National Economic Outlook: Does Good News/Bad News Mean A Construction Recession Bottom Is In Sight?
Getting a handle on how the
national economy is going to effect construction and real estate for the
remainder of 2009 has become less difficult since the second quarter played
out. That doesn’t mean that forecasts (this one included) still won’t miss
the mark, but the course of the macro economy finally seems to have some
definition, which means the course of the construction market will be more
predictable hereafter.
May’s economic numbers offer the most recent total picture we have to judge
the health of the overall economy, but virtually all indicators are that the
worst results of the recession have occurred and that either stability or
recovery will mark the third quarter.
To highlight a few of the indicators that have turned positive (or less
negative), we can look first at the Conference Board’s Leading Economic
Index (LEI), a measurement of ten indicators (including building permits)
which tend to predict future economic direction. The LEI turned sharply
positive after March and is up 1.2 percent for the past six months, the
first such six-month climb in two years. Another key positive trend is home
sales, which have been slightly positive for both new and existing homes
since January. While not a big upward move, the positive trend, accompanied
by low housing starts, is beginning to erode the excess inventory of unsold
houses. Further good news on housing was that the first two national builders
to report quarterly earnings, KB Homes and Lennar, touted significant
increases in orders in May.
The Commerce Department reported that durable-goods orders rose 1.8% in May,
contrary to analysts' expectations for a slight retreat. A gauge of capital
spending in the report also jumped, and orders for non-defense capital goods
excluding aircraft rose by 4.8%, after decreasing 2.9% in April. It was the
largest increase since 8.2% in September 2004.
Some early mid-year indicators are also showing more stability, if not
growth, in the business sector. The service sectors of the U.S. economy
contracted at a slower pace in June, the Institute for Supply Management
reported July 6. The ISM non-manufacturing index rose to 47.0% from 44.0% in
May. This was better than expected; economists were looking for the index
to rise to 46.0%. Anthony Nieves, chair of the ISM services survey, said the
report was "encouraging." The business activity index rose to 49.8% in June
from 42.4% in the previous month. New orders rose to 48.6% from 44.4%. The
employment index rose to 43.4% from 39.0%. Inflation pressures picked up.
The price index rose to 53.7% from 46.9% in the previous month.
For consumers, there is a mixed bag of indicators that effect construction.
The best news is that the pace of unemployment seems to have slowed
significantly. The number of initial claims dropped by several hundred
thousand in May. Continued slowing in layoffs would back up the LEI’s trend
showing recovery. Perhaps the firming employment picture is borne out in the
reversal of the decline in consumer spending since January; however, the
level of spending is still below $10 billion monthly and well below the
spending levels of 2007.
The most difficult indicator to use as a gauge is the savings rate. On the
good news side of the ledger is that personal savings has spiked in the last
three quarters, currently at around seven percent. This reversal in trend
was needed to provide consumers the opportunity to reduce their debt burden
so that a healthier economy could return. The bad news is that personal
savings has spiked in the last three quarters, meaning that consumers are
paying off past purchases instead of making new ones. And that is not good
for the nation’s retailers.
One of the bellwethers of future construction is retail. Second to increased
housing starts, it is always a good indicator when retail chains begin to
grow their capital expenditures in anticipation of a recovery, much like the
stock market anticipates recovery. The size of the investment in a new store
represents a sufficient risk on the part of the retailer that they tend to
research the market conditions thoroughly; consequently, increased
retail capital spending always predicts increased construction spending in
general.
The current retail climate is improving, at least in terms of earnings, but
that is a result of reduced costs rather than better sales.
“We’re looking at difficult conditions until at least spring of 2010,” says
Brooks Brothers president Diane Hamilton. “I think we’ll see things begin to
eke out small increases, maybe one or two percent, in comparable stores
sales throughout 2010, but beyond that it’s hard to see much more than three
or four percent growth. Most retailers are down 25% from last year, so it
will take a while to recover at three to four percent.”
Construction of retail space began to tail off more than a year ago, and as
is cyclically normal, activity in other non-residential sectors is now
following a downward trend.
The latest data from the two national construction services, Reed
Construction Data and McGraw-Hill Construction, show upbeat May numbers in
counterbalance to pretty dismal year-to-date performance. For the first five
months, Reed shows a decline in total nonresidential starts of 6.1%, and
while May was up from April, the volume in May was 20% lower than May 2008.
| PERCENTAGE CHANGES IN COSTS | May 2009 compared to | ||
| 1 mo. | 3 mo. | 1 yr. | |
| Consumer, Producer & Construction Prices | |||
| Consumer price index (CPI-U) | 0.3 | 0.8 | -1.3 |
| Producer price index (PPI) for finished goods | 0.5 | 0.4 | -5.0 |
| PPI for construction | 0.6 | -0.4 | -5.3 |
| Costs by Construction Types | |||
| Highway and street construction | 2.1 | 0.9 | -10.8 |
| Nonresidential buildings | 0.6 | -0.3 | -5.9 |
| New warehouse construction | -0.4 | -0.8 | 5.7 |
| New school construction | 0.0 | 0.4 | 11.5 |
| New office construction | 0.3 | -0.5 | 6.4 |
| Multi-unit residential | 0.2 | -0.7 | -3.8 |
| Single-unit residential | 0.1 | -0.9 | -1.0 |
| Costs for Specific Construction Inputs | |||
| #2 diesel fuel | 4.4 | 14.6 | -58.1 |
| Asphalt paving mixtures and blocks | 3.5 | -1.5 | 11.7 |
| Concrete products | -0.1 | -1.3 | 2.1 |
| Brick and structural clay tile | -0.6 | -1.2 | -0.5 |
| Plastic construction products | -0.1 | -0.5 | 1.7 |
| Gypsum products | -2.4 | -2.5 | 4.2 |
| Lumber and plywood | -0.9 | -3.4 | -13.8 |
| Architectural coatings | 0.0 | 0.1 | 12.4 |
| Steel mill products | -2.7 | -9.5 | -33.8 |
| Copper and brass mill shapes | 0.8 | 21.4 | -25.1 |
| Aluminum mill shapes | 1.4 | -2.2 | -23.7 |
| Fabricated structural metal | -1.6 | -3.6 | -8.1 |
| Prefabricated metal buildings | -0.7 | -6.5 | -7.1 |
| Crude petroleum (domestic production) | 18.6 | 68.5 | -55.1 |
| Cement | 0.0 | 0.9 | 0.5 |
| Iron and steel scrap | 18.8 | -3.8 | -62.0 |
| Copper ore | 18.4 | 36.0 | -43.0 |
| Source Bureau of Labor Statistics | |||
| Compiled by Ken Simonson, Chief Economist AGC | |||
Bureau of Labor Statistics data
from June 1 shows a significant drop in construction costs since mid-2008
and more stability in prices for 2009.
