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Driver of SA economy is collapsing

26-06-2015

Over the past few decades the tertiary (services) sector of the SA economy has been growing in relative importance – as has been the case in the developed world. Anomalously, this has happened in a country where inexpensive labour should have driven the secondary sector (manufacturing) – as in Asia. The anomaly can perhaps be explained by the fact that since the 1970s, our labour has gradually become too expensive relative to Asia, and on top of that entrepreneurs have seemingly lost their appetite for risk-taking in a country where investment horizons are becoming shorter and shorter on the back of rising macro risk.

However, in this article we show that the remaining driver of the SA economy – the services sector – is also stagnating, if not collapsing. This trend is of crucial importance for the offices sector of the property industry as it partially explains why office vacancies are still edging up, and are now uncomfortably above their long-term average (first graph).

In the reporting quarter, the combined national grades A and B vacancy rate stood at 10%, three percentage points above its 17-year average of 7%. Besides being above its long-term average, the vacancy rate is also moving uncomfortably close to its historic high of roughly 11%, last reached in 2003.

In the shorter term, output produced by the services sector is accelerating somewhat. In the first quarter of 2015, growth in output of this sector heated up to just below 4% (quarter-on-quarter, annualized), marking the third consecutive quarter of accelerating growth. But the underlying cyclical component of the real (2010 prices) seasonally-adjusted services-sector output is still heading south. The graph which follows shows the strong inverse relationship between this component and the national decentralized office vacancy rates.
 

A time series can contain all or some of the following components: Trend (T), Cyclical (C), Seasonal (S) and Irregular (I). Usually, it is assumed that they are multiplied or added, i.e. yt = T x C x S x I or yt = T + C + S + I.

“De-trending” is the statistical or mathematical procedure of removing the trend from the series in order to emphasize the other components of the time series. In our example, the already seasonally adjusted services-sector output time series was “de-trended”, thereby highlighting the cyclical (C) and irregular (I) components of the time series. Any pattern showing an up-and-down movement around a given trend is identified as a cyclical pattern.

Source: http://cmapskm.ihmc.us/rid=1052458821502_1749267941_6906/components.pdf

 

 

Our interpretation of the graph is as follows:

• Between the years 2000 and 2002, output produced by the services sector was in a cyclical upswing, while at the same time vacancy rates increased (first shaded area of graph). The explanation for this anomaly was overzealous office development activity between the late 1990s and early years of the following decade – activity that placed strong upward pressure on vacancy rates. The supply-side boom at the time could possibly be linked to the dot-com bubble that climaxed in March 2000 in the USA. In this regard, bear in mind that property supply lags demand by about two years.
• Over the period 2002 to 2015Q1, the cyclical pattern of services-sector output explains as much as 70% of the change in national decentralized office vacancy rates.
• Since 2010, output produced by the services sector has been below its long-term (22-year) trend (second shaded area of graph), a sign of the underperformance of this sector.
• In fact, at present the services sector is at its lowest cyclical trough since 1994. The implication – read together with the outlook for the economy in general – is that one should not expect job creation in this sector in the medium term.

This is bad news for the offices sector of the property market.