China’s new strain of bird flu is less deadly than the old one. But that is about it for good news out of China these days. Monday’s manufacturing surveys for May showed that factory output had slowed and new orders fell sharply. This follows weeks of tightening in credit markets designed to rein in China’s shadow banking sector. Investors were indifferent to the news that China’s purchasing managers’ index had fallen to a four-month low – the Shanghai Composite index moved sideways. But that does not mean that all the bad news is fully priced in.

Granted, Chinese shares are cheap. Companies now trade in Shanghai on just below 7 times expected earnings – well under the 12 times level in the wake of the collapse of Lehman Brothers, and the lowest rating in over a decade. The story is the same for Chinese companies trading in Hong Kong. Net profit margins, which had fallen for eight consecutive quarters to the end of last year, were just beginning to stabilise near 8 per cent, according to S&P Capital IQ data. But they do not look poised to bounce yet.

Tighter credit is already leading to higher borrowing costs, which is likely to erode margins once more. Tougher access to financing will also hurt investment, especially among China’s small and medium enterprises which depend on the more informal shadow financing sector to access credit. That will hurt top lines, too. For example, same-store sales at China’s largest shoe maker, Belle, had grown barely 5 per cent in the first quarter versus a year earlier and Barclays estimates those sales fell in the second quarter. Similar trends can be seen at the restaurant chain Ajisen. Chinese companies trading in Hong Kong lost over a third of their value in the four months that followed the tight credit environment in mid-2011. If that bad news repeats itself, Chinese shares still have further to fall yet.