A strong highway and bridge construction market is expected to power the construction industry ahead in 2007, countering such worrisome factors as the slowdown in the residential housing market, according to leading economists interviewed by Construction Equipment Guide (CEG).
“We experienced an almost unbelievable increase in highway and bridge work in 2006; I think we’ll see some leveling off in 2007, but it will stay at a record level,” said William Buechner, chief economist of the American Road & Transportation Builders Association (ARTBA) in Washington, D.C.
Buechner said the 16.5 percent increase over 2005 in the value of road and bridge construction put in place “was the biggest increase since 1984 and an extraordinary year for contractors and dealers.”
Kenneth Simonson, chief economist of the Associated General Contractors of America (AGC) in Arlington, Va., told CEG: “Yes, highway work has been at a record pace. I think this market will continue to rise in 2007, but not as dramatically as we’ve seen so far in 2006. I expect its growth rate next year to be about 8 percent, about half of this year’s growth. We’ll see some increase in the dollars going into projects, but I’m not sure that the number of miles paved or bridges built will actually increase. This is because we’ve had such a big jump in materials costs that many states are having trouble awarding projects. Bids are coming in much higher than they estimated.”
Economists expressed optimism about the construction industry’s prospects for the year ahead, but tinged this with concern about such worrisome factors as the aforementioned costs of materials, the “leveling-off” of the housing market, a possible rise in energy prices, a higher-than-desired inflation rate, a possible increase in interest rates by the Federal Reserve, and “doomsday scenario” Hurricane Katrina-type events. They worry that, if negative events combine in these areas, the U.S. economy could enter a recession.
Construction Spending Up Over 2005
The U.S. Census Bureau of the Department of Commerce announced on Dec. 1 that total construction spending, both private and public, amounted to $1 trillion during the first 10 months of 2006. This was 5.9 percent above the $952.5 billion for the same period in 2005.
The announcement said that construction spending during October, however, was at a seasonally adjusted annual rate of $1.18 trillion, which was 1 percent below the September estimate of $1.19 trillion (annualized). The October figure is 0.5 percent above the October 2005 estimate of $1.17 trillion.
Residential Housing May Make Comeback
The residential housing market, which, with its associated services, accounts for approximately 15 percent of Gross Domestic Product (GDP), slumped as expected in 2006. Housing starts tend to be a leading indicator of the health of the construction industry and the U.S. economy. The National Association of Home Builders (NAHB) in Washington, D.C., forecasts this market will rebound, however, about midyear of 2007, which would be very positive for the U.S. construction industry and economy.
“We’re still expecting 1.5-million single-family housing starts during 2006, with this falling to 1.3-million starts in 2007,” Bernard Markstein, NAHB’s director of forecasting in Washington, D.C., told CEG. “This compares with a record 1.7-million single-family housing starts in 2005 and 1.6-million starts in 2004. Adding in multi-family housing starts brings total starts to 1.8 million starts in 2006 and 1.6 million in 2007.”
An NAHB announcement, however, said single-family housing starts dropped 15.9 percent in October (to an annualized rate of 1.2 million) while multi-family starts were down 9.1 percent to a rate of 309,000 (bringing total housing starts to 1.5 million). Residential construction permit applications fell 6.3 percent between September and October. Starts and permits have traditionally been indicators of the outlook for the construction equipment industry.
“We still have an inventory overhang, which is being worked off and demand is clearly down,” Markstein said. “I think we did more building than buying in the last few years. I think we’re now experiencing a pause as we work off the overhang.”
Markstein and other economists told CEG they do not expect the housing “bust,” which follows five “boom” years, to lead to an economic recession.
“Most forecasters, ourselves included, agree that, although the slowdown in residential construction is a drag on the economy, we’re not talking about a sharp-enough drop-off to lead to a recession,” Markstein said.
“We think we’re going through a period of underbuilding to bring things back into line, and that this adjustment phase will be over by the spring of next year . We’ll see a flattening and a little bit of a turnup towards the second half of next year. This will be primarily residential, but we also expect non-residential to continue to expand through next year and 2008. Non-residential is definitely a contributor to the economy at this point.”
