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Thursday, 31 July 2014

2 million more vehicles on Aussie roads in 5 years

Motor Vehicle Census

The next fortnight brings with it an avalanche of economic data. Much quieter this week, so let's take a quick look at the Motor Vehicle Census to see what we can learn from it.

Firstly and most obviously there has been a huge increase in the number of vehicles on Australia's roads, up from 15.67m in 2009 to a staggering 17.63m in 2014.

The population of Australia is growing at 1.7 percent per annum but the number of vehicles is increasing at a much faster pace of more than 2.5 percent per annum, and the growth rate has accelerated.

The number of vehicles is up by a staggering 12.5 percent over only five years equating to nearly 2 million additional vehicles. 

In terms of vehicle types, there are many more motorcycles over the past half decade as our major capital cities become denser, but in fact there are just many more of, well, everything.

The lowest percentage increases in vehicles were in South Australia and Tasmania largely due to weak population growth in those states, but elsewhere the percentage growth rates were exceptionally strong ranging from 2.1 percent to 3.5 percent.

The percentage increases instead presented graphically:

Australians are becoming wealthier and with low interest rates have higher disposable incomes and this is translating to what can only be described as a splurge on vehicles. 

When we look at the number of motor vehicles registrations by population we can see that there has been a dramatic increase across every state, reinforcing the point.

The average age of vehicles has remained flat for the past five years at 10.0 years as new vehicle sales have remained robust.

When we consider the absolute numbers of vehicles on the register the figures make for eye-popping reading.

In particular, New South Wales has seen the number of vehicles increase from 4.56m to more than 5.1 million in only five years.

Meanwhile Victoria is not far behind running up from 4.0 million to nearly 4.5 million, and Queensland (3.3 million to 3.7 million) and Western Australia (1.8 million to 2.1 million) are also seeing similar trends.

The figures were comparatively small in other states.

Implications for investors?

This is all good for levels of economic activity in the four major capital cities, but what does it mean for investors?

Firstly and most obviously, don't spend more money on new cars, because in ten years you will have an average car which is worth a heck of a lot less than you paid for it!

In terms of the share markets, the last century has taught us that it does not make sense to invest blindly in car manufacturing companies simply because there are millions more cars on our roads.

Clearly, that would not have been a profitable move in many cases. In a similar vein, while one of the greatest trends unfolding over the past century has been a huge increase in global travel, investing in aviation companies has largely been an unprofitable exercise, some of the reasons for which I discussed here previously.

Ultimately, investors tend to see outstanding returns when they invest in companies which have a strong economic moat, generate strong and sustainable profit margins and that cannot easily be undercut by competitors based in locations with cheaper labour and materials costs.

Australia's car industry, as has been the case in other developed countries, has struggled badly to remain profitable or viable, and will now be allowed to die.

Just as investors in companies which service the resource giants have frequently seen greater returns that those owning shares in the mining companies themselves, investors might instead look towards investing in infrastructure and engineering companies. 

Property market impacts

As for property market impacts, we've always believed that the best property investments are those located in prime-location, landlocked suburbs in thriving capital cities with booming population growth, such as Sydney and London. 

Over the course of a property cycle, the demand outstripping available supply helps certain properties in these locations to outperform.

One of the things we have always looked for is easy access for train links to the Central Business District and employment hubs.

It's been an important lesson learned from mature capital cities such as London where car ownership is often seen to be a bind rather than a benefit, and homes located close to Tube stations and key transport hubs can at times fetch huge premiums while remaining more robust in economic downturns. 

The new Crossrail in London which is to be constructed over the next four years is forecast to increase property prices by 40 percent in certain suburbs which stand to benefit from the improved transport links.

The above data merely serves to reinforce that view in relation to Australia.

With more than half a million vehicles on New South Wales roads in only five years it is a cast iron certainty that Sydney traffic congestion will continue to worsen dramatically over the coming decades, and I for one know that I want to own as many inner suburb properties close to key train links as possible.  

Saturday, 26 July 2014

Large cities - the engines of Australia's economy

Capital city hubs the engines of our economy

There has been a long running debate in Australia about the seachange phenomenon, but to my knowledge there has been not one iota of compelling evidence that Australians are moving away from the capital cities en masse.

In fact, all of the available evidence has proved precisely the opposite to be true: we have an overwhelming and increasing focus on the inner suburbs of our major capital cities.

The Reserve Bank of Australia recently carried out its own demographic research into the subject and found that jobs growth, population growth and house price growth are all becoming ever more inner capital city centric.

