Bad analysis of capex survey means market misses the point

While not all of the commentary surround the capex release was poor, a bit portion of comments made showed that many analysts simply do not understand the dynamics of the survey.  In particular many have have committed a fatal error in deriving forecasts for FY14 when they should really know better.

It is usually the case that final spending is higher than first expected as shown on the graph on the left.  This upward bias usually occurs even in years of recession, although the degree can vary a lot.

To compensate for this, what is usually done is to scale up the first estimate by what is called a realisation ratio, which is basically the ratio of actual final expenditure relative to a given estimate.

The next chart shows the historical realisation ratios for the first estimate and the average over the last years.  What a lot of analysts have done is used an average for the last 5 years to derive their full year FY14 forecast.

As the chart shows, the last 5 years is huge skewed to the upside thanks to the unexpected (and welcome) resilience of the Australian economy following the financial crisis.  So if you have been using 5 year averages you have been wrong every year for a long time.

Furthermore, while we don't have full data for FY13, it is more than likely that the realisation ratio will be pretty close to 1 or perhaps even less.

Wouldn't it make much more sense to use this number than the 5 year average of conditions which bear no bearing to today?

Using this more sensible number means that rather than projecting further growth next year, we are looking at something like a 8%YoY decline in investment next year rather than an 11%YoY rise.

While this may seem like a silly debate around numbers, its actually hugely important to the bearing for growth in the Australian economy.  For investors it also represents a real opportunity given the complacency and misunderstanding of what these data actually mean.

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