NAHB Chief Economist David Seiders said in an association news release: “As builders continue to work off excess inventory, we expect that new housing starts will bottom out by the middle of 2007, with most of the decline occurring this year. Meanwhile, economic conditions and results from our recent builder surveys show that the demand side of the market appears to be stabilizing as affordability measures move up. Mortgage rates and energy prices have been declining in recent weeks, applications for new home loans are up, consumer sentiment is rising, and employment and income growth are on the rise.”
Prices of Homes Became Too High
Markstein said demand for homes slackened “because housing prices went up so dramatically.”
“All of a sudden, people stepped back and said ’Wait, I can’t afford this anymore’ so there was an oversupply,” he said. “Then, when builders saw demand dropping off, they said ’Wait a second, I can’t afford to keep building like this.’ Prices had just moved too high. Mortgage rates are not the problem. The effective rate of 6.25 percent for the week of Nov. 23 is only about 65 basis points higher than July of 2005.”
The National Association of Realtors reported on Nov. 28 that home prices continued to slide in October, with the median price of existing homes falling 3.5 percent (to $221,000) from a year earlier. This was the largest year-over-year price decline on record.
According to McGraw Hill Construction’s Construction Outlook for 2007 (see Balancing a Drop in Single-Family Housing on page 40), “By the second quarter (of 2006) it became clear that the boom in single family housing was deflating, and it was occurring at a faster pace than widely anticipated. On a percent change basis, this year’s downturn for single family housing will match what took place in the early 1990s, marking a significant shift from the supportive role played by single family housing over the past five years.”
ARTBA’s Buechner observed that the housing slowdown could have at least one good effect on highway construction: “It will free up a lot of materials capacity, and that may help keep prices under control for awhile.”
Highways, Bridge Work Set Record
“The number one good thing in 2006 has been the transportation construction market,” ARTBA’s Buechner told CEG.
ARTBA said that “through September, construction on highways and bridges has totaled $56.7 billion, up 16.5 percent from $48.6 billion during the first nine months of 2005 … Pavement construction has totaled $35.8 billion, up 6.3 percent from the 2005 pace … the first substantial increase in five years.”
Bridge construction through September totaled $15.7 billion, up 41.5 percent from the previous September.
Buechner, AGC’s Simonson, and McGraw-Hill said much of the increased work came from increased funding from SAFETEA-LU, the new six-year transportation bill that was passed in 2005.
“A lot of projects had either been deferred or had continued at prior-year levels; SAFETEA-LU ended that uncertainty about when the funding would come through,” Simonson said “It also boosted spending totals, as you had this catch-up and jump-up growth.”
The transportation bill provides 38 percent more funding than the previous six-year bill.
McGraw-Hill said Congress is expected to pass a 10 percent increase for the federal-aid highway program and that “highway and bridge construction for the nation is estimated to rise an additional 9 percent in 2007 to $54.6 billion; higher material costs mean that the real growth for highways and bridges in 2006 and 2007 will be closer to 5 percent.”
Delay in Appropriations
Although SAFETEA-LU’s guaranteed funding levels include an increase of $3.4 billion for the highway program in 2007 (to $39.1 billion) and $470 million in the transit program, the actual appropriations bills releasing the money to state departments of transportation haven’t been enacted.
“We’re three months into the current fiscal year and we don’t have a transportation funding measure in place while transportation funding operates under a series of continuing resolutions,” said David Bauer, ARTBA’s senior vice president of government affairs. “The actual appropriation bills still aren’t in place and funding is still an open question, complicated by the fact that we have a huge transition going on at Capitol Hill.”
Commented Christian Klein, vice president, government affairs in Washington, D.C., of the Associated Equipment Distributors (AED): “The short-term uncertainty surrounding the 2007 highway program is causing some heartburn. Whether this is something that the next session of Congress will be able to work on right away is questionable. It’s not the end of the world but people in business like certainty and there’s a lot of uncertainty surrounding the money that will ultimately get out there.”
Cost of Materials Is Sky-High
The cost of construction materials is expected to be a continuing problem in 2007.
“The cost of materials was up 12.5 percent and has been up pretty substantially in 2006,” said ARTBA’s Buechner. “In just three short years we’ve had a 30 percent increase in the cost of building highways and bridges and we expect this rise to continue.”
