The hottest China bull argument is melting

Things have been tough in China for months now, but when you talk to people bullish on its economy they still often point to one sector of the economy — the services sector.

The problem with that, though, is that it too is showing signs of deterioration.

On Thursday the September Caixin services PMI came in at 50.5, down from 51.5 in August. Anything below 50 suggests a contraction.

The official government services PMI held steady at 53.4 from August to September.

In other words, it doesn’t look like the services sector is growing, no matter how you slice it.

That’s important, because it’s a growing services sector that’s supposed to get China out of this mess. It’s the argument some China bulls have been making to explain why people shouldn’t be worried right now.

Last month, China’s Beige Book — which is not released by the government but by a private New York-based firm — argued that recent perceptions of a Chinese slow down were “thoroughly divorced from facts on the ground.”

It conceded that the manufacturing sector — which posted a 49.8 PMI reading in September, up slightly from August’s 49.7 number — was contracting. But it also said that manufacturing was no longer the force of the Chinese economy.

Instead, it said, investors should look at the country’s growing services sector. China bulls know that the country’s traditional growth drivers — like property development — have languished.

They just argue that that’s ok, because the services sector will pick up the slack.

This month’s PMI read of the services sector, however, casts more doubt on the argument that it is growing fast enough to carry China’s transitioning economy as it moves from one based on investment to one based on consumption.

“The story of strong services offsetting weak manufacturing looks increasingly unlikely to have a happy ending,” wrote Bloomberg economist Tom Orlik in a note following the data release.

Expect the government to continue enacting measures to stimulate the economy — more rate cuts, more loosening of housing policy to breathe life into the real estate market.

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