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National Economy Poised for Smoother Performance

The U.S. economy finished 2013 with a bit of a bang, expanding at a 3 percent annualized clip during the final six months of the year. However, a significant buildup of inventories during the third quarter prompted a disproportionate share of that growth. That set the economy up for an early-2014 swoon, which was exacerbated by an awful and seemingly endless winter. According to the final estimate from the Bureau of Economic Analysis, the U.S. economy contracted 2.1 percent during the year’s initial quarter.

The national economy came racing back as the final snows melted, including in the form of expanding business investment. Construction projects that were delayed by the harsh winter are now under way, auto sales are surging, the nation supports 2.635 million more jobs than it did a year ago and unemployment has fallen below 6 percent for the first time in six years. Even the quality of jobs being added seems to have improved of late, with more middle-income jobs being produced in construction, manufacturing, energy, professional services and IT.

After shrinking during the first quarter, the U.S. economy bounced back with a robust 4.6 percent annualized performance during the second quarter. Stakeholders can expect around 3 percent growth for the latter half of 2014. Additionally, the International Monetary Fund upgraded its most recent growth projection for the United States from 1.7 percent to 2.2 percent.

Consumers continue to ramp up outlays, with specific emphasis on automobiles, online shopping, travel and home improvement. In fact, retail sales began to trend higher as early as March. The recent acceleration of job growth should keep consumers spending.

Even consumer confidence has been on the rise of late. The Conference Board’s Consumer Confidence Index attained a seven-year high of 90.3 in July. The last time the index reached that level was in October 2007, two months before the recession began. The index rose again in August 2014 to 93.4, though it quickly declined to 86 due to a combination of factors, including Ebola and ISIS. Still, September’s reading was among the highest registered since January 2008.

Consumers have reason for optimism. As of October, the nation had added 2.643 million jobs during the prior 12 months—well over 200,000 jobs per month. Of that total, a quarter (657,000) were in professional and business services. The list of other rapidly expanding employment sectors includes distribution (e.g., retail and wholesale trade), health services, and leisure and hospitality.

In October, the nation added 214,000 jobs, according to the Bureau of Labor Statistics’ initial estimate. This followed the 256,000 jobs the economy added in September. The growth in October was led by the leisure and hospitality sector, which accounted for 52,000 jobs. The professional services sector added 37,000 jobs, while retail added more than 27,000 jobs. Health care also continued to be an important job generator, adding 24,500 positions in October. Manufacturing added 15,000 jobs and construction added just 12,000.

The unemployment rate fell again in October to 5.8 percent, the lowest rate since August 2008, when the nation was on the precipice of the financial crisis. As is well known, much of the progress in reducing unemployment is due to falling labor force participation. Though 168,000 jobseekers returned to the nation’s workforce during the third quarter (July to September), 533,000 workers had left during the previous quarter. However, the labor force has expanded by 818,000 overall since the beginning of the year.

Residential Rebound
The multifamily rental market remains red hot. Low apartment vacancy rates persist and projects are being readily financed,  leading to an increase in demand for residential specialty trade contractors. On the other hand, the owner-occupied housing market has been less buoyant. Last summer’s surge in mortgage rates seems to have helped dampen enthusiasm for ownership. This is especially true among first-time buyers, who represent just 28 percent of purchases presently (normally 40 percent).

However, there has been a bit of a recent rebound. In June, existing home sales reached an annualized pace of five million—the first time that level has been reached since October 2013.

Nationally, home prices continue to rise, but at a slower pace than during the first half of the year. According to August’s S&P Case-Shiller data, the composite home price index for 20 major cities has expanded 5.6 percent during the past year. Though all of the cities incorporated in the index saw a positive return, only two cities registered double-digit annual appreciation (compared to three locations in July and five in June). These two cities were Las Vegas (10.1 percent) and Miami (10.5 percent).

