2012 – A Year of Uncertainty

Edited by Greg Sitek

During the course of a lifetime we encounter many challenges. Predicting the future is one of the greatest, especially in times like these. The challenge would be daunting by itself but add the mystique of a presidential election to the agenda and it becomes monumental. There is so much going on that can and will influence all things that effect the economy: What happens in the European community; developments in Iraq and Iran; the ongoing conflict between Israel and Palestine; oil prices; gold prices; China’s reaction to any and everything; domestic manufacturing and production; residential construction; nonresidential; construction unemployment; inflation; the highway bill; the election are only a few of the happenings that will have an impact on our future.

Looking out across the economic horizon that is tomorrow I think we can expect to see slow gradual growth as we, as a country and we as an industry, adjust to the new norm. There will be no sudden “something” that is going to jerk us back to the “high” that immediately preceded the current economic low. We are at the new norm and will grow from here.

We need to rediscover the innovative, creative thinking that launched us from being a “wannabe” to being the world’s industrial leader. We need to look in the mirror and ask, “What happened to us?”  Even more importantly, we need to accept the reality that slaps us in the face.

What can we expect for our industry in 2012?

Let’s look at what a couple industry economists think.

Anirban Basu, ABC Economist, Predicts 2012 Will Be A Slow Year for Construction

Associated Builders and Contractors (ABC) recently released its 2012 economic forecast for the U.S. commercial and industrial construction industry. “ABC’s analysis of construction trends indicates 2012 will be a year of gradual progress as advances in private construction are partially offset by ongoing declines in publicly financed construction,” said Anirban Basu ABC chief economist.

“Nonresidential construction spending is expected to grow 2.4 percent in 2012 following a 2.4 percent decrease in 2011,” Basu said.

“The pace of recovery in the nation’s nonresidential construction industry remains soft and 2012 is positioned to be a year of slow gain. The first half of 2012 may be particularly challenging, a reflection of the soft patch in economic activity experienced during much of the first half of 2011.

“ABC’s national Construction Backlog Indicator, which stood at 8.1 months for both the second and third quarters of 2011, is not expected to advance substantially and likely will remain in the vicinity of 8 months of backlog for much of 2012,” said Basu.

“However, backlog is one month higher from the same time last year. A backlog of less than eight months is associated with construction spending declines, while a backlog exceeding eight months is statistically associated with future construction spending increases. Today’s level of backlog is consistent with flat construction spending.

“Nonresidential building construction employment is expected to increase 0.4 percent in 2012 following lackluster 0.6 percent growth in 2011,” Basu said. “Employers will continue to seek increased productivity among existing workers in order to boost weak industry margins.

“There may be a degree of relief for construction contractors with respect to materials prices.  In 2011, prices for construction inputs rose 7.5 percent,” said Basu. “ABC expects 2012 materials prices will rise 4.7 percent. Despite a sluggish construction recovery, input prices are likely to remain elevated as global investors retain significant ownership in commodities and hedge against risks emerging from Europe, the U.S., China and Brazil.

“The direction of the U.S. dollar will play a major role in determining construction input prices in 2012. However, the dollar’s direction is far from obvious,” Basu said. “Although the nation continues to run a large trade deficit, which implies further deterioration in the value of the dollar over time, investors often race to dollar-denominated assets during times of global financial stress. We are in one of those times now, which could keep the dollar, inflated in 2012. While this would create a more challenging environment for U.S. exporters, it would likely result in lower construction materials prices.”

“For the most part, 2011 has been disappointing. However, recent economic news has been more positive, including data regarding the gross domestic product (GDP), business investment and exports,” Basu said. “If the U.S. economy continues to progress, eventually this will translate into more vigorous recovery in the nation’s nonresidential construction sector.

“Many prominent forecasters expect GDP to expand less than three percent next year. The economic recovery in the United States to date cannot sustain brisk expansion without the participation of real estate and construction activities,” Basu said. “With office vacancy rates still high, job creation still slow and lending still disciplined, 2012 is not positioned to be a year of significant progress in private investment. Public construction spending continues to decline in many communities across the United States.”

“ABC anticipates ongoing improvement in the volume of privately financed construction as economic conditions gradually improve and lending institutions become more comfortable lending to deep-pocketed investors operating in stable contexts,” said Basu. “More importantly, certain leading indicators have turned the proverbial corner, including ABC’s Construction Backlog Indicator. This forward-looking measurement has shown slow but steady improvement in the commercial/institutional construction category, presently associated with a backlog of 8.4 months.

