Sinopec Shanghai Petrochemical Co. (ADR) (SHI), Komatsu Ltd (ADR) (KMTUY): China’s Growth Engine Goes Cold

You can thank the manufacturing sector for China”s rapid rise to among the world’s elite economies. Exports and cheap labor defined China’s thriving economy during its unrivaled growth years, with lower-cost manufacturing the source of every “Made-in-China” product sold in advanced economies. Manufacturing’s been the country’s lifeblood — so what happens when it runs out of steam?

Sinopec Shanghai Petrochemical Co. (ADR) (NYSE:SHI)We’re seeing that happen right now. China’s manufacturing sector and exports both have slowed recently, with the country’s troubling credit crunch and high lending rates adding to the woes of Chinese manufacturers. Is China’s manufacturing revolution over, and if so, what’s left for investors to profit off of in the world’s second-largest economy?

Manufacturing can’t dig out of its rut
China’s purchasing managers’ index fell again in June, according to a report by HSBC and Markit, the reading’s lowest mark in nine months. The country’s PMI currently stands solidly in contraction territory with a score of 48.2, nearly 2 percentage points lower than the reading of 50 that marks neither contraction nor expansion in the sector.

A separate PMI poll by Chinese officials recorded a slightly better mark of 50.1 that showed slight expansion, but it left out a reading of new export orders — a key cog of the Chinese growth story. Even with the improvement, China’s PMI still ranks nearly a percentage point lower than the U.S.’s reading, which came out at a score of 50.9 in June, according to the Institute for Supply Management. That won’t help Chinese exports to the U.S., particularly with rising Chinese labor costs making it more expensive for firms to produce goods in the second-largest economy.

Chinese exports have experienced their own horror story lately, growing just 1% year-over-year in May. That was a 10-month low for growth, and while China’s maintained a trade surplus throughout its recent troubles, falling imports have helped prop up weak export demand. In particular, exports to Europe have taken a hard hit as China and the EU have engaged in a spat over trade barriers recently. It’s a double whammy for both sides, as Europe relies heavily on Chinese demand for its own exports. Any upset in the trade relation won’t help the region’s attempt to dig out of the recession that has persisted since 2008.

Even worse for Chinese manufacturing exports, new orders from abroad declined for a third straight month and at the fastest rate since September as foreign manufacturing demand wanes. Total new orders declined to a reading of 47.6, the worst such mark since October and far below the U.S.’s reading of 51.9 in June.

China’s stocks take a pounding
Yet even with all the negativity regarding China’s manufacturing sector, Beijing has been content to let things play out with minimal intervention. The country’s cash crunch has temporarily eased after China’s central bank ensured it would support a slower-growth economy, but the trend could grow worse with the tapering down of American stimulus efforts in the near future as emerging market outflows grow.