I didn't form my views by accident, by the way. Rather I've watch similar trends play out over the last couple of decades in a mature capital city (London) where the focus on prime central locations continues to grow and the disparity between dwelling prices in inner and outer/regional locations grows by the year.

With another 1 million people expected to descend upon London over the next decade, properties located to key transport hubs on the new Crossrail transport links are anticipated by analysts to boom by another 40% over the next four years.

Still, it's always good to consider a range of independent sources, and in that context I'll take a look today at the Grattan Institute's recent report "Mapping Australia's Economy" to see what we can learn from it.

Finding 1 - Economic activity is focused on a few capital cities

First and foremost, Grattan found that a stunning 80% of Australia's goods and services are generated on just 0.2% of our land mass leading to the inescapable conclusion that "cities are the engines of our prosperity".

This is partly because of the concentration of jobs in our Central Business Districts, but also because jobs based withing the inner cities are more productive than those located elsewhere. 

The largest cities and not regional centres are the key to Australia's future because economic output is becoming more knowledge and services based than it was in decades gone by when agriculture and mining dominated the economic landscape, a conclusion also reached by the most credible of economists, Ross Gittins. 

Even in the mining states such as Western Australia, a third of employees in that industry live in the state's capital city of Perth, partly due to fly-in fly-out, and partly because the accountants, engineers, executive and administrators are based in the city locations.

The red areas on the map produce 80% of Australia's economic activity on just 0.2% of the land mass.

Grattan found that capital cities are vital to economic activity, driving most of the economy is every state .

Even for regional centres, Grattan found that it is their proximity to the CBD which largely drives their fortunes and respective rates of growth. According to Grattan's research, regional centres located less than 150km from the CBD are growing at a considerably faster pace than those located further away.

Finding 2- Economic activity is most intense in Central Business Districts (CBDs)

Even within metropolitan areas, economic activity is heavily focused on central areas, and in each capital city intense activity is focused on only a small number of locations.

In Sydney, for example, half of all economic activity is generated from less than one percent of its land mass, with a similar pattern evident in other large cities.

Finding 3 - Inner city hubs have greater economic productivity

Economic productivity is much higher in the CBDs, partly because these areas are the major employment centres. But according to Grattan it's more than that, because concentrations of economic activity offer other big economic benefits:

"Businesses are more productive when they interact with larger numbers of customers, suppliers, competitors and partners, and when they can do so more frequently and closely. Employers are more productive when they have a larger pool of employees to draw on. 

Employees with a larger choice of potential employers are more likely to develop and make the best use of their skills. They also typically have better chances to be re-employed quickly if they lose their job."

In a virtuous circle, businesses also benefit from having a wider range of employees to choose from to fill vacancies, while specialist roles are also easier for them to fill. Being near to and interacting easily with other businesses helps corporations to flourish.

Finding 4 - Access to jobs is poor in outer suburban locations

Unfortunately, Grattan found that access to jobs in outer suburban locations is poor and "too many workers live too far from jobs. Few people are willing to commute further for jobs than they have to".

In all major capital cities, concluded Grattan, there is a major advantage in proximity to the city's centre. Research showed that in outer locations a very small percentage of jobs can be reached with 45 mins by car travel.

When Grattan considered public transport, their conclusions were diabolical for outer suburbs. In Sydney, for example, huge swathes of the city are almost totally cut off from access to jobs even if commuters are prepared to travel for a full hour by public transport.


Grattan's conclusions were direct and to the point: further urban sprawl would be damaging for economic prosperity, job opportunity and productivity.

"The vast majority of economic activity takes place in Australia’s large cities. And within these cities, economic activity is heavily concentrated. Australia's cities are the backbone of our economy, with CBDs and inner city areas critically important to the nation’s prosperity. 

Their predominance reflects the economy’s evolution from one based on primary industry, then manufacturing, then increasingly knowledge-intensive services."

Grattan advises that governments need to rezone or make land available for more people to live close to the cities while also improving transport links for those located in middle ring suburbs.

Former Reserve Bank of Australia senior analyst Callam Pickering, who's views and analysis are always worth a read, similarly concluded:

"Australia will continue to shift towards a more services-based economy, which suggests that activity will become increasingly concentrated within our major cities. As that happens, I expect that higher-density living will grow more popular as Australians put a premium on living where the action is."

Indeed so. The above conclusions help to explain why house prices have continued to and will continue to rise faster in inner ring city locations than outer ring suburbs in every capital city. This has demonstrably occurred both over the long term and over the past 7 years too as the ratio of inner ring to outer ring prices continues to widen in its disparity.

