Stocks ended 2013 on a high note, but 2014 has thus far been rocky (yes, all one day of it). Volatility can happen at any time for any reason—or even no apparent reason—and Thursday, many blamed China’s slowing manufacturing PMI. Some fear weaker Chinese manufacturing may drag on the whole country, the world and the bull! But investors needn’t fear 2014’s rough start or even one country’s potential impact. In the short term, markets swing on sentiment over just about anything, but longer term, fundamentals rule—and plenty of other manufacturing data released Thursday show global growth is likely to continue even if China slows a bit (which isn’t guaranteed).
China has two PMIs—the official one, which centers on large state-owned firms, and HSBC’s gauge, which focuses on small private businesses. The official December PMI slowed slightly from November, reading 51.0, while HSBC’s survey hit 50.5. Though the figures remain in expansionary territory (readings above 50 indicate more than half of survey respondents saw growing orders), many fear slower manufacturing will drag on Chinese growth.
And, well, it might. But perhaps not for the reasons many assume (i.e., inherent weakness). Forward-looking new orders held up reasonably well, implying demand for industrial goods remains fine. Output was the biggest drag in December’s PMI—by government design. In recent years Chinese firms have overproduced steel, iron, chemicals and more, creating supply gluts and denting profitability. To “fix” matters, Chinese officials ordered a cutback. But after strongly worded notices failed to drive much change, in December, officials resorted to demolishing blast furnaces, leading to big production drops in Northern China.
What Manufacturing PMIs don’t register is that officials are also trying to channel energy/resources into other areas of the economy, like domestic consumption—this is all part of the long-telegraphed economic shift. A healthy and growing Chinese consumer class can make up for a deliberate decline in industrial production—and for China, it’s likely more sustainable long term than squeezing more out of factories suffering from being on the wrong end of the law of diminishing returns.
Plus, and importantly for markets, this is nothing new. Chinese manufacturing PMIs have been off-and-on for the last three years, and the term “Chinese hard landing” is no stranger to headlines—even though industrial growth continued and GDP growth stayed above the official target. In each of the last two years, folks fretted the official target being reduced. Growth continued, exceeding the target, and the global bull market marched on. Markets may occasionally wobble when China reports relatively weak figures, but that needn’t signal a derailing. Overall market well-being hinges on more than daily volatility or one country’s short-term economic results. As Benjamin Graham famously observed: “In the short run, markets behave like voting machines, but in the long term they act like weighing machines.” Sentiment drives volatility as investors react to new news, but markets’ overall direction in the long term is driven by fundamentals, which globally, are strong.
Exhibit A: The many other manufacturing PMIs released Thursday. Leading the pack, UK PMI came in at 57.3, slightly down from the previous month, but solidly growing. The US was a close second at 57.0. And the eurozone had its best reading in almost three years (52.7)—all countries but France and Greece had expanding PMIs. Even Greek PMI was on the cusp of growing, at 49.6. And most surveys showed strong new orders, PMI’s most forward-looking component.
Taken at face value, even with a softer reading from China, global manufacturing data suggest growth will continue. So do other reports. In most of the world, Leading Economic Indexes are high and rising. Plus, yield curves are widening and should keep doing so as the US winds down its QE program, giving many economies the fuel they’ve lacked in recent years.
Most investors don’t understand how strong a case these data make for stocks to march higher—they show expectations still lag reality. Steeped in dour sentiment, folks focus on one weak spot in an otherwise bright picture and believe their fears are justified by daily volatility. But this coincidence doesn’t mean one disappointing dataset signals more bad news for stocks. Volatility is unavoidable in stock investing, and not all countries or sectors need to grow at the same clip for the whole world to benefit or exceed expectations—an invaluable lesson for long-term investors that today’s data help illustrate.