The economy of China appears to be soft patch

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China's economy appears to be losing traction, with some sectors showing signs of slackening after a initial growth spurt, although it's too early to call an end to the recovery, economists say.

What's shaping up looks like a 'soft patch' in the next few months that won't derail the recovery story, but could be painful to investors betting on a firm rebound in activity.

Credit Suisse's chief China economist Dong Tao says the economy has noticeably cooled since the second half of April, with electronics goods and department store sales both trending lower -- joining the weaker data indicating a slowdown in the materials sector and electricity consumption.

'Following a fact finding trip to China we conclude that the economy is still recovering from the drastic slump in the fourth quarter of 2008, but that the pace of improvement has slowed or even reversed in some sectors,' Tao wrote in a research note earlier this week.

He said the cooling recovery was especially negative for the shipping and commodity-related sectors, which have been seen strong investor interest on the basis of a 'V-shaped' recovery.

Credit Suisse cautioned in another note early this week that China's Purchasing Managers Index for May is likely to dip below 50, indicating conditions in the manufacturing sector are contracting.

Data for the May PMI index are due to be released next month.

Credit Suisse said that while investors shouldn't take an overly negative view of China's growth outlook, it could still be a good time to shift out of property, materials and transportation stocks.

The broker favored large-capitalization banking, insurance and telecom stocks that have lagged the recent advance in the market.

Merrill Lynch more upbeat

Merrill Lynch also said China's PMI for May is likely to show some softening in the pace of growth, but it was generally less pessimistic, saying the recovery trajectory will remain upward.

Merrill said some seasonal slowdown is to be expected around this time, owing to the comparison with April, a month that features a trade fair in the southern industrial city of Guangzhou -- the largest and most important of the year. The Guangzhou fair is large enough to lead to a temporary boost in that month's PMI reading, it said.

Merrill forecasts the PMI in May to come in at 50.2.

Merrill also cautioned against using comparative industrial data from a year ago, such as electricity consumption, saying these figures could be distorted by manufacturers' front-loading production ahead of the Olympics.

China's PMI for April held above 50, the second straight month the gauge has come in above the tipping point between expansion and contraction. The reading was 53.5, up from March's 52.4, according to data released by the China Federation of Logistics & Purchasing and co-compiled by the National Bureau of Statistics.

Credit Suisse's Tao said it's likely in the next few months that the PMI will trend below 50, reflecting weaker real-estate transactions, softer bank lending, declining production in the electronics sector, and generally fewer orders from the infrastructure-related projects following a big surge after the Chinese New Year festival in February.

'In our view, the economy is likely to hit a soft pocket over the next few months,' Tao said.

Chris Oliver

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