How to Trade the Skyscraper Index

A skyscraper is a thing made from a sunny outlook. A skyscraper of record-breaking height is a thing made often from a mix of cheap money, debt and a fat scoop of hubris on top.

Somewhere a real estate man with dirt under his shoes and drywall dust on his shoulder must’ve had a hunch that skyscraper booms happen just as things go bust. But it took an economist to put it down on paper and create an index.

In 1999, economist Andrew Lawrence did just that. He created the Skyscraper Index. It showed that the tallest skyscrapers sprouted just as business withered.

Its ability to predict collapse is surprisingly accurate…#-ad_banner-#

In a 2005 paper, economist Mark Thornton took a stab at vetting the index. He wrote that “the Skyscraper Index… does have a good record in predicting important downturns in the economy.” And most recently, Erste Group Research released a report in March that calls the track record of the Skyscraper Index “impressive.”

Here’s how it worked in Dubai. The Burj Khalifa took the crown of world’s tallest building from Taiwan’s Taipei 101 in 2007 — just before the onset of the global financial crisis. Here the Skyscraper Index worked perfectly. (And Taipei 101 itself fits the theory of the index too. Construction began in 1999, just before the tech bubble reached its peak.)

Some of the index’s successful past signals:

   — The Singer Building (1908) and the Met Life Tower (1909), both record-setters, began before and were completed after the Panic of 1907 — which Thornton calls    “one of the sharpest downturns in American economic history”

   — The Chrysler Building (1930), and then the Empire State Building (1931), heralded the Great Depression

   — The World Trade Center (1973) and Sears Tower (1974), were both completed amid the 1973-74 economic crisis

   — The Petronas Towers in Malaysia (1998) began construction on the eve of the Asian Crisis.

   — The Erste Group also points out that three of the four highest skyscrapers in Europe were finished in Madrid as the Spanish property bubble was set to pop. There are more examples that fill out the theory, but you get the idea. What first appears to be a fun plaything suddenly looks very real.

What does the Skyscraper Index say today?

It is flashing major warning signs over China and India. A Barclays report in January — written in part by the aforementioned Andrew Lawrence — shows that most of the skyscrapers currently under construction are in China and India.

China has more than half of the world’s 124 skyscrapers under construction. In the next six years, it’ll double its collection. Barclays notes, “China’s skyscrapers are not only increasing in number… but the average height of the skyscrapers that it is building is also increasing.”

In India, only two of its 276 skyscrapers are more than 787 feet tall. However, in the next five years, India will have 16 more. One of these is India Tower, which will be the world’s second tallest when finished.

Barclays comes to the bitter but inescapable conclusion:

“The writing, so to speak, would seem to be already on the glass curtain walling. For if history proves to be right, this building boom in China and India could simply be a reflection of a misallocation of capital, which may result in an economic correction for two of Asia’s largest economies in the next five years.”

Looking further out, the Skyscraper Index flags little Azerbaijan. Yes, Azerbaijan. The small country sits on the crossroads of Eastern Europe and Asia. Size is no impediment to putting up skyscrapers of mind-numbing height. As Erste reports, “The world’s highest skyscraper is currently in the planning stage in Azerbaijan. The Azerbaijan Tower will be 3,444 feet high and thus overtop the Burj Khalifa by 728 feet.” It is set on an artificial island — one of 41 — in the Caspian Sea. The country aims to be the “Dubai of the Caspian Sea.” Construction begins next year and is set for completion in 2019.

Oil and gas account for half the country’s economy. Might the builders of the Azerbaijan Tower be taking high prices for oil and gas as a given? “One could interpret this situation as a long-term warning signal for the oil price,” Erste guesses.

To me, the Skyscraper Index is another caution flag to add to the mix. China’s and India’s booms fuel the need for steel and oil and copper. It is a time to be extra careful investing in these themes.