Oz Construction Cycle: The Impact Is Now

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

In this week's Weekly Insights (published in two separate parts):

-Oz Construction Cycle: The Impact Is Now
–On Bear Market Alert
-Conviction Calls: CS, Shaw, Morgans, UBS, Bell Potter, Deutsche Bank
-CBA And The Premium Gone (Vol 4)
–New Website: Set Dedicated Email Alerts
-Rudi On BoardRoomRadio
-2016 – L'Année Extraordinaire
-All-Weather Model Portfolio
-Rudi On TV
-Rudi On Tour

[Note the non-highlighted items appear in part two on the website on Thursday]

Oz Construction Cycle: The Impact Is Now

By Rudi Filapek-Vandyck, Editor FNArena

Not a day goes by without at least one economist, or journalist, pointing towards the housing cycle in Australia with the message: the cycle has peaked.

Certainly, recent data support the thesis, at least for high density dwellings, but not so for other segments of the domestic housing market. With high density dwellings, industry commentators are referring to apartment complexes of four storeys, and higher. Recent years have seen a true explosion in the construction of such buildings and most cities outside Melbourne and Sydney are now staring at, or already experiencing, over-supply.

Think Perth and Brisbane, and falling prices.

Here's one ominous sentence from a recent market assessment from the economics team at Westpac: "Our own research highlights large slippages in vendor settlements and valuations."

An Uneven Correction

Overbuilding with Australian households taking on ever more debt, at a time when financing costs are rising, macroprudential pressure is causing credit tightening, and with foreign investors increasingly battling headwinds, this seems like an ominous cocktail for a guaranteed negative spiral down the road. Indeed, there have been times over the past 2.5 years or so that investors in the share market decided to shoot first and wait for more clarity later.

This time around, however, the Australian housing construction market has mimicked the share market in that different dynamics for different segments make this downturn a rather uneven one. So tiny details matter.

There is now broad agreement among experts that the downturn in construction is firmly concentrated in the aforementioned high density dwellings, and more so in Brisbane, Perth and Canberra than it will affect Melbourne or Sydney. There is still growth in medium density and detached houses, but above all, government spending in infrastructure projects is ramping up significantly, in particular in the eastern states.

The bottom line is that growth in roads, rail, hotels, office buildings and hospitals will underpin overall building activity in 2018 and 2019, virtually securing a soft landing for a cycle that had become too dependent on foreign and local investors' appetite for small units, cobbled together inside high rise towers.

This, of course, doesn't mean there won't be any consequences. High density construction is more labour intensive, so there should be, all else being equal, a net negative impact on jobs and on jobs creation. Equally important: how will Australian consumers respond to the absence of wealth creation from rising house prices when electricity prices remain high and real wage increases absent?

The graph above, from a recent ANZ Bank report, shows building approvals for three key segments of the market in Australia. The big blue mountain that is now turning into a serious downturn; that is the new trend in high density construction.

Is RBA Really Ready To Hike?

For good measure: not everybody is on the same song sheet when it comes to assessing the impact from oversupply in small units on the rest of the housing market, apart from the fact that regional differences are real and pronounced. Speakers at the BIS Oxford Economics conference in Sydney last week predict small price decreases for dwellings in Sydney, in general terms, but small decreases are a major change from the steady rises experienced in years prior.

Apart from any potential impact on national jobs and underemployment trends, I am worried about the psychological impact and the consequences for discretionary spending next year. Hence my ongoing aversion to jumping on board bricks and mortar retailers in the Australian share market.

To me, this is not just about Amazon and the potential impact on local profit margins, this is equally so about the devil within Australian households; too much debt, no wealth creation and plenty of threats and annoyances to worry about.

For more than a year now, economists and commentators of all sorts are engaged in a public debate about what it will take for the RBA to start hiking the cash rate again. Those who had set their mind on a Melbourne Cup Day rate hike have now shifted their timing towards the second quarter of next year. A view supported by bond market movements in recent weeks.

I remain firmly in the camp with BIS Oxford Economics, ANZ Bank, Westpac and others, standing stoically behind the response "tell them they're dreaming!"

Further supporting that view is the fact that a re-weighting of the CPI basket will weigh on reported inflation and no, we do not believe there's a significant catch-up, or otherwise sustainable recovery, about to announce itself in wages.

Here's how Westpac Chief Economist Bill Evans put it: "It is fortuitous that the non-residential cycle will ease the impact from a growth perspective although, as discussed, the impact on employment will be significant.

"Under these circumstances we do not support current market pricing which points to the beginning of the rate hike cycle in mid-2018 with a full rate hike priced in by end 2018. We continue to expect rates to remain on hold in 2018."

While it may as yet remain too early to determine who's going to be correct and wrong in the current debate about interest rates in Australia, the next twelve months will bring data and further developments to a head – this debate will be concluded either way.

Morgan Stanley: A New Level Of Concern

Last week, sector analysts at Morgan Stanley reported their proprietary housing model, MSHAUS, has now declined to a record low in the 28 year history of this indicator. According to the analysts, more macroprudential measures, strong supply growth and higher debt servicing on mortgage repricing all conspired to push the indicator to -0.9 in the second quarter.

They in particular singled out a sharp fall in the share of interest only mortgages, a result of APRA placing further restrictions on Australian banks.
 

Morgan Stanley is looking for ongoing softening in approvals and price growth over the next three quarters. The analysts report apartments already have fallen in relative pricing "and in Brisbane, Melbourne and Perth are increasingly being valued below contract price". Ongoing audits and media revelations around the widespread use of combustible cladding in Australian buildings can potentially impact on demand, valuations and settlements, note the analysts.

