Building Investment Decline Poses Problems for the Australian Economy

Before getting stuck into today’s Markets and Money, I want to fill you in about something that’s been going on behind the scenes here at Port Phillip Publishing…

Next week, our company takes its first dive into full-fledged investigative journalism.

But, as you will see, we’re doing it our way.

As independent journalism collective Propublica.org writes:

Investigative journalism is at risk. Many news organizations have increasingly come to see it as a luxury. Today’s investigative reporters lack resources: Time and budget constraints are curbing the ability of journalists not specifically designated “investigative” to do this kind of reporting in addition to their regular beats. New models are, therefore, necessary to carry forward some of the great work of journalism in the public interest that is such an integral part of self-government, and thus an important bulwark of our democracy.

Is Port Phillip Publishing — with its complete independence from industry, government, shareholders and advertisers — part of this new model?

Next week, we’re about to find out!

In short, we will be releasing our very first 88-minute Special Investigation.

It’s years in the making.

And all I’m allowed to say at this stage is this: The investigation, helmed by our own Vern Gowdie, blows the lid on a 41-year-old Australian mystery.

Except that this whodunit has very real implications for your wealth and freedoms in 2017.

Stay tuned…

Back to the market action… Oil was the winner again in overnight US trade. Late in the trading session, West Texas Intermediate crude had jumped more than 3.5%, adding to yesterday’s 8% rise.

But it didn’t do that much for the market overall. The Dow Jones was up a bit, while the S&P 500 fell slightly. At the time of writing, futures point to a flat start for the Aussie market today.

But that’s not surprising, given yesterday’s strong showing on the ASX. Energy stocks propelled the index higher. They had their best day in years, and should receive good support again today.

If you’re interested in getting some unique energy exposure (and avoiding some of the debt-laden majors), check out my recent report that examines the coming East Coast energy squeeze in Australia, while identifying who the winners might be.

Despite the recent general bullishness, it’s not all rainbows and lollipops, though. As you can see in the chart of the ASX 200 below, the market has put in a strong rally since Trump won the election, but it’s still below the August high.


Source: BigCharts
[Click to enlarge]

And while everyone is getting excited about the prospects for a resurgent US economy, the Aussie market faces major headwinds going into 2017.

Investment data released yesterday for the three months to September was worse than expected. The Financial Review reports:

Economy-wide investment slumped at almost twice the pace that was forecast in the September quarter, with an unwelcome decline in non-resources spending pointing to a weak 2017.

Total spending by companies on new buildings and equipment slid 4 per cent from the previous quarter, to be down 13.7 per cent from a year earlier, the Australian Bureau of Statistics said on Thursday.

Most concerning, however, are signs that the nascent rebound in non-mining investment has run out of steam. Capital expenditure by services companies fell 1.9 per cent in the quarter.

Combined with recent data showing a sharp contraction in building approvals, the latest figures are not good news for the economy in 2017 as they imply the drivers of growth since the mining boom ended four years ago are themselves starting to flag.

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Investment isn’t a huge part of the Aussie economy. But it’s vitally important because investment creates jobs, which, in turn, leads to increased consumption, credit creation, tax receipts, etc.

Over the past few years, the economy has been working off falling investment spending in the resources sector. This has been a drag on growth, and a major reason why the RBA cut interest rates so vigorously from late 2011.

The aim was to ignite a housing construction boom to offset falling investment in the resources sector. That worked a treat, and now the major East Coast cities are facing an oversupply of apartments.

I don’t see it as being a big deal in Sydney or Melbourne, as population growth over the next few years will soak up any excess.

But the shorter-term issue for the economy is that building investment is beginning to fall.

Therefore, investment spending is likely to either detract or add very little to growth for the time being.

That puts the pressure on household spending to prop up economic growth. Which is going to be difficult if the RBA is done with its interest rate cuts.

Household consumption has underpinned economic growth in Australia over the past few years. Falling interest rates have pushed up house prices, and the wealth effect from this (or, more accurately, the debt effect) has led to an increase in spending.

Interest rates are now on hold, so there won’t be any additional monetary stimulus unless something goes pear-shaped in the economy. That means household spending will continue to slow (as rising debt levels continue to eat into purchasing power) at the same time as investment spending comes under pressure.

This concern will at least keep the RBA from raising rates anytime soon. But the lack of growth impetus will probably force the government’s hand in 2017; as a result, they’ll open their purse strings (even more) and announce some sort of Trump-lite infrastructure package.

The thing holding them back right now is the political risk of losing Australia’s AAA credit rating. That would almost certainly happen if they caved in on their commitment to contain government deficits.

It’s not a good look for an ‘economically responsible’ government to be the one to lose a ‘prized’ credit rating. But if you’re going to do it, you should do it at the start of an election term, rather than at the back end.

The problem with Australia’s government deficit is that it is ‘structural’. That is, our onerous middle class welfare system means that spending increases are baked into the cake. Without a decent pick-up in tax receipts, these spending increases will translate into rising deficits.

Unfortunately, this situation restrains the government from increasing spending on infrastructure, which, if done correctly, is actually productivity-enhancing and good for the economy in the long run.

If the economy does hit a rough patch next year, which looks likely, the government will step up and spend more. In today’s ‘money grows on trees’ world, politicians (and central bankers) think it is their duty to avoid recessions.

So expect more recession-fighting rhetoric next year. Only this time, the leading actor will be the government, and not the RBA.

Regards,

Greg Canavan,
For Markets and Money

Editor’s Note: Newman Show Hijacked! James Woodburn and Kris Sayce hijacked The Newman Show to discuss recent market news across Money Morning and Markets and Money.

Join Woody and Sayce for an informal discussion on…Trump infrastructure spending…where the money’s going…resource investment opportunities…how far the Aussie housing market has left to run…the war on cash… You can watch all that, and more, right here.

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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