Graph 11: House Price Gradient

Open Golf

Major season

Apologies for the low productivity in the blogging sector this week, I've been over in the Old Dart enjoying some sunny summer weather and have been totally engrossed by the British Open golf, which was hosted up at Liverpool.

Golf was an utter obsession for me as a teenager, the blistered hands testament to the fact that my mates and I would think nothing of playing 36 or even 54 holes in a day through the school hols.

At my best I was a single figure handicapper, which may sound impressive if you're a high handicapper, but in reality given the endless summers spent out on the course or on the practice range, I probably should have gotten lower.

Upon heading off off to Uni to study there was far less time to dedicate to the game and I was frustrated to see the junior pros from our club improve and overtake me - golf is a terribly unforgiving sport to those who do not practice. 

The moral of the story is that if you can't be the best at something, then you should just quit and give it up. 

Ha! No I'm jesting, of course. Here are 5 golfing analogies for investors I picked up from watching the British Open...

1 - Discipline

My teenage mates and I were always thrilled by watching John "Wild Thing" Daly play golf with his "grip it and rip it" mantra. 

An eccentric anti-establishment character, Daly drove coaches and administrators to distraction with his non-conformist behaviour, and against all the odds won two major championships including the British Open itself at the home of golf, St. Andrews.

As young lads, Daly appealed to our young male egos. He belted the golf ball a proverbial mile with his 'Killer Whale' driver and a bit like us he was rebellious, drank lots of beer and had a terrible haircut.

As a general rule, though, major-winning golfers are not like John Daly. 

Ian Woosnam reportedly enjoyed a pint, and some golfers periodically over-indulge in food or other 19th hole pleasures, but most pro golfers at the peak of their game are relatively fastidious in their discipline and detailed preparation

Routine, preparation, discipline.

Discipline is the first rule of successful investment. 

Take the stylised example of a person aged 25 who earns $50,000 per annum and receives annual pay increases of 3.5% through their working career. 

Thanks to compounding growth, even at only 3.5% annual pay increases their total cumulative gross earnings could be far, far higher than you might intuitively expect (click chart). 

It's not fashionable to say so, but wages growth has outpaced inflation for years in Australia across all income brackets, and on average folk have more disposable income than in years gone by. 

It takes a level of commitment and discipline, sure, but the fact of the matter is that most people with a full-time job should be able to save and invest something for the future.

You tend to make some enemies pointing this out, but there's nothing like living in a Third World country for a couple of years to change your perspective and realise just how blessed we are to live in a country of abundant wealth such as Australia. 

The first rule of investing is to establish the discipline to spend less money on junk that we don't need and set aside money to invest.

One of the scariest things about working in professional practice where there are many high income earners is seeing people work for decades yet setting aside nothing for the future (often in Britain, not even a pension contribution). 

2 - Sacrifice

In a similar vein, the greatest golfers through history have made huge sacrifices to reach the top echelons of the game.

Instead of idolising John Daly or the eccentric genius of Severiano Ballesteros, in hindsight as youngsters we should have been learning from the unstinting work ethic of the single-minded Sir Nick Faldo.

From a very young age Faldo was driven by a "quest for excellence", and dedicated countless thousands of hours to being the finest and most thoroughly prepared player that he could be. 

A golfer of incredible mental fortitude, Faldo took the unthinkable step for an Order of Merit winner of remodeling his swing under the watchful gaze of David Leadbetter in the mid-1980s. 

After enduring several frustrating years in the relative wilderness, the brave step paid dividends and Faldo went on to win no fewer than six major championships, becoming a true golfing great and fulfilling his quest for excellence.

Outstanding results in all spheres almost always require sacrifice and a willingness to go the extra mile.

3 - Patience

At the major championships, pro golfers aim to get themselves into contention by keeping the ball in play and making few costly errors, perhaps looking to pick up a few birdies on the par 5 holes.

As a rule, professionals don't go out on to the course aiming to shoot a 62, instead they focus on playing the percentages, approaching each shot in isolation and playing every situation on its merits.

Golfing legend and 8 time major winner Tom Watson aged 64 incredibly recently shot his age - a round of 64 - by applying precisely this disciplined approach.

If a player is on course to miss the cut towards the end of the second round they may take a few more calculated risks, but generally major championship golf is a percentages game and being too aggressive can backfire.

Golf psychologists therefore tend to use phrases like "control the controllables", "routine, routine, routine" and "beat them with patience". 

