China is weak, but Europe is strong. We haven’t heard that in a while. Overnight economic data indicated further deterioration in China (Flash PMI at 47.7, its lowest level in 2013). Meanwhile, European Composite PMI data inched above 50 (the expansion level) for the first time in more than a year:
The divergence in economic data among the three major regions (U.S., Europe, and China) over the last few months has been interesting. The U.S. has muddled along, Europe is showing signs of recovery, and China has been persistently weak.
The U.S. Composite PMI has not been below 50 since mid-2009. It has weakened to near 50 this year, but most economic indicators in the U.S. continue to indicate slow but stable growth. The U.S. Citigroup Economic Surprise Index is still negative, though close to 0 (and has been much less volatile in 2013 than in the prior 3 years):
The European Economic Surprise Index has spent much less time in positive territory over the past couple years, but has been the strongest region in terms of data surprises over the past month (not just low expectations, but better overall data too):
In contrast, China has reported persistently poor economic data for the past 3 months, continually surprising on the downside:
What are some of the implications of this divergence?
First off, I don’t expect much of a rebound in industrial commodities or their related stocks as long as Chinese data remains disappointing (CAT’s weak results this morning are more confirmation of that). Even though some are speculating that the weak data might be a reason for stimulus, Chinese policymakers seem intent on pursuing their rebalancing from fixed investment towards consumption, no matter the short-term difficulties (last night’s article: China Bans New Government Buildings in Five-Year Crackdown).
Second, European stocks could outperform the other developed markets in the second half of 2013. Even the leaders, like the FTSE and the DAX, which are near all-time highs, are priced more cheaply than U.S. stocks on most valuation metrics. The real issue for Europe is the continued bifurcation between the North and the South.
Finally, emerging markets are likely going to have a difficult time gaining footing if China remains in the doldrums. Without Chinese stabilization, rallies in both EM bonds and stocks are likely to be sold.
It’s a three-speed world. Shift gears accordingly.