Sinopec Shanghai Petrochemical Co. (ADR) (SHI), Abbott Laboratories (ABT): The Trends Investors Need to Watch in China’s Slowdown

A downbeat outlook from China’s manufacturing sector couldn’t hold back Hong Kong’s  HANG SENG INDEX (INDEXHANGSENG:HSI) from big gains this week, as the index pulled in gains of 2.7% over the past five days. It was a welcome turnaround for the index for China investors, who have dealt with the nation’s stocks sliding all year. To date, the HANG SENG INDEX (INDEXHANGSENG:HSI) has lost more than 6% in 2013 in one of the worst performances for a stock index in a major global economy.

Manufacturing may be down in China, but is the country’s undeniable slowdown setting up the nation for long-term stability? Let’s dive into what’s ahead from the world’s second-largest economy — and what investors need to watch out for.

The pros and cons of a planned slowdown
China’s manufacturing sector has been sliding for months. July’s preliminary PMI reading by HSBC Holdings plc (ADR) (NYSE:HBC) didn’t offer any hope for improvement this month, coming in at contraction territory with a reading of 47.7 this week — a half percentage point lower than June’s reading. The country’s credit crunch has tightened lending across China’s financial sector, part of a wider slowdown in manufacturing, as the government has reduced infrastructure investment. Still, some analysts project that Beijing will step in if growth slows too much, particularly as China’s GDP reading last quarter came in at 7.5% — far below the growth of recent years.

Yet, some of manufacturing’s decline could be planned. Beijing’s let much of the ongoing cash crunch occur without propping up its financial sector with stimulus like the U.S. and Japan have done. The result will hit growth hard now, but in the long term, the hands-off policy is designed to weed out shaky banks and lenders and letting them fail. The planned slowdown has extended to manufacturing, as the Chinese government has ordered domestic companies to cut excess production in light of slowing growth.

The question now is whether or not that deliberate slowdown will impact China’s growth too much for Beijing to bear. For investors, it’s made finding growth stocks in this former growth haven a more challenging prospect. Some small firms in China have exploded into star-studded growth stories in the past — the solar industry being a notable example — but with Beijing more inclined to let poorly run firms live and die on their own merits, it’s more important than ever for you to look for solid and strong companies to invest in across the Pacific, rather than taking a flier on high-risk gambles.