I recall the junior golfers at our club frequently annoyed senior members by knocking them out of Matchplay events where points are awarded for winning individual holes, yet were rarely so successful in the Medal tournaments where cumulative strokes are instead recorded.

Being a good investor is more akin to a Medal competition than a Matchplay event...but it often takes an early defeat or two to understand this.

The first time I went to a casino I won £690 and I thought it was brilliant (bad news). The next time we went I lost the lot which was a salutary lesson, and funnily enough I've gambled in casinos very rarely since! It also took me a hefty $50,000 loss on speculative mining shares to realise that there is no need to go down that path again.

Investing should be fundamentally simple for those of a patient temperament and an accumulator's mentality. Why speculate in low quality companies which have never made a profit or buy property in remote mining towns to chase a fast buck? 

Far better to aim to continue accumulating high quality assets such as shares in dividend-paying blue chip companies, index funds or well-located capital city properties, which will continue to deliver returns in perpetuity. 

4 - Leverage

I'm not sure about you but I can't move my hands particularly fast. Yet when a supreme athlete such as Tiger Woods hits a golf ball, it really stays hit and the clubhead speed generated can top an awesome 120mph. How so? The reason is due to leverage.

Using the longest club in the bag, the '1 wood' or driver, there are golfers out there who can hit the golf ball extraordinary distances...up to half a kilometre in some cases! As Archimedes said: "give me a lever long enough lever and I shall move the world". 

Whooshka! Of course, in tournament play, one will rarely see a golfer hit a ball in such a manner, due to the necessary lack of control. All golfers use leverage to their advantage, but it must be utilised with a level of restraint and control, and a bit of common sense. 

Leverage is the principle reason that average investors look to investment property - residential real estate is the one asset class which allows them to use the greatest leverage. 

I recall as a nipper my parents selling their house which they'd bought for £4,000 in Sheffield for more than double the amount they had paid for it. They upgraded and later bought a house for £30,000 which they'd negotiated down by £1,500.

Even as a youngster I was struck by three things. Firstly, the sheer size of the numbers involved as compared to my old man's reasonably modest pay cheque.

Secondly, how even for a family where funds were pretty tight - a family of five boys supported on my Dad's probation officer salary - it was possible to build thousands of pounds of equity over time as a property owner.

And thirdly, how each time my parents moved house, prices had moved higher - much higher - and that wasn't only because they were trading up.

That's the combined power of leverage and compound growth at work, which allows sensible homeowners to build up significant equity or net worth over time.

In my case, I intuitively looked to investment property when I was in my 20s because it allowed me to invest with millions of dollars that I could not otherwise have done.

It should go without saying, however, that leverage is a double-edged sword and should only be used sensibly and with a long-term outlook, since while gains can be magnified, so too can losses.

The anti-real estate contingent tend to oscillate interchangeably between two lines of argument: that property has not been a good investment (demonstrably false, if you have invested sensibly) and that property investment is unethical or socially useless.

The fact of the matter is, if you know what you're doing, property can be an outstanding investment as part of a balanced portfolio.

5 - Risk Management

If you were watching the British Open carefully, you'd have seen the brilliant Rory McIlroy decline to use his driver on the 72nd hole, instead opting to hit a more conservative long iron.

Why would a guy who had been melting it up to 400 yards off the tee across the hard links turf not use his biggest club? Risk management. 

McIlroy had already taken calculated risks earlier in the tournament and now was using less leverage and eliminating risk. It worked a treat and he took out the claret jug as the Open Championship winner.

Successful investing is very much like a 72 hole golf tournament in the the winners must use sound 'course management' to avoid making catastrophic mistakes and manage risk.

Moreover, it generally pays to be a bit more aggressive and invest in what are perceived as riskier growth or ownership when you are younger and have time on your side. 

Later in the game you may elect to deleverage or transition towards income assets, but the key is to get yourself into the happy position of having these choices.

Wednesday, 23 July 2014

Cranewatch - London development snapshot

I was expecting to see masses of development around London following on from the property price boom. Here's a quick 60 second snapshot of what I looked at today.

South Bank cranes

To the west of the Shakespeare's Globe and the Tate Modern, we see...cranes. 

There has been development aplenty around Borough and Southwark, while Lend Lease is undertaking a colossal regeneration of three sites comprising some 28 acres in Elephant & Castle. 

This development alone will provide 3000 new homes, over fifty new shops, restaurants, cafes and bars, and London's largest new park in over seventy years. Wow.