“Much of the growth in recent years has emerged from publicly financed projects, including projects related to the U.S. stimulus package passed in February 2009,” Basu said. “With the impact of stimulus-funded projects steadily declining, the U.S. nonresidential construction sector will become increasingly dependent on privately financed projects for growth.

“However, certain segments are better poised for growth than others. Leading the way in recent months has been construction related to the nation’s power industry, which ABC projects to expand 11.4 percent during the course of 2011,” said Basu. “The driving force for the United States appears to be in energy, and the growth of this economic segment has been evident in a number of states, including Texas, Oklahoma, North Dakota and Pennsylvania. ABC expects power construction to continue to lead the way with a projected 9 percent increase in spending in 2012.

“Health care represents another likely candidate for economic expansion. This is true for a number of reasons, including thawing credit markets, the nation’s demographics and health care reform, which will continue to increase the number of Americans with insurance and therefore enhance utilization,” Basu said. “Because of this, ABC projects health care construction spending to increase by 8 percent in 2012.

“In many communities across the nation, industrial contractors can be characterized as busy, or at least increasingly occupied, while commercial contractors generally have struggled with overcapacity in 2011,” said Basu. “However, following several years of decreased spending, ABC expects lodging and office construction to progress in 2012.

“Unfortunately, the impact of tight state and local government budgets will continue in 2012,” Basu said. “A number of key categories closely linked to state and local government spending are expected to decrease in 2012, including educational spending, edging down 4 percent. Overall, ABC forecasts public nonresidential construction spending will slip 2 percent in 2012.” 

ARTBA’s 2012: Transportation Construction Market Outlook

by Alison Black

No matter how you slice it, the American Road & Transportation Builders Association’s (ARTBA) outlook for the 2012 transportation construction market is mixed.

First the bad news: The highway and bridge construction market is expected to contract 6 percent, to $72.6 billion from an estimated $77 billion in 2011. The subway and light rail markets will be down even more.

The good news: The railroad market, driven largely by private sector investment, is expected to increase by nearly four percent; and the value of construction for ports and waterways is expected to grow by six percent, driven by work on both coasts in preparation for the 2014 expansion of the Panama Canal.  Also in the good news category, the transportation construction market sector, as has been the case for the past five years, will remain the most stable industry sector.

The main factors driving the decline in highway and bridge construction are not surprising: The winding down of infrastructure investment under the American Recovery & Reinvestment Act (ARRA), continued weak growth in the U.S. economy, persistent state and local budget challenges, and a static federal-aid highway program.

Of course, the long-delayed highway/transit reauthorization bill remains a “wild card.”  If Congress in early 2012 passes a multi-year bill, that at minimum maintains current investment levels, it could help interject greater certainty in the market. Both the Senate and House proposals also contain language to expand the Transportation Infrastructure Finance and Innovation Act (TIFIA), which if leveraged quickly, could offer another market boost.

The Most Stable Construction Market

The transportation construction sector remains stable compared to other construction markets.  Between 2007 and 2011, the real value of highway and bridge construction, adjusted with the ARTBA Price Index for material prices, wages and inflation, fell only 10 percent. Over the same period, the real value of total construction work in the U.S. fell by one-third from $1.1 trillion to an estimated $769 billion.  And the real value of residential construction tanked more than 50 percent from $500.5 billion in 2007 to $236.5 billion in 2011.

The historical stability of the transportation market is in large part due to the role of public sector financing. Federal investment, through the highway program and ARRA, has increased significantly over the last few years, and accounts for nearly 45 percent of all highway and bridge construction spending.  And although state and local governments continue to have budget challenges that impact their discretionary highway and bridge spending, most state highway user fee revenues are constitutionally protected and must be used for transportation purposes.  So although the transportation construction market is not immune to the overall U.S. economy, it is significantly less volatile than other construction sectors, which are more dependent on general economic conditions.

Slight Decline in Pavement Work for 2012

After a sharp decline of 14 percent to an estimated $45 billion in 2011, pavement work in 2012 is expected to decrease by 2 percent to $44.1 billion, again attributable to less ARRA money in the marketplace.

Bridge Market Slow Down Dramatic   

The value of bridgework in 2012 is expected to drop by 10 percent from $26.3 billion to $23.6 billion. The bridge market has continued to grow over the last three years, despite the recession, for two reasons: Projects are often larger and work has continued on projects that were awarded and underway before the economic downturn; and second, state DOTs and local governments have put $3.2 billion in ARRA funds toward bridge work.

Part of the forecasted decline in bridgework is because nearly all the projects that include ARRA investments are finished or underway. State DOTs and local governments are now pulling back on new projects. This is likely due to a combination of the delayed federal reauthorization legislation and continued state and local budget challenges.

