March 21, 2003

The Hazy Outlook for the Economy and Construction in the U.S.
Presentation to AGC Convention, Honolulu

Why is the outlook hazy? First, the two major indicators of construction activity—employment and value put in place—are pointing in opposite directions. Second, there is a hesitancy throughout the economy about the future, even though a variety of current indicators are positive.

Current construction indicators

The employment figures are dreary. Nationally, seasonally adjusted total nonfarm employment plunged by 308,000 jobs (0.2%) from January to February, the Bureau of Labor Statistics (BLS) reported on March 7. Construction employment slumped by a disproportionately large 48,000, or 0.7%. In each case, the loss was roughly double the gain recorded for December. Seasonally adjusted average weekly hours for construction workers fell sharply, to 37.4 in February from 39.5 in January and 39.4 a year ago.

BLS divides construction into three groupings. Of these, general building contractor employment fell for the third straight month by 6,000 but was up by 6,000 from February 2002, reflecting the still-strong market for homebuilding. Heavy construction, except building, shed 19,000 jobs (2.1%) in February alone and 37,000 (4%) since February 2002. Special trade contractors lost 23,000 jobs (0.5%) in the month and 44,000 (1%) over the year.

Value of construction put in place, on the other hand, eked out a record in 2002 of $847 billion (up 0.5% from 2001), then smashed it in January, rising for the fifth straight month to a seasonally adjusted annual rate (SAAR) of $878 billion, the Census Bureau reported on March 3. (SAAR is useful for comparing months within a year for statistics that have seasonal variation. Not seasonally adjusted data is valid for same-month or year-to-date comparisons.)

A less comprehensive measure, McGraw-Hill’s Dodge index, showed a similar pattern, with a modest gain in new construction contracts for all of 2002 and a further 2% jump (SAAR) from December to January. (Dodge measures the full value of new construction contracts in the month they begin and covers about 60% as much as Census. Census counts the value spent each month for ongoing projects.)

Census divides construction into private residential and nonresidential and public construction. Private residential building (including improvements to existing structures) and public construction each climbed by 6-7% in 2002, while private nonresidential buildings fell by 16%. These patterns continued in January: residential was up 2.5% (SAAR) from December, public rose by 1%, but private nonresidential buildings were down 0.3%.

Another set of indicators, manufacturers’ orders, suggests that construction firms expect rough times ahead. Census data for January, released March 6, show that orders for construction machinery tumbled by 12%, seasonally adjusted, from December to January and by 6% from January 2002. Orders for construction materials and supplies, which are more likely to reflect current demand from projects already under way, slipped 0.1% for the month but rose by 3% compared to the year-ago month.

General indicators

The Federal Reserve’s March 5 “Beige Book”, a summary of soundings by economists in the 12 regional Fed banks of local businesses, found that in all parts of the country economic activity is soft and uncertainty great. Similarly, surveys by the Institute for Supply Management of manufacturing and non-manufacturing purchasing executives found business activity weakened slightly in February, with great hesitation to invest in inventories, equipment or plant. And recent consumer confidence or sentiment surveys have had very dismal readings.

In contrast, the “hard” data on recent activity is more mixed. The Fed’s industrial production index for manufacturing slipped 0.1% in February after rising 0.6% in January. Personal income grew 0.3% in January as it had for the previous five months, although personal consumption expenditures fell, reversing a rise in December. Existing-home sales set another record in January but new-home sales plummeted. Retail sales in February had their steepest one-month decline since November 2001.

Construction outlook

Public construction has the most uncertain outlook. Most of the growth has occurred in educational construction (+13% in 2002, +1.5% December-January), conservation and development (+10% and +0.5%), and sewer systems (+7% and +3%). Highway and street construction was up by 0.5% from 2001 to 2002 and 1% from December to January. Many contractors say they are still busy with projects approved years ago, when states had plenty of tax and bond receipts, but that their order books are empty. Bond issues generally fared well last November; most of that money will help keep K-12 school construction healthy. But general-fund financing has been shrinking in nearly every state, making the outlook shaky for most categories of public construction.

Now that President Bush has finally signed an omnibus appropriations bill to cover federal spending through September 30, it is clear that funding for highways and other federal construction money will remain close to the 2002 levels. But getting funding increases in fiscal 2004, or even holding the line, will be a major challenge.

As for residential construction, several factors should keep single-family construction strong in 2003, although it will be hard to improve on last year’s numbers. Mortgage rates should stay low, if not quite at the 40-year low of 5.6% that prevailed last week. Personal income should continue rising fast enough to outpace inflation, giving people the wherewithal to buy homes. And now Freddie Mac and Fannie Mae have raised the limit on mortgages they finance by 7%, to $322,700. These factors will keep resales healthy, too. All of that is good news for a variety of nonresidential contractors as well. A strong new- and existing-housing market helps grading, paving and utilities contractors, in addition to other businesses that in turn spend more on construction: landscapers, furniture and furnishings stores, residential contractors themselves, real estate and mortgage brokers.

In contrast, rising rental vacancy rates have cropped up in most cities. The high level of housing sales is helping to draw tenants out of multi-family housing. Young adults who can’t find a job are moving back in with parents instead of renting. And persistent unemployment also undermines the rental market.

The most mixed picture for construction is within the broad private nonresidential segment. Census now provides more detailed national information (in supplemental tables on the same website) than in its printed release. The detailed tables show some winners among the devastation. Understandably—given the jump in spending on health-related items—drugstore construction was up by 39% in 2002 and health care (itself subdivided into hospital, medical building and special care) by 15%. Outweighing these positives are: factories (-44%), lodging (-29%), offices (-29%), warehouses (-25%), shopping malls (-29%), and shopping centers (-13%).

A special case is electric power construction, which was up 1% for 2002 but by January was falling at a rate of 13% compared to the same month last year. The explanation lies in the long-term nature of power plant construction: the value put in place for the year reflected projects begun years ago but the monthly drop from the year before showed that cancellations were beginning to take their toll.

On the plus side, agricultural spending should turn up in 2003, thanks in part to last year’s farm bill, and some of that income growth will spill over into construction related to farms, farm suppliers and food processing and transportation. Employers, consumers and governments will all pour money into health care, which in turn means more construction of hospitals, clinics and doctors’ offices, laboratories and manufacturing facilities, and even pharmacies.

Construction costs, including wages, should remain well-behaved for the most part. With construction employment down and inflation running at only about 2%--one of the lowest levels in nearly 40 years—wage pressures should be minimal.

Despite the jump in overall producer prices the past two months, most prices not connected to energy are flat or falling, and there is capacity to spare throughout the manufacturing sector. The cost category most likely to go up by large amounts is insurance of any type. Premiums have increased by an average of 30% and in some cases much more, and coverage has been substantially reduced.

Conclusion

In closing, the short-term future for the nation’s and the world’s economy depends on what happens in Iraq. For now, construction related to housing and some other types of consumer activity should remain strong, but business-related construction will not pick up until there is more certainty about the world situation. That in turn means government revenues are not likely to revive, let alone permit a return to spending on construction other than security and defense-related, for several more months.

Copyright © 2002 Mike Holt Enterprises,Inc.
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