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CEO AllenWargent Property Buyers, & WargentAdvisory (institutional). 6 x finance author.

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Thursday, 26 February 2015

Capex was crapex -- interest rates deemed likely to fall

Capex comes in soft

The ABS released its Private New Capital Expenditure and Expected Expenditure figures for Q4 2014 this morning.

It takes a little time to digest this release fully as it has a few moving parts, but having had time to do so, one is drawn to the conclusion that data remains soft and interest rates are deemed likely to head down to 2 percent or lower.

Let's take a look, in particular with a property markets angle.

Part 1 - Total new capital expenditure

Actual total new capital expenditure in seasonally adjusted volume terms fell by 2.2 percent in the fourth quarter to be 3.9 percent lower over the past year.

The "expected" figures showed that Estimate 5 for the 2014/15 financial year below of $152.6 billion was 8.6 percent lower than last year's equivalent estimate, driven largely by expected mining capital expenditure plummeting by 19.6 percent.

Diagram: Financial year actual and expected expenditure - Total Capital Expenditure

The "Estimate 1" figure for 2015/16 total capital expenditure of $109.8 billion could be enough to send a shiver down your spine, but in truth represents "only" a 12.4 percent decline on the prior year equivalent figure.

The first estimate for each financial year is always low and often unreliable, as the shaded bars in the chart above shows.

As a stalwart contributor to dozens of ABS capex surveys over the years I can attest to the woolly nature of some such estimates!

Nevertheless, the outlook appears broadly to be that new capital investment may fall from ~$150 billion to perhaps ~$130 billion in 2015/16 in itself could be enough to raise a clamour for further rate cuts.

Part 2 - By industry

Low interest rates are having some effect on other industries - and non-mining investment has increased over the past year representing a rebalancing of sorts - but mining investment is now set to enter near freefall.

Concerningly, if not surprisingly, manufacturing in Australia also appears be on its its knees.

Property market tip #1 - be sceptical or wary of advisors recommending investing in manufacturing regions, for at the very least the manufacturing share of Australian employment is in a pain-inducing decline.

And that is the best case. In a number of regions manufacturing industries have died which is likely to result in an explosion in unemployment. 

The above chart, presented here in current prices terms, is key to this release.

Although the capex survey is representative rather than definitive, it shows that the rate of improvement in "other industries" at least on its own does not stand Buckley's chance of plugging the gap left by the mining investment decline which is one of the reasons why futures markets believe that the cash rate must fall again.

Part 3 - State versus state

Australians are of course well familiar with the concept of the "two speed economy".

For years we understood that the amazing fortunes our economy were being held aloft by a mining construction boom, the great bulk of investment taking place in Western Australia and Queensland.

Well, we still have a two-speed economy, but today it is working in reverse as mining investment collapses.

What can we learn from this data at the state level?

Firstly, low interest rates are doing wonders for Sydney's economy - if not booming, it is certainly thriving and is presently the king of Australia's city economies. 

Despite mining construction flailing as the prices of coal and other commodities have dived, other industry investment in New South Wales has stepped up and capital expenditure is improving.

Secondly, mining construction is Queensland is driving a capex bust in the Sunshine State which I'll look at in a little more detail in Part 4 below.

Part 4 - Queensland case study

Queensland's capital investment has gone into reverse gear, but it is instructive to drill down in order to understand the drivers of this.

I have covered on this blog on multiple occasions why employment in a number of coal mining regions was inevitably set on a path to be clobbered.

The collapse in coal prices led to an element of Australia's coal production becoming unviable with a significant number of our producers sitting too far up the cost curve.

This is one of the drivers for Queensland's economy, with the weakness of a number of other commodity prices adding to this malaise.

The key point to take away here is that low interest rates are steadily assisting most other industries in Queensland as the green line below shows, but mining regions are headed for an economic downturn as employment evaporates.

In fact, this is already happening, it being more than evident on the ground in Brisbane that "blood on the streets" in some mining towns and regions ans associated changes of circumstances have forced many to relocate back to the capital.

Property market tip #2 - as I have been warning on this blog for a long, long time, a number of Queensland's coal mining towns are likely to experience rising vacancy rates, falling rents and a crash in prices.

Don't be tempted to speculate in housing markets based upon the expectation of new coal projects passing feasibility - including Adani's proposed investment in the Galilee Basin - unless you have a very high tolerance for risk. 

And even then think twice, or three times - and still don't do it.

The proposed Adani project essentially isn't viable without a significant recovery in commodity prices so it is a huge leap of faith to expect everything to sail through to production smoothly.

On the flip side, although it is too early for it to show up in the data, turnover in Brisbane's inner ring property market has clearly been heating up, with quality stock in the inner suburbs now selling quickly.

Moreover there is a good deal of evidence locally of buyers agents at work and a gentle stampede of interstate investors being drawn in by the Pied Piper of record low borrowing rates.

Summarily, Queensland has a two speed property market in addition to its two speed economy.

Part 5 - Sundry thought

A final point is to note for today is that while the macro picture tells one story, at the industry level there are plenty of other interesting sub-trends.

Even in current prices terms, for example, capital investment in tobacco and beverage manufacture has capitulated, perhaps a win here for the advocates of the Tobacco Plain Packaging Act 2011 which came into effect in 2012.

The Wrap

Overall, a relatively weak set of numbers which tilt the balance back in favour of an interest rate cut, with markets pricing a March cut by the close as a 56 percent likelihood.

As the iron ore price resumes its decline after the Chinese New Year break, those odds appear likely to sneak higher.

Two more rate cuts are fully priced in by Q4 2015 and implied yields on cash rate futures on December contracts running as low as 1.715 percent.

As resources export volumes ramp up the new two speed economy appears likely to be driven forward by capital city financials and services based industries, and record low interest rates will create a number of opportunities for investors, with share markets looking set to surge past 6,000 despite a likely weakness in the resources component.

Meanwhile, record low borrowing rates are already set to send some property markets into orbit - but there will be also be some serious fallout in many regional areas.

In fact, this is already playing out as the regional employment data is beginning to reveal.


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