Nonresidential Construction's Choppy Ride

Nonresidential construction spending shrank 1 percent on a monthly basis in September, but spending was still 4.2 percent higher on a year-over-year basis. This serves as a microcosm for the nonresidential construction recovery, which has been punctuated by fits and starts since 2010. The harsh winter postponed a large volume of construction during the year’s initial quarter, and a portion of that construction took place in April and May, inflating those months’ spending numbers.

For the most part, the nonresidential construction recovery has been driven by private construction spending, including segments such as office, power, commercial and amusement/recreation. The recovery of these segments fits neatly with the tenor of the
larger macro-economy. The sector that has added the highest number of jobs during the past year is professional/business services, which is closely aligned with the nation’s office market. The surge in energy production has fueled construction of power plants and distribution terminals, while expanding consumer outlays has helped support faster construction spending in commercial and recreational segments.

This will continue. The federal government still lacks long-term infrastructure financing structures, and many state and local governments remain fiscally constrained due in part to rising health care costs and underfunded pensions. While the growing role of public-private partnerships (P3s) helps, they still represent a small share of total infrastructure investment and have fallen far short of addressing the nation’s massive infrastructure spending gaps.

Not only has productivity growth been hampered by mediocre infrastructure quality (e.g., road, rail and communication speeds), but the last few years also have been associated with incredibly low interest rates and stable construction materials prices. The government could have accomplished a lot on a per-dollar-spent basis if it had embarked on an infrastructure investment program. In turn, that program would have helped stimulate near-term economic performance.

A Bump in the Road
Though nonresidential construction spending remains well below its all-time peak achieved in October of 2008, industry leaders are growing increasingly confident about revenues, profits and hiring. According to Associated Builders and Contractors’ (ABC) Construction Confidence Index for the first half of 2014, business owners’ expectations for sales rose from 63.2 to 68.2, and their expectations for profit margin expanded from 57.5 to 60.3. Additionally, they anticipate acceleration in hiring going forward, with the index for staffing levels moving from 62.2 to 65.

However, the prospect of severe skills shortages remains a major concern. As nonresidential construction has continued to recover, particularly in natural resource-intensive states such as Texas, Louisiana, Oklahoma, North Dakota and Colorado, skills shortages have become more apparent. ABC continues to predict double-digit annual wage and per diem increases for a number of occupational categories in energy-rich and industrial production-rich communities.

This is not unique to construction. Trucking firms, manufacturers, health care providers and others are increasingly complaining about a lack of available skilled personnel. To date, there has not been much evidence of economy-wide wage inflation. That is likely to change during the coming year, and should begin to shape monetary policy in late 2015 in the form of higher interest rates. That could set the stage for an interesting 2016 as economic momentum encounters rising financing costs.

The Big Picture
Overall, ABC forecasts nonresidential construction spending will expand by about 7.5 percent in 2015. Contractors can expect especially pronounced construction spending growth in power (e.g., natural gas-related spending), lodging, manufacturing and professional services, such as office space.

Construction spending growth will be far more sluggish in the public sector—following a multi-year pattern of disparity. In 2013, private nonresidential spending was 15.6 percent greater than public nonresidential spending and the spending gap between private and public spending leapt to approximately 28 percent in 2014.

Of course, other issues may arise that could limit growth. Compensation costs per worker will rise faster in 2015 than in most recent years, particularly in certain portions of the country that are experiencing significant economic acceleration, such as Louisiana and Northern California. Materials price inflation also may accelerate in 2015 after prices were suppressed
in 2014 by a combination of factors, including softer growth in much of Europe and Asia, rising American energy production and a stronger U.S. dollar. Some of these factors may not be as prominent next year, setting the stage for materials price increases closer to 3 percent.

Given current economic momentum, including employment growth and accommodative monetary policy—and consumer spending recently buoyed by falling gasoline prices—the next year should be a decent one for the U.S. economy.

