Chinese PMI - Why you should care and what is it REALLY telling you now

Unsuccessful businessman using a megaphone with a curve going doSo we had the latest Chinese Flash PMI data out this morning and already we have the clamoring of financial media commentators, knee jerking from here to New York through London and back to Australia. Is it really telling us that the Chinese economy is about to (or according to some already has) fall into an economic abyss or merely just the normal path on what is a state of continued growth and contribution to global financial well-being?

What is PMI?

The HSBC Flash China Manufacturing Purchasing Managers’ Index (PMI) is published by the Markit Economics group every month (http://www.markiteconomics.com) . The Flash data is released ahead of the Final PMI data making it a well thought of, and historically reasonably accurate, gauge of what the final PMI figure may be.

The PMI is an important leading indicator if overall company health and activity and appears to be relatively well correlated not surprisingly with overall economic health.

The thinking is that purchasing managers are among the first to know when market conditions, and so company behavior and performance, are changing either for the better or otherwise.

The process is that in each country, a panel of purchasing managers thought to be representative of the economic make up of that country. Questions in the PMI surveys only ask for factual information (not opinions, intentions or expectations). These cross several key variables such as output, new orders, prices and employment. Questions take the form of up/down/same replies.

Responses are weighted according to the size of the company in the final calculation of the overall data and also adjusted for normal seasonal variations.

 

What does the score mean and why should I care?

The Headline PMI figure provides financial markets with two key pieces of information.

  1. The major “line in the sand” is the 50 mark meaning there has been no change on the previous month. A figure above this is indicative of expansion and conversely a figure below of contraction.
  2. The second is a comparison against the previous months figure and is the rate of change. This can be faster or slower dependent on whether higher or lower, if in the same overall state as the previous month

e.g. If the figure the previous  month was 49 and this month it is 48.2, it is said to be contracting (or decreasing) at a faster rate.  49.5 would be decreasing at a slower rate.

If the figure the previous month was 55.2 and this month is 56, is it expanding at a faster rate.

For completeness it is worth mentioning that the headline figure can broken down into 5 different data points rolled into one, looking at different parts of what makes up the PMI.

At the end of the day of course, although the bottom line figure is important, the impact on the markets, as with any data point, is whether the figure met, beat or missed what was expected , the theory being of course that the previous figure and the expected figure for this month is already priced into markets.

 

So here is the story for the last two years…

Just for a moment assume this isn’t Chinese data, but it is the same sort of chart that you would look on any day for your chosen trading instrument of choice.

What you see on any chart is collective market sentiment towards a particular asset class in response to current information on the economy.  Be it Gold, AAPL, EURUSD or perhaps even Chinese PMI, the rules of the game are surely the same.

So if you were to look at a chart, like the one you see below, what would you think or rather (As we know thinking is a dangerous occupation sometimes when trading, what do you see?

 Chinese PMI

So whether you view this as a distortion of how these figures should be viewed (and a little boldness on my part to put a new tilt on how you couldread them) or otherwise…

  1. We have 13 months in contraction and 11 in expansion over the last 24 when the equity markets remain in an uptrend.
  2. Over the period…Is that a double bottom, followed by a double top, followed by a re-test of the low, then the high, and the low again?

 

Let me ask a few questions to help you along a little…

  1. Does this look like a “position” you would “short” NOW? (OR in other words does this say the Chinese economy – and so global economy – is ripe for obliteration?)
  2. Historically what has happened when the PMI number has reached similar levels over the last two years?
  3. What may be the critical line in the sand that would lead you to be concerned?
  4. What may have happened (or intervention put in place) when it previously hit these levels.

My place here is not to state what is likely to happen from here of course, but merely to put some “what do you see” questions in front of you, rather than “what do you think” (or what do others think – as there are plenty offering indisputable “facts” about China at the moment flying around the hallowed chambers on CNBC and Bloomberg).

As an educator, someone who is passionate about what they do, and being ahead of the herd detecting significant market change (particularly important for directional options traders), I personally think and teach that PMI data is one of the most important and potentially leading figures out there in the economic data world. It is important not just to “plant your flag” in what this may REALLY mean right NOW, but also, and arguably more important, to make a decision as to what it means to your behavior.

 

So to finish and for what it is worth, my thoughts..

….. does this create a state of comfort that there is likely to be a continuation of the bull run and time to push the accelerator on the “long” peddle, no absolutely not… But neither does it say we are in for the market capitulation that some would suggest is about to happen.

What does that mean in terms of behavior (along with other market signs which you have heard me repeatedly talk about at the trading rooms – see http://hawkeyeoptions.com/pages/room/ ) is that long trades are still “on”, but with caution (i.e. reduced position sizing and./or fewer positions) for now with the intention to continue to monitor.

 

Trade safe and learn with passion

 

Mike Smith

www.hawkeyeoptions.com

 

Be Sociable, Share!