Slowdown Coming For Oz Economy

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 – Westpac Leading Index suggests a slowdown is coming
 – Data is likely to prompt RBA to cut rates in July
 – Building materials stocks impacted by weak dwelling approvals data
 

By Chris Shaw

Yesterday the release of the Westpac-Melbourne Institute Leading Index, which indicates the likely pace of economic activity three to nine months into the future, pointed to a sharp slowdown over the second half of 2012.

The growth rate in the Index came in at 0.2% for April, Westpac senior economist Matthew Hassan noting while this is an improvement from the minus 1.5% reading in February it remains well below the long-term trend rate of 2.6%. 

As Hassan points out, Index readings over the past three months have been the weakest since 2009, with growth close to the levels seen in 2000-2001 when the Australian economy came close to recording a technical recession.

The biggest drags on the Leading Index growth rate at present are coming from increasing unit labour costs, a measure of declining productivity, dwelling approvals, commodity prices, corporate profits and overtime worked. On the positive side were US industrial production, growth in the money supply and the All Ordinaries index. 

In Hassan's view, the sharp fall in dwelling approvals is largely due to some legislative changes in Western Australia. A rebound is expected in coming months. 

While the Leading Index remains weak, Hassan notes the Coincident Index of current activity remains strong, with growth significantly above trend levels. The mix of both measures indicates an abrupt loss of momentum is likely over the second half of 2012.

As Hassan points out, the Reserve Bank of Australia (RBA) next meets on July 3. While policy has already been eased in response to weakness in the domestic economy, a further cut to the cash rate of 0.25% is expected as the Leading Index data suggests conditions in the Australian economy are not as strong as suggested by the recent quarterly GDP report.

Westpac's expectation is the cash rate eventually falls from 3.25% currently to a rate of 2.75%. Supporting this view is the expectation rates will continue to be heavily influenced by developments abroad, as the Eurozone crisis continues to play out.

With respect to the March dwelling commencements data, Macquarie notes the seasonally adjusted rate of 30,623 commencements was the lowest since the June quarter of 2001. The east coast of Australia led the fall, with New South Wales down 47% in quarter-on-quarter terms and Victorian numbers down 20% on the same basis.

Macquarie suggests the latest forward indicators show a continuation of low activity levels in the near future, as private sector hosing approvals data for April was down 28% month-on-month and 17% in year-on-year terms.

UBS is a little more positive, seeing the March quarter data as likely the trough given the number for the period was below GFC lows. Also supportive in the view of UBS was that building 'approvals' were only 2% lower into the first quarter, while the period experienced much wetter than normal weather conditions.

As well, UBS notes lending for new construction is now more than 10% above the low of the final quarter of 2011, while there is evidence of rising sentiment towards buying a house and new construction focus policies in place in NSW.

In terms of how the housing data impacts on the building materials sector, Macquarie notes Boral ((BLD)) and CSR((CSR)) have the greatest exposure to the Australian housing market. This suggests residential linked returns for both will struggle to recover until there is a sustained recovery in residential activity in Australia.

James Hardie ((JHX)) has the lowest exposure, while both Brickworks ((BKW)) and Adelaide Brighton ((ABC)) are both defensibly positioned for continued weakness in activity.

Macquarie's order of preference among the Australian building materials plays remains Adelaide Brighton, rated as Outperform, then James Hardie, rated as Neutral. 

As a reference, the FNArena database shows Sentiment Indicator readings for the major players in the sector as 0.5 for Adelaide Brighton and Brickworks, 0.3 for James Hardie and 0.1 for Boral and CSR.

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