Their conclusion: "Housing construction now looks to have peaked, with activity falling over 1H17, but we expect both the 'front book' of approvals and work done to continue declining through 2018. Alongside risks to house prices after an extraordinary ~80% rise in Sydney and ~60% rise in Melbourne since 2013, this makes it even more imperative for both public and private sector investment to create jobs and generate the wage growth that may help rebuild household buffers".

Economists at National Australia Bank have now joined the Yes camp (nothing to do with Same Sex Marriage). On the assumption household budgets will be in a better shape by mid next year, and on expectation of further global economic growth, NAB is now calling for the RBA to hike by 25bp in August 2018 with the cash rate to increase by a further 75bp over the next 16 months (cash rate at 2.50% by end 2019).

See also "The Bubble Is (Finally) Ready To Burst, 15 March 2017.

CBA And The Premium Gone (Vol 4)

This is how successful sequels are born…

I have been arguing in the prior three editions in this series, the share market is displaying a shift in sector leadership for the major banks in Australia. No longer does the sector come with the caveat CommBank ((CBA)) first, and then the rest follows.

This reversal in relative valuations is easily recognised when looking at the gap in share prices for the Big Four and their respective consensus price targets on the FNArena website. National Australia Bank ((NAB)) shares are now at touching distance of their target, whereas for ANZ Bank ((ANZ)), CommBank and Westpac ((WBC)) there is still a gap of 2.0%, 2.3% and 6.3% respectively waiting to be closed.

If my assumption is correct, and NAB is now the new leader, then NAB shares should rise beyond target while the others continue their attempt to close the gap ahead of the banking reporting season in November (ex-CBA). A second observation is, of course, this week's rally is rapidly closing whatever is left in gaps.

The local investment community has thrust itself upon the CBA versus the sector dilemma in recent weeks, including Clime Asset Management which joined in favour of CBA shares, calculating on FY18 forecasts the shares already were valued cheaper than ANZ and Westpac.

The most interesting aspect of Clime's analysis is the chart below, showing how CBA's sector premium has moved since the mid-1990s. The recent de-rating, argued Clime, had transported CBA shares back into the framework of 2001-2003.

New Website: Set Dedicated Email Alerts

As most paid subscribers are probably aware, it is possible to add email alerts to stocks included in Portfolios or Watchlists on the FNArena website. The process centres around individual stocks, but broader sectors are an option in extension of each chosen stock.

But some of our most popular publications -the Australian Broker Call Report, the Overnight Report and Rudi's Views- are not stock specific or even sector-based. Subscribers can set specific email alerts for these stories via the My Alerts section on the top horizontal black bar, squeezed in between "Write a Message" and "Portfolio & Watchlists".

Here one discovers there are currently six such specialised options, including Broker Call Highlight and All-Weather Stocks. The idea is that every time FNArena publishes a story related to such a specific theme, an email shall be sent to your inbox.

There is even the option to click on "Please send me news alerts for every article you publish".

Don't forget to press the Save Alerts button.

Rudi On BoardRoomRadio

Last week's audio interview:

https://boardroom.media/broadcast/?eid=59b75a3d0f7013455d23aa33
 

2016 – L'Année Extraordinaire

It was quite the exceptional year, 2016, and I did grab the opportunity to write down my observations and offer investors today the opportunity to look back, relive the moments and draw some hard conclusions about investing in the world today.

If you are a paid subscriber to FNArena, and you still haven't downloaded your copy, all you have to do is visit the website, look up "Special Reports" and download your very own copy of "Who's Afraid Of The Big Bad Bear. Chronicles of 2016, A Veritable Year Extraordinaire" (in PDF).

For all others who still haven't been convinced, eBook copies are for sale on Amazon and many other online channels. You'll have to visit a foreign Amazon website to also find the print book version.
 

All-Weather Model Portfolio

In partnership with Queensland based Vested Equities, FNArena manages an All-Weather Model Portfolio based upon my post-GFC research. The idea is to offer diversification away from banks and resources stocks which are so dominant in Australia, while also providing ongoing real time evidence into the validity of my research into All-Weather Performers.

This All-Weather Model Portfolio is available through Self-Managed Accounts (SMAs) on the Praemium platform. For more info: info@fnarena.com

Rudi On TV

This week my appearances on the Sky Business channel are scheduled as follows:

-Tuesday, 11.15am Skype-link to discuss broker calls
-Thursday, noon-2pm
-Thursday, 7-8pm interview on Switzer TV
-Friday, 11.15am Skype-link to discuss broker calls

Rudi On Tour

– I will be presenting in Adelaide on November 14th to members of Australian Investors Association and other investors, 7pm inside the Fullarton Community Centre, 411 Fullarton Rd, Fullarton. Title of presentation: Investing In A Slow Growing World – An Update

(This story was written on Monday 18th September, 2017. It was published on the day in the form of an email to paying subscribers at FNArena. This is part one. The second part will be published on the website as a separate story on Thursday).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via the direct messaging system on the website).

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BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS

Paid subscribers to FNArena (6 and 12 mnths) receive several bonus publications, at no extra cost, including:

– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow.
– Who's Afraid Of The Big Bad Bear? eBook and Book (print) available through Amazon and other channels. Your chance to relive 2016, and become a wiser investor along the way.

Subscriptions cost $380 for twelve months or $210 for six and can be purchased here (depending on your status, a subscription to FNArena might be tax deductible): https://www.fnarena.com/index2.cfm?type=dsp_signup

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