Regional Difference-Makers

An analysis of the states that have added the most construction jobs during the past year yields some interesting insights. There are really three types of states that have enjoyed rapid construction employment growth:
  1. energy-intensive states such as Texas, Louisiana and Colorado;
  2. states that are now recovering from vicious recessions such as Florida, California, Nevada and Georgia; and
  3. states that have embarked on ambitious capital investment programs despite lackluster economic performance, including Illinois, Pennsylvania, Maryland and Virginia.
Despite the fact that the nation is in the midst of its sixth year of economic recovery, sustained momentum in construction job creation remains elusive. Fifteen states either failed to add construction jobs or lost them between August 2013 and August 2014.

One way to gauge regional momentum is through Associated Builders and Contractors’ Construction Backlog Indicator, which reached an all-time in the third quarter of 2014. Additionally, backlog lengthened in all industry segments (industrial, commercial and institutional, and infrastructure) and in every region, with the Northeast boasting the longest backlog (10.17 months) followed by the West (9.42 months), South (8.89 months) and Middle States (6.93 months).

The states set to experience the fastest construction spending growth in 2015 and beyond feature strong industrial output. After three decades of steady decline, the nation’s factory output has been growing in recent years, in part because of the availability of affordable natural gas. In general, states in the South have been the principal beneficiaries of new plant construction, including the new Airbus plant in Mobile, Ala., Caterpillar’s facilities in Texas and Georgia, and Volkswagen’s decision to build a plant in Chattanooga, Tenn.

While industrial production is positioned to continue to rise, the leading source of regional variation in economic performance remains energy. Among the largest investments that will take place during the next few years are export-oriented liquefied natural gas (LNG) terminals.

In September, the U.S. Energy Department handed critical licenses to Sempra Energy’s $10 billion Cameron LNG project in southwestern Louisiana, as well as a smaller Florida facility. A separate Cheniere Energy project, the Sabine Pass LNG facility in Louisiana, currently is under construction at a cost of $12 billion. Also in September, Dominion Resources Inc. secured final U.S. approval to export LNG from Cove Point in southern Maryland. Construction is estimated to cost as much as $3.8 billion.

Of course other types of construction work—hotels, office buildings, roads and bridges—are expected to take place in every state, but energy and industrial production stand to be the most important regional difference-makers.

Weaker Global Economy Implies Ongoing Materials Price Stability

Based on the U.S. government’s producer price index (PPI) for nonresidential construction, inputs to construction have risen about 1 percent during the past year. 2014 represents the third consecutive year of input price stability—remarkable given the patterns of volatility observed from 2003 to 2011.

Certain prices have actually declined, including products that use oil as an input (e.g., diesel fuel and asphalt). This has helped support contractors’ margins, a welcome contributor given the elevated levels of competition that continue to characterize the nation’s construction industry. Crude petroleum prices fell another 5.5 percent in October and were down more than 11 percent on a year-over-year basis.

To arrive at a forecast of materials prices, it’s important to understand why input prices have been so well-behaved during the past year, particularly given nonresidential construction spending growth in 2014 and the impact of that on demand for materials. The list of contributing factors includes:
  • a stronger U.S. dollar;
  • emerging economic weakness in much of Europe, including in France, Italy, Germany and Russia;
  • slower growth in a number of key emerging nations, including China and Brazil; and
  • advances in extractive technologies, including those for oil and natural gas production.
Though monthly price shifts are likely to be more volatile in 2015 due to a number of factors, including geopolitics and monetary policy shifts, profound increases in construction materials prices remain unlikely. While America may manage to expand 3 percent or better next year (which would be the first time since 2005), the rest of the global economy is actually softening.

The International Monetary Fund recently downgraded its global growth forecast for 2014 and 2015. While that hardly guarantees materials price stability next year, the chances of a significant upward move have become more remote.

Anirban Basu is chief economist of Associated Builders and Contractors. For more information, visit www.abc.org.

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