Uneven Growth Among States

Despite the national downturn in market activity, some states are poised for growth. There are 18 states where the value of state and local government highway and bridge contract awards for fiscal year 2011 is higher compared to fiscal year 2010. This is an indicator that the value of work in those states will likely increase in the coming year as those projects are underway. The value of contract awards is down in 19 states and Washington D.C. Contract awards in the remaining eight states were relatively stable, either up or down within five percent.

Airport Runway Work Slated to Dip

The value of work done on airport runways is expected to fall four percent from $4.9 billion in 2011 to $4.7 billion in 2012, primarily because of flat funding for the Airport Improvement Program and continued failure by Congress to pass a new aviation reauthorization program.

No Fast Track for Subway and Light Rail

After a decade of rapid growth, the real value of subway and light rail construction is expected to decline nearly 16 percent from an estimated $5.4 billion in 2011 to $4.6 billion in 2012. This drop is in large part due to the continued delay in the reauthorization of the federal surface transportation bill. State and local government contract awards for subway and light rail are down sharply in 2011, indicating transit agencies are pulling back on projects.

Private Investment Spurs Railroad Market

The railroad market, driven largely by private investment, is expected to increase 3.6 percent from an estimated $10.2 billion in 2011 to $10.6 billion in 2012. The sector is expected to grow in the long run as the U.S. economic recovery gains strength.

Ports and Waterways Floating Higher

The value of construction work for docks, piers and wharves is expected to grow nearly 6 percent from $1.9 billion in 2011 to $2 billion in 2012. ARTBA expects continued growth over the next five years. A number of East Coast ports are taking on projects in anticipation of the 2014 Panama Canal expansion. West Coast ports are also investing in infrastructure improvements.   Spending by the Army Corps of Engineers for inland waterway projects is expected to decline next year compared to 2011 levels.

About the Models

ARTBA has a series of econometric models that take into account current economic conditions, state and local funding and federal investment.

The ARTBA forecast model assumes: 1) the U.S. economy will continue to show modest growth in the coming years; 2) material prices and project costs will be in line with inflation; and 3) there is no major increase or decrease in federal investment over the next five years. The outlook would change if federal, state or local governments provided significant increases in their investment levels.

No economic forecast would be complete without a look at the housing market and consumer spending predictions. Wells Fargo’s involvement in all construction market segments as well as the consumer side of the economy puts them in a position to analyze and understand market trends better than most. The company has a 28 page forecast that can be viewed on: wellsfargo.com/research

According to Wells Fargo’s Forecast, Then Housing Outlook Is: Another Tough Year for Homebuilders

Residential construction continues to struggle across much of the country amid a glut of excess single family homes and condominiums. Starts of single-family homes are expected to hit a modern-era low of 420,000 units in 2011 and improve only modestly during this coming year, rising around 8 percent to 455,000 units. Overall starts were down less dramatically in 2011, thanks largely to a 35 percent rise in multifamily starts. Most of that increase was in apartments. Apartment construction should increase further in 2012, helping to push multifamily starts up 25 percent.

Single-family construction is essentially dead in the water, with the exception of a few infill developments in some better performing metro areas. New single-family construction continues to be weighed down by the oversupply of existing homes, which has been bloated by the backlog of foreclosures and bank-owned properties. The latest data place the inventory of existing homes at around 2.86 million units. We conservatively estimate that the shadow inventory totals an additional 2.0 million units, made up of homes either already in the foreclosure process or homes where the mortgage is currently 90 days or more past due.

With so much supply on the market, home prices have continued to drift lower. The S&P/Case-Shiller Home Price Index has fallen every month since last April and is expected to slide an additional 6 percent by the middle of 2012 as distressed transactions account for a larger proportion of overall sales. The prospect of so much additional supply coming onto the market is also weighing on appraisals, which has led to a spike in contract cancelations and also discouraged many would be home sellers from putting their home on the market.

The competition from foreclosures has severely limited the pricing power of new homebuilders, which has reduced their ability and incentive to build. Inventories of new homes are at a modern era low of just 163,000 units, and builders are limiting new construction to niche markets, such as infill locations or partially built-out developments where lot prices have fallen substantially.

Amid the gloom, there are a few bright spots. The northeast continues to do relatively well, particularly Boston and New York. The Washington, D.C., region has been strong for quite some time and seems to be weathering concerns about a slowdown in government spending. Activity also remains strong in most of the Texas markets, particularly Austin, San Antonio and Houston.