Ludgate Hill...more cranes

Below, looking across the once-wobbly Millennium Bridge to the City of London School and St Paul's Cathedral masks a swathe of new development around Cannon Street following on from the Paternoster Square triumph, including Minerva's massive Walbrook development.

The Walbrook development alone will add some 410,000 sq ft of commercial office space and 35,000 sq ft of retail and restaurant space. There's plenty more underway besides to the north of London Bridge.

Below, the phenomenally popular 87 storey Shard which was opened in 2013. It's London's tallest building and one of the tallest in Europe at well over 300 metres high. It looks unfinished at the top, but that's why they call it...ah, never mind.

Looking back at  the city over the infamous Traitors' Gate, where Anne Boleyn was taken by boat into the Tower of London to be executed by Henry VIII...and there are cranes practically everywhere all around the City's Square Mile (click image to enlarge).

Note above some of the other major developments of recent years. From the right, the Swiss Re building aka. 'The Gerkin', 122 Leadenhall aka. 'the Cheese Grater' and 20 Fenchurch Street aka. the 'Walkie Talkie'.

Londoners like to give tall buildings funny names, in case you didn't already notice.

Also note how the Walkie Talkie to the left of shot is currently in the process of having light-absorbing fins attached to its river-facing side. 

Last year, the building was reflecting heat of such incredible intensity that one poor chap had his Jaguar car melted. True story!

Moving across to the South Bank and the famous Oxo Tower (right of shot) is set to be upstaged by a monster redevelopment of the old South Bank Tower. 

In several stages over recent years permission has been granted to add another 11 levels to the existing 30 storeys. When completed and redeveloped the tower will stand at 128 metres and will be home to 173 apartments with retail space surrounding the base.

The British Airways London Eye. The massive new Southwark redevelopment visible to the north-east (bottom left of shot):

Looking over to the Square Mile from the south-west shows cranes everywhere (click to enlarge images).

This photo of Tower Bridge below is taken from the renowned 'white tower' in the Tower of London. 

Even from here, the oldest surviving building in London founded by William the Conqueror in 1066, we see yet more cranes.

To the east of the 'glass egg' or what Lord Mayor Livingstone christened 'the glass testicle' and Lord Mayor Boris Johnson calls 'the glass gonad' (officially, the Lord Mayor's building or City Hall - what did I say about silly names?), a stack of new development is underway, including One Tower Bridge.

Prices at One Tower Bridge ramp up rapidly from £3.36 million to £16 million for the penthouse collection - liabilities that debtors tortured on the rack in the 16th century could only have imagined...

One Tower Bridge (and the glass gonad) from out on the River Thames. 

Looking back at Traitors' Gate to the City and Square Mile.

When I used to do audit work at the Billingsgate Fish Markets 15 years ago, the are surrounding One Canada Square comprised modest housing in the Isle of Dogs and some fairly shoddy council flats in Poplar. 

The development of Canary Wharf since that time has been nothing short of staggering, and now a mass of further residential development is underway to complement the range of office space. 

Canary Wharf is now a major financial centre for London, being unique in its ability to transact with Asia and America thanks to the time zone, although Lehman Brothers have since departed tenancy.

Below, more cranes and new residential tower blocks being built across at South Quay to the south of Canary Wharf. Better known for being the bit on the credits sequence of Eastenders where the river bends around. 


I took this photo on the way into the wharf at Greenwich, which is one of the locations we at AllenWargent property buyers have bought property for our clients.

Along with Croydon, Greenwich is one of the areas we identified as 'overgrounder' hotspots, with rising Central London property prices causing young professionals to consider transport links that are not Tube lines.

Greenwich is located 5 miles from the City and is on the Docklands Light Railway as well as having other great transport choices.

Fanous for being home to the recently singed Cutty Sark and for giving the world its global standard measurement of time from the Royal Observatory (Greenwich Mean Time) Greenwich is a very attractive and fully regenerated location.

Greenwich is situated on the water and has great transport links to the City (Bank), Westfield Stratford to the east and central London (Charing Cross).

With an array of restaurants, pubs and shopping, what's not to like?

If you're interested in buying property in London, contact us at or email me at


With property prices having risen in London, a wide range of new developments are now underway, a small flavour of which I've captured with a few photos above. We expect to see something similar playing out in Sydney over the next 2-3 years. 


No prizes for guessing where I am this week...

Yeah, pretty obvious innit...I'm back in London.

I haven't been over to London for nine months, so I'll do my usual scoot around town to see what's happening in terms of new development as well as checking out a few of our favourite hotspots.

Stay tuned for that later.

To cut to the chase, I'm expecting to see development almost everywhere around town.

