Requiem for a construction bubble

Pete Wargent

In this report, we have isolated two of the leading indicators in Australia’s economy, namely building approvals and money growth, and highlighted some key themes arising from our findings. Our analysis is independent and takes account of evidence through liaison with industry contacts, combined with data.

In our experience, too many analysts take their cues from lagging indicators, such as the unemployment rate or inflation figures. While these figures are important, they tend to be lagging indicators and as such are of limited value when trying to anticipate future trends, generate trade themes, or make informed asset allocation decisions.

The market has generally been too positive about recently reported data. Commentary has often focused on strong employment growth, and the ongoing budget repair, which has seen the deficit narrow to the lowest level since April 2009 at just $12.1 billion or 0.7 per cent of GDP1, maintaining Australia’s AAA-rating.

However, strong employment growth in 2017 and the rolling budget deficit as taxation revenues have increased are backward-looking. Instead, we look towards trends such as jobs advertisements, which are now showing signs of softening after 17 consecutive gains and a 31 per cent increase from the cyclical nadir, and money growth which is slowing2.

7 key findings

Housing credit growth has slowed

Housing credit growth has slowed significantly and may be expected to slow further as a result of tighter lending standards and findings arising from the Royal Commission into Misconduct in the Superannuation, Banking, and Financial Services Industries (“Royal Commission”). Deposit growth and broad money growth have declined to 25½ year lows. 3

Housing market investor activity slowing

Liaison with mortgage brokers shows that investor activity is expected to be considerably slower in H2 2018 than it was a year earlier. Major banks are at risk of losing market share to non-bank lenders and intermediaries

Dwelling prices now in decline

Dwelling prices in Sydney are now rolling over, with Melbourne set to follow, with a potentially negative impact expected on household consumption. Dwelling prices have already been in a multi-year decline in Perth and Darwin, and Brisbane apartment prices have also declined, and significantly so in some cases

Detached house approvals robust

Building approvals are still tracking at reasonably robust levels, especially for detached houses, driven by strong population growth and demand in Greater Melbourne and Greater Brisbane

Apartment construction to fall sharply

We have significant evidence to show that new apartment projects are struggling to get finance approved, and therefore total residential construction is expected to slow in H2 2018. Dwellings approved but not yet commenced have already increased to the highest level on record, driven by apartment project approvals

Apartment default rising

Liaison with industry contracts indicates that settlement defaults for some of the major developers have increased, particularly in relation to offshore buyers. The resale market is considered healthy enough at this juncture for most developers not to be materially impacted, however there is a strong likelihood that residential construction activity will now fall

Employment growth to fall

Construction now directly employs just under 1.2 million persons in Australia, recently capturing a record high in absolute terms and, at 9.6 per cent of employment, the construction sector is at its most bloated in approximately a century4.

About ¾ of construction jobs are accounted for by the residential sector5. There is significant potential for employment growth to slow sharply over the next 12 months

Key implications and trade themes

Construction bubble

The sector looks severely bloated, with construction employment as a share of total employment at the highest level in approximately a century.

The sector swelled through the mining boom, and even further through the apartment boom. We see this as the biggest risk for the economic outlook.

Yield curve to flatten

Rate hike expectations should be scaled back or pushed out to at least H2 2019 or beyond

Wealth effect and construction multiplier to fade in Sydney and Melbourne

There appears to be a danger that declining dwelling prices will negatively impact dwelling commencements, household consumption, and demand for some classes of household goods

Settlement defaults rising

Developers are reporting rising settlement defaults. It is unclear at this stage how significant this will prove to be, but the trend should be monitored carefully

Materials demand solid but should be watched carefully

Materials companies have delivered strong returns to fund managers since Q1 2016, but exposure should be carefully monitored and managed in H2 2018 and beyond. Although a range of significant infrastructure projects should keep demand robust and detached house approvals are rising in Melbourne and Brisbane, the residential sector is set to slow significantly as the apartments pipeline shrinks

AUD downside risk:

If employment growth and the housing market slow as expected there is downside risk for the Australian dollar from US$0.755

US valuations remain stretched

Equities valuations in the US remain at high levels, and there is a risk that tighter policy in the US sees share markets revert lower, with implications for other global stock market indices.

You can access our full report here.


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berge der sarkissian

Great article, 100% agree the only other thing I'd overlay is that NDIS has resulted in large employment growth which now will subside

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John Ryan

As a Builder in Sydney I would say you have hit the nail on the head!

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Craig O'Doherty

Thanks Pete Great article. I live in Perth & construction, mining, property & retail trends seem to be easier to observe here compared to Melbourne & Sydney. I am a food retailer & active ASX trader

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