Even California is looking a little bit better, particularly Los Angeles and San Francisco, which are benefitting from growth in international trade and the entertainment and technology sectors.

While there will likely be a few positive developments in 2012, for the most part the year is likely to look like a rerun of 2011. Sales will likely languish during the early part of the year and pick up modestly in the spring and summer, but we are still a long way off from a true recovery in homebuilding. Conditions will not improve on a sustained basis until the backlog of distressed properties is cleared, which will enable the price discovery process to play out. From there appraisals and underwriting standards will normalize, which should set the stage for a sustainable recovery. There are other issues to be decided as well, including the issue of what the federal government’s role in financing homeownership should be and what to do with Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA).

Apartment construction remains the lone, unambiguous bright spot, and the recovery in that market still has quite a ways to go. Vacancy rates for apartments have fallen 1.5 percentage points to 5.6 percent over the past year and rents have increased 2.1 percent. Construction activity began to rev back up during the second half of last year and is expected to rise further this year. Development activity is still being constrained by concerns about sluggish job growth and credit availability. Sales remain strong, however, and the relatively high prices apartment communities are fetching should keep the development pipeline growing.

Residential improvements are also taking on renewed significance, having risen to 23 percent of private residential construction spending last year from around 16 percent at the height of the housing boom. Some of this increase reflects investor purchases of foreclosed properties, which are being repaired and remarketed either as for-sale properties or rentals. Homeowners are also likely spending a bit more refreshing their homes now that their time horizon for selling their current home has lengthened. This year’s rash of violent storms also contributed to the rise in renovation spending. Most of these trends can be expected to remain in place this year.

Consumer Outlook: Spending to Remain Constrained

Consumer spending remains constrained by a lack of real income growth and continued deleveraging. Real after-tax income grew just 0.9 percent in 2011 and is expected to rise 1.0 percent in 2012. Income growth has been restrained by sluggish job growth and higher inflation, particularly for necessities, such as food and gasoline. Despite only tepid income gains, consumers managed to boost their spending by 2.3 percent in 2011. That modest gain came at the cost of a 1.8 percentage point drop in the saving rate. Moreover, consumers benefitted from a temporary two-percentage point reduction in Social Security taxes that may or may not be renewed for 2012.

Wells Fargo’s forecast assumes the temporary payroll tax cut is extended another year. The initial tax cut provided little immediate relief, as it was more than offset by the surge in energy prices that occurred early last spring (2011). Failure to extend the temporary tax break, however, would likely have a more immediate negative effect and result in much weaker income gains during the early part of the year. Even if the payroll tax cut is extended, consumer spending is expected to slow following the 2011 holiday shopping season. Sales during the holiday season are off to a surprisingly strong start and look to be in line with our forecast of a 5.2 percent gain. Holiday spending was led by purchases of highly popular, and relatively high-priced, tablet computers and smart phones. Once this euphoria dies down, spending should quickly fall back in line with real after-tax income growth, which, unfortunately, is expected to rise just 1.0 percent in 2012.

The sluggish pace of income growth incorporates a modest improvement in job growth and slightly lower inflation rate during the coming year. Businesses are expected to add an average of 123,000 workers per month in 2012, while state and local governments continue to trim payrolls. Inflation is expected to moderate, as energy prices subside amid a slowing global economy.

Even with slightly stronger job growth, consumers hardly appear to be won over. The Consumer Confidence index ended the year at a level more typical at the depths of a recession than two and half years into recovery. Consumers’ view of current economic conditions is fairly dire and expectations for the future have been scaled back. One of the more disturbing aspects of the consumer confidence data published by the Conference Board is that for most of the second half of last year, more consumers expected their income to fall over the next six months than expected it to increase. The difference between these two responses has been a fairly reliable indicator of consumer spending in recent years, although the most recent data show a sharp deviation in the two series, with spending rising despite renewed worries about slower income growth.

Consumers’ worries about the economy appear to be well placed and are the key reasons we see consumer spending slowing right after the holiday season. Consumers simply lack the wherewithal to increase spending more than a 2 percent annual rate on a sustained basis. With the saving rate already drawn down and many consumers apparently putting their holiday purchases on credit, some payback appears to be in order for earlythis year. Hiring should gain momentum over the course of the year, however, providing a bit more income growth in the second half of the year.

2012 will be an interesting year. The outcome of this presidential election will probably go down in history as one of the most significant for the U.S.A.

 

Anirban Basu is ABC’s Chief Economist

Alison Premo Black is ARTBA vice president, policy and senior economist

Note: This article appeared in the January 2012  issue of the ACP magazine

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