U.S. Construction Outlook – 2014 Fourth Quarter Update

Tom Wiggins
After a 2.1 percent first quarter decline, GDP strengthened significantly in the past two quarters with annual growth rates of 4.6 percent in the second quarter and 3.5 percent in the third quarter (advance estimate).

Overview of the Economy

Increases were broad-based including consumer spending, inventories and business investment and state and local government spending. Federal government spending continued to decline. Annualized GDP growth through three quarters is about 1.8 percent. The official recovery from the Great Recession began five years, yet the economy seems to just be developing the foundations to support robust growth.

Economists believe growth will be strong in the fourth quarter, but annual GDP growth for 2014 will likely be similar to last year, 2.2 percent. If so, the economy will conclude a five year period of positive, yet subpar, growth averaging just over 2 percent for the period. Most GDP growth projections for 2015 are above 3 percent.

Real GDP Growth

200920102011201220132014 (e)
Growth -2.8% 2.5% 1.6% 2.3% 2.2% 2.2%

Economic indicators show the economy is gaining a firmer footing. The Federal Reserve (Fed) ended its bond buying program in October. The inflation measure watched by the Fed remains below the 2 percent threshold set by the Fed to act on interest rates. Indications are the Fed will hold off raising interest rates.

Some positive signs of growth stabilizing:

  • The Conference Board Leading Economic Index® (LEI) continued to indicate expansion increasing 0.8 percent for in September. The Consumer Confidence Index rebounded in October after falling in September. It has trended up most of the year.
  • The Institute for Supply Management (ISM) Manufacturing and Non-Manufacturing Indices, leading indicators, continue to show an economy in expansion. The Non-Manufacturing index for September was 58.6 percent and the Manufacturing Index was 56.6 percent. Both down slightly from August, but still indicating expansion.
  • The trend this year for factory orders and durable goods, reported by Department of Commerce, is generally up, but they fell in the last report. Inventories continue a long steady rise.

Employment and wages remain closely watched by analysts. Jobs added each month averaged just over 225,000 for first ten months of 2014. Employment grew about 1.5 percent year over year. Employment is now at pre-recession levels. However, construction employment remains lower than pre-recession levels and its 10-year average.

A significant employment question, which is unanswered, concerns how much excess capacity is there in the employment market. How many potential workers are not showing in the statistics? Many people are in jobs that are part-time or lower paying. This would indicate untapped capacity remains. The employment-population ratio is 59.3, a slight improvement over a year ago, but below the low 60’s leading up to the recession.

The U-6 (total unemployed plus marginally employed) unemployment rate seems to support this. It is 12.0 percent, compared with 13.6 last August. The unemployment rate in September 2014 was 5.9 percent, down from 7.0 percent in September 2013. The September 2014 construction unemployment was 7.0 percent.

Wages are declining slightly or stagnant at best since the recession ended, which helps explain the tepid nature of the recovery over the past five years. However, indications suggest that wages may show growth pressure soon.

While stagnant income does not help consumer spending, a significant component of GDP, the Commerce Department’s personal consumption indicates modest growth so far this year. It could end the year at over 2 percent after just 1.2 and 1.5 percent growth for the two prior years.

The positive trending economic indicators bode well for growth in the construction industry. A series of quarters with GDP growth over 3 percent will support some level of continued growth. There is increased optimism that the non-residential construction sector is improving. The AIA Architectural Billings Index has been above 50, indicating an increase in billings since May. The Billings Index is a leading indicator of construction activity.

Overall, construction activity continues to increase, but this is uneven across sectors and location. The Census Bureau estimated the seasonally adjusted annual construction in September at $950.9 billion. The estimate indicates a 2.9 percent growth over September 2013. Non-residential construction was estimated at $601.9 billion, which is a 4.2 percent growth. Since 2008, non-residential posted only one year of growth, 2012. Public construction will likely post a small growth in 2014, reversing a four year decline. Improvements in state and local revenues contribute to the increase. Residential construction continues to expand, but the pace is much slower than last year.

The 2014 non-residential sector put-in-place value will grow about 5 percent as the economy sustains GDP growth above 3 percent in the fourth quarter. In the private sector, hospitality, office, commercial, power and manufacturing are key growth areas. The energy sector has created robust construction markets in several areas of the country. If oil prices fall continue to fall, this market will be adversely affected.

Threats to a continued robust economic expansion remain. Perhaps the most uncertain, and potential impactful, are geopolitical. Struggling economies in other areas will affect trade; the Euro zone economies are sluggish and the Japanese economy remains troubled. China’s economy continues to grow, but at a slower pace.

With a strengthening economy, the non-residential sector growth will be stronger next year reaching about 7 percent. Growth will remain uneven. In areas experiencing more robust growth alarms are already being sent about adequate labor supply and higher bid prices.

As the construction sector growth continues the long slack construction labor market is tightening. The Great Recession combined with the aging workforce may have short term impacts on the construction labor market. Nationally, 2015 should not have a sharp rise in labor rates, 3 and 4 percent. Very active markets, where labor supply is tight, will pay a premium.

The New Construction Materials Producer Price Index produced by the Bureau of Labor Statistics shows material prices increased about 2 percent in 2013. Material price increases this year should remain low, between 2 and 4 percent.

Construction prices have risen moderately over the past couple of years. Various measures, which do not truly reflect market conditions, are between 1 and 3 percent. This year should show a slight increase between 2 and 4 percent nationally. A price index for non-residential buildings produced by the Department of Commerce shows escalation this year will be less than 2 percent. The series of indexes in the Producer Price Series attempts to reflect some aspects of market pricing at the subcontractor level. As a national average, it appears competitive market forces continue to keep prices from rapidly rising. The accompanying chart shows price movement for the four subcontractor trades they measure.

Escalation in 2015 should again increase slightly if the market expands as predicted, perhaps in the range of 3 to 5 percent. Some of the hotter U.S. markets will experience less competition and escalation will be above this range.