Is the Glass Really Half Empty?

Tuesday, April 19th, 2016
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The pervasive catch-cry regarding economic conditions seems to involve the word ‘weaknesses’ in the first quarter of 2016.

It is true that the outlook for the global economy has deteriorated, although the (partial) recovery in the iron ore price suggests there are areas of hope.

On the domestic front, we have occasionally questioned whether the persistently negative commentary about Australia’s economic growth prospects was justified. That question appears easier to justify in early 2016, as Australia’s economy is in better shape than many give it credit for.

For the last few years, we have all been lamenting the fact that economic growth had been stuck below trend as non-mining business investment remained lethargic, while the inevitable end of the mining boom loomed ever closer. Indeed, growth in the year to June 2015 slowed to around two per cent, which was hardly worthy of celebration. However, the back end of 2015 saw some significant improvements, and these have carried on into 2016.

A positive change in labour market conditions has been one of the most significant developments, notably because it occurred against widely held expectations that the labour market would deteriorate as 2015 progressed. It didn’t; in fact conditions actually improved.

The second half of 2015 saw strong growth in the number of people employed and a fall in the unemployment rate. While the official labour market statistics have been interpreted with caution after some hiccups over the last few years, the more positive labour market conditions are also evident in figures tracking job vacancies and job advertisements.

And while households are not seeing real growth in incomes, subdued wage pressures is probably one of the factors that enabled employers to create the additional jobs. The perception of improved job security is likely to have had a positive influence on consumer sentiment.

More positive sentiment was evident in the December 2015 quarter Gross Domestic Product (GDP) result, where growth in household consumption provided one of the strongest contributions to overall growth. Along with a positive contribution from residential building, the strong contribution from the household sector boosted Australia’s annual rate of economic growth to three per cent during the December 2015 quarter.

Unfortunately, a decline in total private sector capital investment provided a significant offsetting headwind, with the ongoing contraction in new mining construction work being the epicentre of the weakness here. The total volume of engineering construction investment fell by 12.3 per cent in the December 2015 quarter to be down by 26.8 per cent over the year.

Furthermore, the survey of capital expenditure intentions for the years ahead suggests the fall in new mining investment still has a way to go, and that we shouldn’t expect any material uplift in capital expenditure by other sectors. However, we should be mindful of the fact that there are often large discrepancies between the early surveys of investment intentions and what actually occurs.

While further falls in mining construction will continue for some time yet, that doesn’t mean there is a universally negative outlook for the engineering construction sector. Actual and planned infrastructure investment remains the key to watch – that is where the opportunities will (slowly) emerge.

The fall in mining investment also overshadowed some other noteworthy improvements in private sector investment. The latest figures showed improvements in new non-residential building investment, which increased by 3.8 per cent in the December 2015 quarter to reach a record high, and new machinery and equipment investment which increased by 1.8 per cent in the quarter. That’s good news for commercial construction.

With residential building ticking along at high levels, household consumption improving, investment in non-residential building and machinery and equipment rising, there is mounting evidence that the economy is weaning itself off the dependence on mining investment. If that is indeed the case, then now is the time to be looking out for opportunities and for focusing on the areas of commercial construction that are showing promise.

From a geographic perspective, there is a strengthening outlook for non-residential construction activity in New South Wales, Victoria and Tasmania. On a sectoral basis, there is a strengthening outlook for factories; agricultural and aquacultural buildings; entertainment and recreation buildings; short term accommodation buildings; and roads, highways and subdivisions.

It is still early days in the adjustment process, so we shouldn’t assume that it will be all smooth sailing just yet. If we can get a federal election out of the way at the start of 2016/17, then next financial year may well have more promise and opportunity for commercial and engineering construction than is widely considered to be the case right now.

Co-authored by Harley Dale and By Geordan Murray
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