CLSA SINOLOGY: 'V'

'V'
The shape of China's economic recovery is reflected in the shape of the CLSA China manufacturing PMI: 'V'. For both GDP and the PMI, the right side of the 'V' will not rise as high as the left side, but it is now safe to say that a sustainable recovery is well underway in China.

Up again
The CLSA PMI rose again in June, to 51.8 from 51.2, and the index is now over the survey's historical average of 51.7. Domestic demand continues to drive new order growth, but export orders broke out into expansion for the first time since last July. Manufacturing employment expanded for the third consecutive month in June. There will undoubtedly be volatility in this series over the coming quarters, but with the headline PMI strengthening for 6 of the last 7 months and in expansion (over 50.0) for the last 3 months, the CLSA survey reveals few signs of weakness in China's manufacturing economy. The Chinese government's PMI also rose in June, to 53.2 from 53.1, and has been over 50 for four consecutive months.

Upside risk
The headline PMI is unlikely to return to the last peak of 55.4, recorded in April 2008, just like GDP growth will not return to 2007's 13% level. But we continue to expect GDP growth of about 8% this year, with the risk now clearly on the upside. Just over half of growth will come from investment, with the balance from consumption and zero contribution from net exports. (We expect about 7% GDP growth in 2Q09, and 9%+ in both the third and fourth quarters. When it is clear that 3Q09 will be 9% or more, that will surprise many and may be an inflection point for new global liquidity flows into Chinese equities.)

Again next year
In 2010, domestic demand will remain very strong, again generating about 8% GDP growth. Recovery in the US and Europe would generate a net export kicker, taking growth up to 9% next year.

Production up again
Manufacturing production expanded for a third consecutive month in June, with the seasonally adjusted output index rising to its highest level for 12 months, to 53.7 from 52.5 in May.

Headcount continues to expand
Manufacturing employment rose fractionally, remaining barely in expansion territory for a third consecutive month at 50.2, up from 50.0 in May. In what must be one of the few global markets where manufacturers are increasing staffing levels, companies reported that new workers were hired in line with rising production requirements.

Layoffs flat
The share of firms cutting headcount ticked up a bit in June (to 6.9% from 6.8% in May) but has held in the 6-7% range for the last three months, down from the 14% levels of November to February. Companies reporting lower headcount commonly linked this to the non-replacement of voluntary leavers, rather than to active layoffs.

New orders strong
The overall (domestic and export) new orders sub-index rose strongly for a third consecutive month in June, to 54.6 from 53.4. The current reading is back to levels not seen since last July, and is up sharply from November's bottom of 36.1. In each of the last 3 months, more than 30% of firms reported a MoM rise in new orders - - a level reached in only 8 other months during the 5 year history of our survey.

Export orders finally break out
Rising for 7 straight months, new export orders finally broke into expansion territory in June, with the sub-index reaching 50.9. This is the first time export orders have been over 50.0 since last July, and this is up from the November bottom of 28.2.
This improvement in the export orders index is consistent with the 'Wal-Mart effect' we have been writing about, and is why we are less pessimistic than most about Chinese export prospects for this year. We believe export growth will be down sharply from last year's 17% pace, but will be in the range of zero to +5% YoY.

Warehouse inventories up slightly
The stocks of purchases sub-index remained below the 50.0 point, signalling a reduction in input inventory levels for the 23rd straight month. Inventories of finished goods held by manufacturers, however, expanded slightly in June (50.4) after having fallen for 6 consecutive months. Several of the panel companies linked higher warehouse inventories to goods awaiting shipment. The ratio of finished goods to new orders ticked up a bit but remains healthy, indicating Chinese manufacturers do not have an excess inventory problem.

Prices
The sub-index for input prices rose for a third straight month, to 49.8 from 44.3, but remained far below last June's 81.0. A year ago, 63% of firms reported rising input costs; last month the share was 22%.
The index for output prices also rose for a third straight month, to 49.0 from 46.1, but remains below the expansion threshold. The share of firms reporting higher output prices was only 15%, compared to 33% a year ago. Pricing power clearly remains a scarce commodity in China.