Global financial crisis

After the collapse of Lehman Brothers we saw a lot of silly articles about a potential Japan-style housing capitulation in London, which can only have been written by people with no idea about housing market economics or experience of buying property here.

The thing about Japan's seemingly endless years of deflation is that they have had such brutal and lasting effects that other developed countries will do virtually anything to avoid the same fate.

In Britain's case, this has meant more than five years of rock bottom interest rates (0.50%), quantitative easing in the form of a gilt-buying program (as well as some high quality private sector assets), and at various points in time over-shooting the 2% inflation target by a country mile on the upside (click chart):

But, importantly, no deflation.

Inflationary economies

In an inflationary economy, capital cities with strong population growth are over the longer term guaranteed to see rising dwelling prices.

If prices are flat or falling, construction falls away until vacancy rates decline, upwards pressure on the housing market returns and prices start rising again.

The cycles can take a while to play out, but they repeat time after time.

When new dwellings are built, they will always necessarily be built in today's dollars (or pounds) and with today's labour and construction costs.

In Britain post 2008, with credit growth dying away, we began to see desperate levels of construction the like of which we had not seen in eight decades, so low they were.

In regional Britain, where population growth is weak, and there is far less pressure on land prices, dwelling prices are only just now thinking about recovering from a serious battering post-GFC.

Yet in London, the property market continues to heat up.

Incredibly, dwelling prices rose by another 25 percent over the past 12 months.

With such a strong market construction must follow, and sure enough UK construction PMI printed at a romping 62.6 in June, up yet further from an already incredibly strong 60.0 in May (above 50 denotes expansion).

I therefore expect to see cranes everywhere I look as I trek around town.

Parrallels in Oz

I have always tried to learn whatever I can from the London market over the years.

As a mature market, it gives us an interesting sneak preview of what to expect in Sydney and Melbourne a decade or two from now.

Note, however, that the dynamics in Australia's regional towns and cities are markedly different. 

Weaker jobs and population growth, combined with more land available for release can see prices falling over a prolonged period of time.

Indeed, in cities where the population is falling (cf. Japan, Detroit) property prices in less desirable locations can fall to zero.

With Sydney and Melbourne recording strong dwelling price growth over the past two years, we have long expected housing construction to break all-time records in Australia over the coming year or two, as noted on this blog.

The supply of apartments in particular has not been restricted by planning regulations as is often suggested elsewhere.

Moreover, dwelling supply has previously been soft because prices were not rising strongly enough - but now prices are on the up we will see record levels of residential construction in Australia, as was the Reserve Bank's target all along.

In 2014/15, housing starts should break through 190,000, easily eclipsing the highest level on record set during Australia's 1994 property boom.

And that's exactly what the Aussie economy urgently needs given the corresponding decline expected in mining construction (click chart).

Saturday, 19 July 2014

Construction multiplier

Construction increasing steadily

In recent weeks, data from the Australian Bureau of Statistics (ABS) has revealed that the number of loans taken out for the purposes of construction has increased to the highest level in around 4 and a half years.

If we smooth the numbers out on a rolling annual basis, we can see that while an upturn is entrenched, the uptrend still remains relatively shallow at this stage, and there is much more lifting to be done here (click chart):

With dwelling prices having risen over time the total value of construction loans on a rolling annual basis is getting set to break new record highs (click chart):

Importance of this?

It's worth noting here why this is considered to be important.

Dwelling construction been extensively researched by the ABS in years gone by, and the data uncovered showed the construction industry to have a very strong multiplier effect on the economy.

One of the more depressing things about visiting Britain over the past 6 or 7 years - apart from the ongoing under-performance of the national sporting teams, that is - has been the near total lack of cranes on the horizon. 

That's rarely a sign of a thriving economy.

Things have been picking up strongly for UK construction of late, but it's been a moribund period indeed for the construction industry.

Here's the ABS on the effect of construction on the multipliers on the wider economy in terms of output and employment in Australia:

"For every $1m spent on construction output (houses, non-residential buildings, etc.) in 1996-97, a possible $2.9m in output would be generated in the economy as a whole, giving rise to 9 jobs in the construction industry (the initial employment effect), and 37 jobs in the economy as a whole from all effects.

These flow-on effects are made up as follows. The initial effect of the additional construction is $1m. The first round effect for this additional construction would be the increased value of activity of around $0.5m in those businesses manufacturing the materials needed for the additional construction, such as concrete and steel frames.

