Skyscaper Index- Warnings Are Flashing For Market Decline

I have mentioned this before but Doug French and the Mises Institute just penned a piece highlighting that the Skyscraper Index is sending a warning signal.

Put on your helmets, a crash is dead ahead. Developers are racing to build the world’s tallest building. China’s economy may be slowing down but 60 of the 100 tallest buildings under construction in the world are located there. 
 

The Broad Group is building the world’s tallest building in Changsha, the capital of the Hunan province. The company just started digging the foundations in late July for the 202-story “Sky City.” Normally one would guess the topping out of Sky City, at a height of 2,740 feet, would be years away. But this building is to be completed in only four months, using factory-built modules.

Broad Group chairman, Zhang Yue, has slowed the project a bit, for safety concerns, but he vows to finish in June or July next year. “No matter how high the obstacles, I will for certain overcome them to make sure this project is completed,” Mr. Zhang told The New York Times.

What skyscrapers have to do with market crashes was spelled out in professor Mark Thornton’s article “Skyscrapers and Business Cycles” published in the spring 2005 edition of The Quarterly Journal of Austrian Economics.

Thornton used economist Andrew Lawrence’s skyscraper index in combination with Austrian Business Cycle Theory to discover the skyscraper index is a good predictor of economic crisis and “that both the cause of skyscrapers reaching new heights and severe business cycles are related to instability in debt financing…”

The first skyscraper cycle began in 1904 in New York when the 47-story Singer Building and 50-story Metropolitan Life buildings began construction. This building boom was quickly followed by the Panic of 1907.

In the late 1920′s Wall Street boomed. Three record-setting towers — 40 Wall Street, Chrysler Building, and the Empire State Building — broke ground, only to be completed after the stock market crash of 1929 and the onset of the Great Depression. The Empire State Building was completed in 1931. Initially nicknamed the “Empty State Building,” it took about two decades to fill with tenants

The third cycle began with the commencement of construction of the Sears Tower in Chicago in 1970 and the World Trade Center in New York, which broke ground in 1966. By the time these projects were completed the US economy was mired in stagflation.

The 88-story Petronas Tower in Kuala Lumpur, featuring twin “cosmic pillars” spiraling endlessly towards the heavens was completed in 1997, the same year as the Asian Financial Crisis.

Thornton explains these four cycles share common characteristics: A period of cheap, easy money, leading to stock market booms and increases in capital expenditures. The new capital leads to technological advances and employment growth. During the booms, the next tallest building is planned and construction begins. However, prior to completion, negative information leads to market panics and the value of capital goods falls.

Since Thornton’s article appeared, his thesis was proven right again. The 2,722-foot Burj Khalifa in Dubai, UAE broke ground as the boom ramped up, but wasn’t completed until late 2009, the depths of the worldwide financial crisis. The world’s tallest building officially opened on January 4th, 2010. Later that same year UAE property developer Al Murjan Real Estate filed for bankruptcy sending shockwaves through the emirate.

The meltdown prompted the UAE to change its bankruptcy laws. Reuters reported, “Dubai’s debt crisis in 2009-2010 shone a spotlight on company restructurings but existing federal bankruptcy laws – seen as opaque and complex – remain untested in UAE courts as distressed firms prefer to settle creditor claims privately.”

Since the crash, the Federal Reserve has fed a continuous stream of cheap money into the financial system which has permeated markets worldwide. U.S. stock markets are setting all-time highs. The Financial Times Index (FTSE) is approaching the highs it reached at the end of 1999. The Hang Seng Index (HSI) has rebounded 70 percent from its February 2009 lows.

Its not just stocks that are soaring, skyscrapers are thrusting skyward all over the planet. Five large Chinese cities, Beijing, Shanghai, Shenzhen, Guangzhou and Chongqing, have buildings underway to be taller than the 108-floor Willis Tower (formerly Sears Tower) in Chicago that was the tallest building until 1998. 

In the U.S., banks, are finally loosening up and lending on large towers again. Veteran developer Francis Greenburger, after years of trying, completed $400 million in financing to construct a 63-story residential project overlooking the Hudson River.

“Other developers also have been taking advantage of the looser debt spigot, which had closed after the downturn,” writes Melvin Beckman for the Wall Street Journal. The total dollars outstanding in construction loans at the nation’s banks increased in the second quarter for the first time since the crisis.

Wall Street’s Masters of the Universe are flush with bonus money and are in the market for expensive housing. A flood of new condo developments are underway in New York’s TriBeCa area to meet the demand. Sales are brisk with some penthouse units selling for as much as

$2,700 per square foot. However, building prices are rising in bubble-like fashion. In 2010, TriBeCa neighborhood buildings were going for $300 a buildable square foot. “Now, if you are buying buildings to convert,” developer Eldad Blaustein tells the NYT, “they are costing $500 to $550 a square foot.” He’d love to buy more buildings “but the competition is fierce.”

 

As cheap money continues to slosh around looking for a home, the next-next tallest building is already under construction. The Kingdom Tower in Jeddah, Saudi Arabia broke ground this spring and is slated to be 3,281 feet high. Although construction is actually further along than Sky City, its estimated completion isn’t until 2019.

One money manager with an Austrian point of view is Mark Spitznagel the founder of Universa Investments which has $6 billion under management. Spitznagel is a fan of Ludwig von Mises and has advanced the Austrian view in op-eds for the Wall Street Journal.

In a recent profile of the money manager, New York Times writer Alexandra Stevenson explained government interventions distort the marketplace and these malinvestments must ultimately be cleansed. This creates opportunities for investors but they must be patient. “When those distortions are present, Austrian-school investors will position themselves to wait out any artificial effect on the market, ready to take advantage when prices readjust,” Stevenson writes.

Spitznagel is ready and claims “the stock market is going to fall by at least 40 percent in one great market ‘purge.’”

If the skyscraper index is right, Spitznagel and his investors won’t have to wait much longer. As developers race to be the tallest, the skyscraper index is beginning to flash red for stock investors. The views may be grand from up high, but the time to get out grows near.

and if you wanted to know more......