Why China May Be Manufacturing Its Economic Numbers

Written by George Leong, Profit Confidential

I’m longer-term bullish on China, yet at the same time, when I analyze a Chinese company – especially small-cap stocks – I often find myself wondering if the numbers are valid.

We all know what happened with Sino-Forest Corporation or Deer Consumer Products, Inc (OTC/DEER) and how these companies tricked us. Sino-Forest apparently didn’t have much of the forest properties or the revenues it claimed. Hedge fund guru John Paulson lost nearly $500 million from investing in this fabricated company. Deer Consumer Products, on the other hand, really didn’t have much going on at its factories, according to someone who observed the company. (Apparently there were no trucks coming or going, and workers were nowhere to be seen.)

Of course, there were numerous other Chinese stocks, many of which debuted via the hotly contested reverse merger process, that fabricated their numbers. (Read “Chinese Stocks Hindered by Mistrust“)

The problem is that China is known as the “Wild West” for creative accounting. This is the reason why you see many of the smaller Chinese companies sporting extremely low valuations, as the associated Chinese risk is high and speculative. The trust is simply not there. You are better off with the large Chinese companies, but then the upside potential is low versus small-caps.

Moreover, there’s also the trust we have in the economic numbers coming out of China. There are some who believe key economic data is also creatively managed.

For instance, China reported its Purchasing Managers’ Index (PMI) last Thursday, and it came in at a surprising 50.3 in July, according to the National Bureau of Statistics. Many on the Street had expected contraction, which makes more sense given some of the recent economic data reported on China that pointed to stalling. So ask yourself: how does Beijing suddenly come up with a number that pleased investors and rallied the Chinese market?

While I’m not saying there may be some validity issues here, you have to wonder about the PMI number and all data surfacing from the government-controlled National Bureau of Statistics.

Case in point: the more authoritative HSBC PMI for China came out at 47.7 in July, which indicates contraction; something that seems to make more sense to us. Going back to June, the HSBC PMI also pointed to contraction, while Beijing showed expansion.

So while I remain long-term bullish on China, you really have to wonder about the reliability of numbers coming out of Beijing.