article, China’s current economic policy is to control inflation and cool the overheating economy. The recent correction in the Shanghai stock market in November proves this point. The market is expecting China’s PMI to fall before the end of 2010. Since China is the leading importer for many commodities (i.e., oil, coal, copper, and iron), any weakness in China’s PMI will provide more excuses for investors to sell commodities and risky assets.

Disclosure: No position