China PMI Data: Stability Now, Slowdown Later.

China's official PMI numbers point to short-term stability.  The Official manufacturing PMI number of 50.4 was the highest in two years and unchanged from August.  The number points to more stability in the short-term, and perhaps relatively strong production numbers to be released in a few weeks.  The service PMI number has been stable all year, coming in at 53.7 in September.

The stable PMI numbers have been driven by mid-year new construction starts, property price increases, and the massive surge of project investment in the pipeline early this year.  Those factors have given a temporary reprieve to old economy industries on a downward trajectory over the last few years.  We can see that reprieve in the rising electricity output (heavy industries use almost two-thirds of China's electricity), improved steel output, higher cement production, growing rail freight volumes, and improved industrial profits.  But, with the large drop in investment recently, driven by a decline in private investment, economic activity will most likely take another leg down in the near-term.  

It is hard to fix a timetable to when we might see China's economic stability shaken a bit, whereby downside economic surprises are meaningful.  In the past, I have used the rule-of-thumb that it takes about 5-6 months for investment to spread through the economy.  Fixed investment fell from 10% YoY to around mid-7% in May.  Then, July saw a drop to 3.9%, one of the slowest investment numbers in decades.  It is likely we see weaker numbers in the last few months of 2016, and meaningfully slower numbers in early 2017.  My models point to a potential half point shaved off of real GDP growth as a result of weakening investment.  Slowing indicators could renew hard landing worries in the markets.  For now, there is still enough fuel in the pipeline for a few more months of expansion.  

Important numbers to note:

The positive PMI numbers are still being driven by large enterprises.  Large firms had a PMI of 52.6, up from 51.8 last month.  Mid-sized and small firms had PMIs of 48.2 and 46.1 respectively.
The steel PMI fell just under 50, coming in at 49.5, after pointing to expansion for previous two months.
Both service and manufacturing expectations are still high, coming in at 61.1 and 58.4.
Employment PMI has been rising (see chart on the top right).  That should be a good sign for policymakers.
Nothing in the PMI numbers this month gives a good indication of Beijing's stimulus policy trajectory.
All-in-all, PMI data points to stability in September.  But, worries in the investment data puts the future of those stable numbers at risk.