The businesses supplying and servicing the concrete and steel frame businesses, such as aggregate quarrying and raw steel production, experience an increased demand for their products and services. This industrial support effect is estimated to be an additional $0.4m.

As activity has increased in the construction industry, as well as in the suppliers to that industry and the suppliers to the suppliers, there is an increase in wages and salaries to employees in this chain. The spending of these wages and salaries induces a further round of consumption effects in other areas of the economy totaling an additional $1m".

Multiplier of 3 for construction

So, there you have it: construction in Australia has a multiplier effect of close to 3. 
That is, for every $1m invested, an additional $3m is generated in the economy as a whole.

Now let's put this in its wider context.

Below is what has happened in Aussie construction over the long run. Note the gargantuan boom in engineering construction driven by the resources building boom.

This sector is set to tail off quite nastily over the coming few years, although it's not yet entirely clear how quickly that will happen. Note how construction has become overwhelming dominated by mining and resources (click chart):

In terms of other building work done, the split between residential and non-residential building has tracked as follows (click chart):

We don't need to get bogged down too much in the headline numbers here, other than to note that if mining capital expenditure falls by 20 percent in the 2015 financial year (which forecasts suggest may well eventuate), and does something similar again in the following financial year too, this leaves a monster hole in the Australian economy to somehow be filled.

Only one shining light exists in the state economies at the moment for infrastructure and dwelling construction, that being New South Wales, which is busily tackling its infrastructure and dwelling deficit (click chart):

States which need to rebalance?

The implication of the mining and resources construction boom detailed above above is that the Aussie economy has gotten itself quite dramatically out of balance.

In the March 2014 quarter the total value of engineering construction seasonally adjusted at around $31,850m was way, way bigger than the total value of building at closer to $21,750m.

This means that some states are going to face very significant challenges when the mining construction drops away.

The quarterly engineering construction figures by state clarify which which states - Queensland and Western Australia in particular - are going to face an uphill struggle in the coming years.

Those two states have benefited greatly from the boom, so they face more of a challenge from the forthcoming downturn (click chart):

This is especially so because when you look at the uplift in building work done in this cycle only New South Wales to date has shown any real sign of thriving.

These figures are not seasonally adjusted so the next seasonal uplift will be key, but it's clear that Western Australia has hit a plateau, Victoria's house building boom was last decade's news and something is not working as it should be in Queensland in terms of building work.

South Australia and the minnow states are floundering, and in any case they aren't going to add much value in chain volume measures terms (click chart):

This something to be wary of when commentators start talking up the Brisbane property market with the usual hyperbole this year, stating that it is "due for a boom".

Look, maybe, yes, and the general consensus is that Brisbane offers relatively good bang for the buck and the outlook for the property markets over the the next few years appears bright.

But equally it always pays to be careful of the shallow property market commentary which takes little (or more typically zero) account of what is actually happening in relation to these huge structural shifts in the Aussie economy.

Yes, there is an argument for dwelling prices to rise strongly in response to low interest rates, but as a general rule people don't buy property when they don't have jobs, and there is a major rebalancing challenge lying right ahead in the Aussie economy, especially in the mining states.

You'd need rocks in your head to call a sustainable property boom while taking no account whatsoever of what the wider economy and labour markets are up to.

It's one to watch carefully.

Rates to fall lower still

The charts detailed above show quite clearly that the hole left by mining construction can't readily be filled only by building more houses and a moderate level of infrastructure.

Net exports need to increase, which they indeed have been doing, albeit in the face of lower commodity prices. Household consumption needs to increase, which it was doing quite nicely, but then appears to have stalled again post-budget.

With the economy looking likely to tread water in Q2 (the unpredictable effect of inventories left aside), futures markets are quickly getting around to realising that the next move in interest rates must be down.

To me another rate cut is looking more and more likely by the week. Pencil in a likely interest rate cut before Xmas, for my money.

Thursday, 17 July 2014

China GDP audit for sceptics

Are things what they appear?

I noted here the other day that China had recorded annual GDP growth of 7.5%. Of course, so it would, because that was the target.

China's economic data always hits the government target, or occasionally it churns out a slight beat just to mix things up and retain a slender sheen of believability.

If there's one thing I can remember from my accounting days it's that data recorded 16 days after a period end can be very rubbery, sometimes referred to as a 'soft close'.

And when it relates to the recording of transactions in an economy with a GDP of more than US$8 trillion, I think it would be being kind to say that the China results released to the market are as much an art as they are a science.

It's worth nothing here that for a country which is supposed to rebalancing away from dwelling construction and fixed asset investment and towards a consumption-driven economy, the data was somewhat contradictory.

