Building cycle navigating a slow turn

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By Cees Bruggemans, Chief Economist FNB

It can be very unsettling when hitting an air sack, and only natural to assume things won’t quickly return to normal as trouble has a way of coming in multiples.

The South African building industry certainly has reason to be suspicious of any early suggestions of recovery, given the exuberant times that lasted for several years after which the plunging descent into deep recession last year was one of the most abrupt in decades.

Yet the deeper it falls, the more likely a bottom is reached, provided shock absorbers are fully extended.

The peaking of interest rates late last year, since then shedding 500 points, certainly provided important support for the building sector.

This evidence is also starting to shine through in opinion surveys. The FNB/BER building confidence index for 3Q2009 released last week offered a series of data points all suggesting a cyclical turn underway in the building industry.

The index covers the entire building pipeline, including architects, quantity surveyors, residential and non-residential contractors, and retailers and manufacturers of building materials.

This index reached a low point of 30 in 2Q2009 (meaning only 30% of respondents expressed themselves confident), perking up to 32 in 3Q2009.

Yet these readings don’t come close to being all-time lows, with the index for instance reaching 10 in 1999.

The reason has to do with the various components of the building pipeline. There are in fact three sub-groupings that warrant closer attention.

The first sub-grouping showing distinct evidence of recovery is retailers and manufacturers of building materials. One suspects this reflects the working of the inventory cycle.

Early in the decline phase, retailers get caught as sales start to fall away and their inventories start to rise. At some point they take corrective action, reducing orders to manufacturers while trying to reduce inventory in a falling sales market. The trough is reached when sales start to stabilize, with inventories deeply depleted and retailers deciding to start re-ordering, in the process improving order levels at manufacturers. It is at this point that their confidence levels also start to rise from depressed levels.

Manufacturers of building materials reached their cyclical low in 1Q2009 with a reading of 1, subsequently improving to 29 by 3Q2009.

Retailers of building materials reached a cyclical low in 2Q2009 with a reading of 19, improving to 32 in 3Q2009.

The proof, though, is in the easting of the pudding. Building contractors have to experiencing a stabilization of falling activity levels for a cyclical turn to become believable.

On this score residential building contractors had reached a confidence level of 17 during 2Q2009, close to the cyclical lows of 1999 and 1993 and thereby providing a believable benchmark of a possible lowest reading.

The 3Q2009 reading for residential contractors was 19, slightly up on 2Q2009 and quite possibly confirming the slow tracing out of a recovery.

Such optimism is warranted, given the lead from the interest rate cycle, but also the evidence of improving property market conditions. This is evidenced by improving real estate agent sentiment according to the FNB Property Barometer, but also banks reporting more transaction traffic, and nominal property prices starting to show evidence of no longer falling (indeed lifting), all such evidence accumulating from mid-2009.

Given the low level to which residential building activity has fallen by now, and the lack of confidence among contractors, together with the collaborating evidence elsewhere as mentioned, it does suggest that the next stage is not even lower activity levels but indeed the start of an recovery in activity.

If building material providers, interest rates and property market conditions are leading indicators, and residential contractors are a coinciding indicator, then non-residential building contractors perform the role of lagging indicator for the industry.

The reason is simple. While a house may get build in six to twelve months from plan stage to completion, a major building may take two to three years (or more).

Residential contractors therefore register changing conditions much earlier than non-residential contractors, architects and quantity surveyors who take longer to complete their ongoing building work before being confronted by new demand falloff.

Non-residential contractor confidence fell to 33 in 3Q2009, still an elevated reading compared to single-digit lows at past cyclical turning points.

The expectation is that non-residential contractors may still register some further decline in confidence in coming months before turning up sometime next year, though we should distinguish between various market segments. Retail and industrial space may still fall off more, but office space may be more resilient.

Thus the overall FNB building confidence index in 4Q2009 could be boosted further by retailers and manufacturers of building materials and residential contractors, while architects, quantity surveyors and non-residential contractors may still keep things back a bit, limiting the overall advance, as per 3Q2009.

Only later in 2010 and into 2011 should all components of the FNB index be rising again, boosting overall building confidence higher. But this doesn’t deny that an industry turning point was probably reached by mid-2009 when going by overall confidence readings.

Source: Cees Bruggemans, FNB, October 19, 2009.

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