“The May starts increase partly offsets an unusually weak April but does not
signal that starts have moved to a rising trend,” says Reed chief economist
Jim Haughey. “Expect a mix of monthly gains and losses for the balance of
the year, with the average level of starts not significantly different from
May.” Haughey noted that credit problems will continue to plague commercial
contracting and that state deficits will dampen public works construction
that is not supported by the stimulus.
McGraw-Hill’s data showed a jump in starts of 7% in May but an even more
severe decline year-to-date, with 38% lower start volume than the first five
months of 2008.
“May’s strengthening was led by a substantial increase for public works,”
stated Robert A. Murray, vice president of economic affairs for McGraw-Hill
Construction. “Meanwhile, housing stayed flat and nonresidential building
resumed its downward trend after the brief upturn reported in April. For
nonresidential building, there’s been the occasional display of resilience
by such institutional structure types as health care facilities and public
buildings, but the downward trend for the commercial structure types is
still very much underway.”
Both firms reported gains in
non-building construction in the range of 1-2%. While that is almost
negligible in terms of all construction spending, it’s worth noting that the
non-building sector would likely be down between two and ten percent without
the American Recovery and Reinvestment Act (ARRA), since almost all state
and municipal owners and looking to fill budget deficits with lower spending
on all fronts. More noteworthy is that the stimulus related spending is
entering the marketplace much quicker than anticipated, meaning that the
salutary effects that are expected on employment will be felt sooner than
expected.
One other impact that ARRA is having sooner than was hoped for is in
stabilizing a troubled sector of the financial markets that has made public
construction difficult since fall, the municipal bond market. As the markets
melted in fall 2008, so few bidders existed for municipal bonds that yields
skyrocketed, making public construction less affordable.
Part of ARRA, the Build America Bonds program offers a 35% rebate from the
federal government to issuers on their interest payments. The rebate is
meant to bridge the gap between the lower rates that could be offered tax
free, and the higher taxable rate that would be attractive to investors.
This means that public authorities can offer higher rates on their debt than
they typically would be able to afford, and so they take their offerings into the
taxable bond market.
For taxable bond investors, the attraction is diversification as municipal
bonds, which offer relatively low risk, are an area that they rarely have
exposure to.
The figures show how Build America Bonds are having the desired impact.
Through the end of May, the number of new issues in the tax-free market has
dropped 17% compared to the year-ago period, according to The Bond Buyer. In
the same period, the number of taxable issues has risen 32%. The numbers are
even more dramatic for May alone, as the Build America Bonds program really
started to take effect. Compared to May 2008, tax-free issues fell 40% while
taxable issues were up 56%.
The growth in bond-funded public construction will help with schools, parks
and public transportation, while the non-building construction market will
be aided directly by infusions from ARRA, in some states (like PA)
increasing investment in infrastructure by 100% year over year. For the
remainder of the construction industry, however, the rest of 2009 will
likely be a period of further soft conditions while demand is rebuilt and
oversupply is absorbed.
While the market struggles with much lower construction volumes to meet
diminished demand, the one factor in the construction industry that is
demonstrating some much needed stability is the price of building materials
and products.
Although energy costs rose again sharply during the mid-second quarter, the
increase paled in comparison to the 100% jump in the first half of 2008, and
by the Independence Day weekend, prices were cooling again. The increased
cost of energy and fuel has sparked some jumps in pricing for steel, asphalt
and transportation (which puts pressure on all manufactured products), but
the sagging demand for building materials overall has kept prices well below
mid-2008 levels. Until there is a significant change in
supply/demand dynamics for construction, which won’t happen this year,
expect the cost of construction to remain more predictable than in several
years.
The
Department of Commerce amended its first quarter loss in gross domestic
product, validating that a recession had created two consecutive quarters of
decline.
Work-In-Process is provided by
Somerset for our clients and other interested persons upon request.
Since technical information is presented in generalized fashion, no
final conclusion on these topics should be made without further review.
For additional information on the issues discussed,
please contact
Ken
Hedlund,
Jay Feller,
Steve George,
Chris
Mayfield or
Rebecca Ogle
of our
Construction & A/E Team.
This document is not intended or written to be used, and cannot be used,
for the purpose of avoiding tax penalties that may be imposed on the
taxpayer.
Somerset CPAs,
P.C.
3925 River Crossing Parkway, Third Floor
Indianapolis, Indiana 46240
317.472.2200 • 800.469.7206 • FAX 317.208.1200
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