Both urban fixed asset investment (+17.3% y/y) and industrial production (+9.2% y/y in June, after rising only +8.8% y/y in March) beat expectations, yet the rate of retail sales growth has been declining and missed, although +12.4% y/y growth is still obviously a big number.

Importantly, China's property markets are now slowing in many of its cities and this is a key area of scrutiny for China bears.

I'd classify myself as a China sceptic rather than bearish - aside from one visit to Macau I've barely seen  any of China and hardly know enough about to form an opinion worthy of the name...not that ever stops some people! Clearly there are genuine risks around the use or misuse of credit.

China GDP for sceptics

When I was training as CA - since today I'm an FCA, so alarmingly this must have been a dozen years ago now - we were taught that auditors should use professional scepticism and consider whether figures pass a "smell test".

In some of Australia's banks, for example, middle managers have on occasion been seen to be living a lifestyle beyond what appeared commensurate with their salary. 

This can be a key indicator of fraud, and in some cases, thus it proved.

Auditors are often tasked with considering alternative ways to substantiate revenues or account balances rather than merely blindly ticking invoices or underlying documentation.

During an audit of a manufacturing firm, for example, auditors might choose to take a spot count of the number of trucks departing through the factory gates each day and extrapolate those counts in order to make an assessment of the completeness of revenue recorded.

During my accountancy traineeship a team of us used to audit the largest chain of strip clubs in the UK (insert obligatory 'assets' quip here), with me in the audit junior role.

Such a cash business tends to come with an inherent risks of incompleteness of revenue and receipts due to misappropriation, so an audit firm should consider how it can gain comfort that revenues are materially complete through designing tests for completeness and understatement. 

One way to do that is to test the rigour of and form an opinion on the internal controls in place. Another might be to check the cut-off of funds recorded to the bank.


How about checking a company's receivable balance or what we used to call 'debtors'?

Rather than checking back to invoices and reconciling the sub-ledgers, an audit firm might choose to write letters to third party debtors asking them to confirm outstanding balances independently, known in the auditing practice as a debtors' circularisation.

The point here is that auditing is sometimes about thinking of other mechanisms to substantiate figures for completeness, accuracy or material misstatement rather than blindly ticking off documentation, and assessing whether accounts "feel right".

When auditors stop applyinh professional scepticism and accept accounts data at face value, the audit process breaks down and its value is immediately diminished.

Back to China...

We can't readily perform circularisations for a country, granted.

However, one thing that we can do is to compare bilateral trade data, such as, for example, checking off China's reported exports figures with Hong Kong's imports data to ensure that the two figures can be reconciled.

This particular "smell test" has repeatedly shown there to be quite a mismatch indicating that China has been indulging in the underhand practice of fake invoicing in order to meet trade and growth targets.

Of course trade data should reflect parity - in this instance an export recorded in China's current account should be matched by an equal and equivalent import entry in Hong Kong's current account.

Yet by Q1 2013 the ratio of China exports to Hong Kong imports had become ridiculously skewed, always in favour of overstating China's exports, with the high point an almost comically high ratio of 2.36 to 1.

The ratio has narrowed significantly of late, implying that China's attempts to crack down on fake invoicing have worked to some extent, but history suggests that scepticism should certainly be applied to China's data.

We know that fake invoicing has taken place in the past in China in order to meet targets with magical consistency, and it strikes me from the trade data reported to be a fair bet that it still is happening, albeit to a significantly lesser extent.

In this case a sceptic would be far more concerned with testing for existence, accuracy, cut-off and overstatement of results than for completeness and understatement.

Other proxies for China GDP?

So, back to China's reported growth rate of 7.5%.

You may not believe it is correct, but how can that ever be substantiated?

Obviously we can't go back and re-test every transaction which makes up China's economic growth, even if we wanted to.

One worthy idea is to look at the rate of electricity output growth as a proxy for China's economic growth.

In the event, China's electricity output has declined from nearly 8% per annum back in early 2012, to only 5.70% y/y as at June 2014.

That suggests that the headline economic growth of 7.5% may indeed be well overstated.

Perhaps the economy is only growing at closer to 6% and is slowing further? Maybe.

Another key indicator one might choose to look at is that of reported truck sales, which declined by nearly 25% in the last quarter to be tracking at a recent trough and levels only recently seen during the financial crisis in 2008/9, and very briefly during the US debt-ceiling crisis of 2013.

Add that to property market data showing slowing and there may be more stimulus in the pipeline for China.