Buechner said that “asphalt has been a big concern; so far this year [November 2006], asphalt costs are up about 60 percent over last year, paving mixtures about 27 percent and diesel fuel about 15 percent last year and another 15 percent this year.”
A continued rise would drive up the cost of construction in 2007, forcing state and local governments to stretch their budgets, with some consequent leveling-off of highway construction, which would still, however, remain at very high levels.
AGC’s Simonson said that “eight percent growth in highway spending is a figure most people would be pleased with considering this very-rapid cost escalation.
“One problem which is likely to surface in 2007 is that high gasoline prices would cut into state and federal trust fund revenues. Pump gallons purchased have been growing more slowly. This means some states are really going to have trouble coming up with money to match their federal funds. That’s a serious problem given how unwilling voters and legislators have been to support increases in the gas tax.”
ARTBA’s Buechner sees some light at the end of the cost tunnel, however.
“The last time we had a big increase in the cost of highway materials, it kind of backed off the next year. We had a little bit of a reduction. If that happens, it would certainly be positive for 2007. If materials costs come down, state budgets will support more projects.”
Costs Impact Equipment Manufacturers
The slowing of the housing economy and building starts, and the pressure of increased input costs for steel, energy and raw materials are putting pressure on equipment manufacturers to raise prices.
“There will be some price and profitability pressures in 2007 that manufacturers will have to deal with in different ways,” said Nick Yaksich, vice president of global public policy at the Washington, D.C., office of the Association of Equipment Manufacturers (AEM). “Everyone has seen a little bit of inflationary pressure and China continues to provide a strong demand for equipment.”
Construction machinery manufacturers participating in AEM’s annual outlook survey for the year ahead predict 2007 construction equipment business to increase 3.9 percent in the United States, five percent in Canada and 6.4 percent in other worldwide markets. These are smaller gains than they see for 2006, in which they expect gains of 11.2 percent in the United States, 12.7 percent in Canada, and 10.9 percent in other worldwide markets.
“Although the U.S. economy is starting to show signs of slowing down, it has displayed surprising resilience,” said Gerry Shaheen, 2006 AEM chairman, who is a group president of Caterpillar Inc., Peoria, Ill.
“For construction equipment manufacturing, the U.S. housing market has leveled off, but this has been offset by strength in non-residential construction, roadbuilding and sales to global markets. We are cautiously optimistic that construction machinery sales will continue to grow through 2007, although at a more moderate pace than 2006. To put this in perspective, 2004 and 2005 sales were among the highest in recent years for the U.S. construction machinery manufacturing industry,” he said.
Survey respondents predicted that lifting equipment would have the biggest increase in sales in 2006 – 32 percent in the United States, 28.5 percent in Canada, and 13.8 percent in other worldwide markets. They also forecast that these sales would increase 10.4 percent in the United States and Canada next year, and 12.3 percent in other worldwide markets.
In contrast, they predicted sales of earthmoving equipment would increase 3.9 percent, 5.7 percent and 11.6 percent this year, and in 2007 decline 0.3 percent in the United States, increase 0.7 percent for Canada and increase 2.7 percent for other export markets.
Equipment Shipments Down
The Census Bureau has announced on Dec. 5 that the seasonally adjusted value of manufacturers’ new orders for construction equipment fell 11.7 percent in October compared with September – to $3.7 billion. It said the value of construction equipment shipments fell 2.2 percent (to $3 billion) in this period.
The construction figures were part of a large drop in new orders for manufactured goods in October. New orders decreased $19.3 million, or 4.7 percent, to $390 billion. This was the largest decrease since July 2000. New orders for manufactured durable goods decreased $18.8 billion, or 8.2 percent, to $210 billion. This also was the largest decrease since July 2000.
Equipment Distributors Concerned About Priorities
AED’s Klein said dealers are worried about possible actions of the new Congress with its Democratic majority.
“Obviously we are concerned about what the new Congress means in terms of our work, whether, for instance, the Democrats will recognize the Death Tax and product liability reform as priorities,” he told CEG.
