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Why China’s PMI affects dry bulk shippers, but raises a question

China manufacturing activity and shipping demand

Because China is the largest importer of raw material in the world, manufacturing activity in China is one of the most influential factors of shipping demand. When manufacturing activity rises, China will often import more dry bulk raw materials, such as iron ore, coal, and grain. This will support shipping rates, which positively affects dry bulk shipping companies’ revenues, earnings, and share prices. But when activity falls, it’s considered negative.

China Manufacturing State PMI 2013-08-01Enlarge Graph

Official PMI unexpectedly rises

For the month of July, China’s official manufacturing PMI (purchasing managers’ index) unexpectedly rose to 50.3 from 50.1 a month ago. The PMI is a measure of economic activity often followed by analysts and traders. Figures above 50 indicate solid expansion, while those between 42 and 50 show possible growth, and levels under 42 signal a potential recession.

Most economists were expecting the data to fall below 50, given weakness in China’s GDP growth of 7.5% for the second quarter of this year. The government is tolerating lower economic growth to implement reforms, and HSBC’s Flash Manufacturing PMI (which has more weight on smaller companies) weakened further. HSBC’s final manufacturing PMI data continued to slump to an 11-month low of 47.7. The divergence between the two puzzles many analysts.

China Manufacturing PMI Breakdown 2013-08-01Enlarge Graph

Business expectation turns around

The composite PMI index, the one that most investors look at, is made up of five sub-indexes—new orders (30%), production (25%), employment (20%), suppliers’ delivery time (15%), and raw-material inventory (10%)—which all improved in July. Business expectation, which reflects managers’ sentiment of business activity, rose for the first time in four months. July’s data comes after the Chinese government recently pledged stable economic growth in the second half of this year through a little stimulus here and there in urban infrastructure, high-speed rail, and energy-saving industries, while pressing ahead for reforms and restructuring.

How the PMI is formed

It’s important to know that the PMI is like a “sentiment” index. The index asks managers whether the sub-indexes were better, no change, or worse compared to the previous month. Answers with “better” get a score of 1, while “no change” get 0.5 and “worse” get 0. So if a business manager had expected growth to be 8% and now expects 7.5%, his or her data could add a zero to the index. On the other hand, some managers could still consider 7.5% as a positive, which may lead to circle “improving.”  In this way, managers’ answers anchor to a recent past, and they’re a mix of objective and subjective answers.

Subjective answers raise a question

Given that China is entering a period focused on reform, we can expect the PMI to hover around 50 for a while. This means manufacturing growth is unlikely to be as robust as it once was. But how much growth is “not robust”? Investors may consider relying more on hard numbers like car sales, construction activity, and iron ore imports to get a better sense of China’s fundamentals and how they may affect bulk shipping companies such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Safe Bulkers Inc. (SB), Eagle Bulk Shipping Inc. (EGLE), and Navios Maritime Partners Inc. (NMM). We publish these under our Marine Shipping page.