China has the markets totally fooled

For the past few months, markets haven't heard a peep from China.

After an incredibly volatile start to the year, analysts and economists all over the world believe that the Chinese economy has stabilized.

In August, PMI came in at 50.4, up from 49.9 in July. Industrial output beat expectations for the month coming in at 6.3% rather than than 6.2%. And Bloomberg's monthly GDP tracker put GDP growth at 7.2% in August, up from 6.9% in July.

So things have been quiet.

However, analysts at China Beige Book (CBB), a private database of the country's economic data, say it might be too quiet. In a report released earlier this week they argue that the Chinese economy actually got worse, not better over the last quarter.

"The chief problem in China economic analysis remains the unwillingness to look behind dubious headline data. High-profile indicators such as GDP and the PMIs this quarter will rubber-stamp the government's recovery narrative, but only those with nothing on the line should accept this at face value. New results from the China Beige Book Q3 2016 survey also reveal a fairly pleasant view…but only from 30,000 feet," it said.

According to CBB, even though corporate borrowing increased across the board, profits and cash flow deteriorated.

Stability is expensive

What's more troubling is that the only sectors that seemed to be chugging along smoothly were the old drivers of the economy - ones the Chinese government has been trying to wind down in an effort to transition its economy from one based on investment in industrial manufacturing and property development to one based on domestic consumption.

CBB's data shows that despite the government's stimulus efforts, that's just not happening.

"...the growth engines this quarter were exclusively 'old economy'-manufacturing, property, and commodities," said the report. "The 'new economy'-services, transportation, and especially retail-saw weaker results both on-quarter and on-year. Deteriorating corporate finances and a rebalancing reversal seem a high price to pay for a quarter's worth of stability [emphasis ours]."

The government seems to be preparing for this to get worse. Earlier this month, the government gave bond traders the go ahead to start trading credit default swaps, which allow investors to insure themselves against the default of a given security. That could be a sign that the government expects more defaults are coming.

This all happened after the government also allowed the first major state-owned organization, Guangxi Nonferrous Metals Group, to make preparations for bankruptcy.

So something's coming y'all. The writing's all over the wall.

This is an editorial. The opinions and conclusions expressed above are those of the author.