A wretched set of Chinese economic data Monday highlights weaker Asian manufacturing activity that threatens the already beleaguered domestic mining sector.
The HSBC China PMI Index is a survey of the country's major manufacturers, who are asked a series of questions on new business orders, hiring and current levels of activity. Readings above 50 indicate positive responses – more production and more hiring, for instance – and reports below 50 indicate declining levels of activity.
The PMI Manufacturing report was released at 48.1, below both the 50 mark and consensus economist expectations of 48.4. This provides more evidence of a slowing Chinese economy.
More distressing, China's all-important housing market is in virtual free fall. A survey of sales activity in 54 major Chinese cities noted a 47-per-cent year over year decline in new home sales. This is the lowest level of sales activity in four years.
It's almost impossible to overstate the importance of real estate values to the Chinese economy. UBS recently estimated that the property industry accounts for more than 25 per cent of total demand for goods and services in the country. With sales activity falling at such an alarming rate, construction, and by extension gross domestic product growth, seems certain to decline.
In Japan, Abenomics-related optimism has given way to a sharp deterioration in economic activity. The implementation of a new sales tax on April 1 led to consumers stocking up on goods in March, and slowed spending after the tax took effect. The Markit Purchasing Manager's Index for Japan has plummeted from 56.6 in December to 49.4 in March.
Developed world PMIs have improved slightly this year, but it hasn't been enough. The most recent update on the Markit/JPMorgan Global Manufacturing PMI was released Monday at 51.9, another decline from the February peak of 53.25.
The declining trend in the global PMI index has decidedly negative implications for Canadian mining stocks.
The accompanying chart shows the historically close relationship between domestic mining stocks and global manufacturing activity. As manufacturers increase production, demand for commodity inputs like aluminum, iron ore and copper also climbs and profits in the mining sector improve.
The chart suggests that domestic mining stocks are not trading above prices signalled by current global manufacturing activity. But, the S&P/TSX Diversified Mining Index's average price-to-trailing 12-month cash flow multiple of 10.04 is higher than the three-year average of 8.9 times.
Improvement in developed world economies could provide a boost to global manufacturing, but Canadian mining stocks are still unlikely to climb significantly with the looming threat of a Chinese real estate implosion and sharply slower economic growth.
Domestic investors should restrict portfolio exposure in the mining sector to specific opportunities where valuations provide a degree of downside protection and they have a high degree of conviction in future growth.
The playing field has changed and the Chinese economy may be moving from the Canadian investors' best friend to a source of portfolio underperformance.
This weekly technical analysis of the S&P/TSX Composite was designed to point out oversold trading and investing opportunities where beaten down domestic equities were poised to bounce. This week there aren't any.
On the contrary, there are indications that the Canadian equity market looks ready to roll over, at least temporarily. Using the Relative Strength Index, there are only two oversold, technically attractive stocks in the benchmark – Yamana Gold Inc. and Dominion Diamond Corp. – compared with 35 companies trading above levels where a short term decline is probable.
The S&P/TSX Composite as a whole isn't overbought yet after a five session rise of 0.4 per cent. The benchmark's RSI of 63 is still below the sell signal of 70.
JPMorgan Global PMI Manufacturing index vs S&P/TSX Diversified Mining index
SOURCE: Scott Barlow/Bloomberg
Follow Scott Barlow on Twitter at @SBarlow_ROB.