“Right now there’s tremendous uncertainty about whether this tax, which repeals in 2010, will come back in 2011. We are less optimistic about the prospects for resolving this in a Democratic Congress than in a Republican one, so our members are continuing to put business resources into Death Tax planning.”
Klein said a survey of members indicated that 51 percent regard highways as their first or second most important market.
“About 7 percent of each dollar spent on highways makes its way into the equipment industry, so the fact that highway appropriations will probably not be approved until 2007 makes things quite dicey,” he said.
“The highway program is not a primary driver of the construction industry but it does provide a nice cushion in case there is a downturn. Obviously, we are seeing a downturn in the housing market so hopefully the more-robust federal highway program will more or less act as a buffer there.
“As we go into 2007, we feel tremendous challenges are looming for the federal highway program. How we pay for it, what for, and the solvency of the Highway Trust Fund are in question out past 2009. I do think the Democratic Congress will provide us with a forum to have an open and honest debate about how to pay for infrastructure down the line.”
Inflation Still Worrisome
The Bureau of Labor Statistics (BLS) in Washington said the consumer price index (CPI) rose at an annualized rate of 3.1 percent in October. Price rises, of course, affect equipment prices.
“The CPI has been trending at the upper bounds of a comfortable inflation rate,” BLS economist Peter Haro told CEG. “I would not be an alarmist, but we’re at the point where we don’t want the rate to get much higher than 4.”
Haro said that the 3.1 “is a very-low reading because of the drop in gasoline prices; the rate was running in the range of 3.4 to 4 at the beginning of the year [when gas prices were higher]. The comfort level is between 1.5 percent and 3.5 percent.”
Haro said the core price index (all items except food and energy) reached 2.9 percent in September and 2.7 percent in October. “We normally like a core index of 1.5 to 2.5, where it was at in 2005,” he said.
Economists said uncertainty about inflation would make the Federal Reserve reluctant to ease interest rates, or might lead the Fed to even raise rates. It has not lowered rates since June 2003, and stopped raising them in August 2006, after 17 consecutive increases. Construction industry sources said further increases in rates would be very negative for the industry, and many expect the Fed to begin lowering rates again in 2007, which would be a plus for construction.
The benchmark federal funds overnight lending rate on Dec. 4 was 5.25 percent, compared with 4 percent on Nov. 30, 2005, and 2.03 percent in December 2004.
Productivity Flattened in Third Quarter
The BLS said productivity (output per hour) in the non-farm business sector (including construction) grew 4.3 percent in the first quarter, 1.2 percent in the second quarter, and zero percent in the third quarter. This compares with productivity growth of 2.3 percent in 2005.
Output growth (indicating the market value of all goods and services not divided by hours of labor input) in the non-farm business sector was at an annual rate of 6.7 percent in the first quarter, 2.7 percent in the second, and 1.6 percent in the third.
“Over the course of the year, output growth has trended down,” said a BLS source, who did not wish to be identified because the figures originated with the Department of Commerce rather than Department of Labor.
Soft Landing Seen in 2007
The Commerce Department reported on Nov. 29 that real gross domestic product (GDP) grew at an annualized rate of 2.2 percent in the third quarter of 2006.
McGraw-Hill’s Construction Outlook predicts a “soft landing” in 2007, “with economic growth slipping from an estimated 3.4 percent in 2006 down to about 2.5 percent.”
The unemployment rate was 4.4 percent in October, a historic low, while exports were a record $123.2 billion in September.
Weaker Dollar Helps Equipment Exports
Exports to China increased 35 percent through November. China’s trade surplus with the United States, however, was more than $200 billion in 2005.
The value of the dollar in foreign exchange has dropped approximately 10 percent in 2006, to approximately $1.33 on Dec. 1 for one Euro. This weaker dollar makes U.S. exports of construction equipment and other products, to countries like China, less expensive for overseas buyers and imports more expensive for them, helping to spur an industrial revival in the United States, making U.S. products more competitive overseas, and lowering the trade deficit.
The down side of the weaker dollar is that it could discourage foreign investment in the United States, making a “hard landing” for the economy more possible.
The U.S. trade deficit is now almost one trillion dollars a year. CEG