If economic performance reflected consumer and business ebullience, the United States would be in the midst of a historic boom.
As an example, a recent Small Business Economic Trends survey from the National Federation of Independent Business (NFIB) indicates that business confidence is at the 97th percentile, meaning business confidence is only this high 3 percent of the time. According to NFIB, “small business owners remain optimistic about the future of the economy and the direction of consumer confidence. We are encouraged by signs that optimism is translated into economic activity, such as capital investment and job creation.”
At the heart of the nation’s confidence is the ongoing strength of its labor market. In May, the construction industry added 11,000 net new jobs, conclusively indicating that the spring’s much weaker performance was a weather-induced fluke. National unemployment is down to 4.3 percent, near a 10-year low. Despite a divided American electorate, the Consumer Confidence Index has recently been at levels last observed in December 2000 (which represented the tail end of the tech-led recovery that began in 1991).
This might seem confusing given that the U.S. economy expanded just 1.2 percent on an annualized basis during the year’s first quarter, according to Bureau of Economic Analysis data. Consumer spending was weak, with personal consumption’s contribution to GDP growth smaller than it had been for many quarters. Export growth remains challenging in the context of modest global economic growth and a strong dollar. The U.S. auto sector also is experiencing growing difficulties, with many households already having purchased a vehicle this cycle and a large number of automobiles coming off leases.
On top of that, implementation of major portions of the president’s pro-growth agenda remains elusive, including promised corporate tax cuts, personal income tax simplification and an infrastructure-led stimulus package.
Despite it all, asset prices continue to zigzag higher, employment is expanding and there are indications of augmenting business investment. The Dow Jones Industrial Average recently established a beachhead at 21,000, the NASDAQ has been squarely above 6,000 for weeks and the S&P has exceeded the lofty 2,400 threshold more than a few times. A likely conclusion to reach is that those who control large sums of capital, including CEOs, remain confident that President Trump’s pro-business agenda will be implemented to a sufficient degree to allow for faster economic growth going forward.
Alternatively, it is possible that U.S. equity market investors never really priced in the probability of policy implementation. Rather, they have responded to a combination of positive economic data, improving corporate earnings and stable long-term interest rates. The probability of tax cuts is high, given the fact that the Republicans continue to be in control and can pass legislation if they remain united.
For now, many factors favor 2017 economic performance. For instance, despite the anticipation among many that faster growth is on its way and that the Federal Reserve will tighten monetary policy in response, long-term interest rates such as the 15- and 30-year fixed mortgage rates have hardly budged. The result is a perfect recipe for home price appreciation, with dwindling inventory meeting a growing number of workers able to leverage low rates.
Rising home prices have been conspiring with surging stock prices to unleash significant and positive wealth effects. This, in combination with improved wage growth, makes for a healthy consumer sector. Because consumers spent little during the initial three months of 2017, they have more to spend during the balance of the year.
The creation of jobs and rising wages are both a blessing and a curse. Wage pressures are building along with other sources of inflation, such as the cost of housing. One would expect that this will eventually translate into rising long-term interest rates, which could not only interrupt current housing market momentum, but also negatively impact the values of stocks and bonds in household portfolios and the value of real estate. That, in turn, would impact construction because the desire to build would decline while borrowing costs for purchasers of construction services (public or private) would rise.
The most likely scenario is that the U.S. economy will continue to expand in 2017, that jobs will continue to be created, and that interest rates will rise, but not by enough to completely undermine current housing market momentum or strength in the broader economy. The 2018 outlook remains unclear, but most economists seem to believe that current economic momentum will persist into next year, though financial market behavior could turn out to be far different. The outlooks for 2019 and 2020 are largely shrouded in mist.
SPENDING AND WORKER SHORTAGE IMPACT CONSTRUCTION CONFIDENCE
Remarkably, while business spending accelerates and consumer spending is set to do the same, nonresidential construction has managed to display signs of weakness. A staggering 13 of 16 nonresidential construction segments experienced spending declines in April. Noteworthy exceptions are office construction, which was flat, and commercial, which sustained only a small monthly decline. Both categories have seen a year-over-year spending expansion of 12.4 percent. Much of the weakness is due to public spending, including in categories such as highway and street, which had been expected to generate growth due to the passage of the FAST ACT in late 2015, and water supply, which had been targeted as a construction spending growth sector due in part to the experiences of Flint, Mich.
There are hotspots. The e-commerce revolution is helping to spur a boom in commercial construction, as Amazon and other large fulfillment centers around the nation look to expand. The office market also continues to be red hot, including in first-tier cities like New York, San Francisco and Boston, where global investors remain especially active. At nearly 19 percent, the communications category experienced the largest year-over-year increase in construction spending during a recent 12-month period due to increased outlays among those supplying data storage and communications services.
Construction employment expanded by 94,000 jobs during the first four months of 2017. Accordingly, construction is on track to grow by nearly 300,000 jobs this year, which would represent another banner performance.
However, the lack of skilled tradespeople means that many of the new hires either must be trained or are susceptible to generating low levels of productivity. The fact that construction employment continues to climb rapidly even in the presence of soft construction spending growth is consistent with the notion that many new hires are associated with low output. Indeed, research suggests that construction industry productivity has barely budged during the course of the past two decades. This might help explain why construction wage gains remain so modest. Between April 2016 and April 2017, construction wages rose 2.1 percent as low-skilled workers were averaged into statistics. When controlling worker productivity, compensation costs are rising closer to 4 percent per annum.
Soft construction spending growth in a number of segments coupled with growing difficulty identifying available talent may help explain the recent lull in industry confidence. Associated Builders and Contractors (ABC) reports that its Construction Confidence Index was at the lowest level observed in three years during the latter stages of 2016. During the second half of last year, expectations for sales, profit margins and staffing levels fell significantly.
REASONABLY STABLE BACKLOGS AHEAD
ABC’s Construction Backlog Indicator (CBI) rose to 9 months during the first quarter of 2017, up 8.1 percent from the fourth quarter of 2016 and 4 percent on a year-over-year basis. For the first time, every category—firm size, industry and region—registered quarterly growth in CBI. Among the big winners were firms in the western United States and those with annual revenues between $30 million and $50 million per annum. If the Trump administration can pass an infrastructure-led stimulus package, it would be excellent for the U.S. nonresidential construction industry and the near-term performance of the U.S. economy. If the right projects are selected and sagaciously financed, it also will be positive in the long term.
However, infrastructure spending will be particularly impactful if it is also accompanied by a program to train skilled workers. America has many pressing economic issues, including its $20 trillion national debt and impending Medicare and Social Security insolvencies. But its greatest issues may be the lack of labor force participation and low productivity. Ultimately, productivity is the arbiter of living standards. The lack of significant improvement in the U.S. standard of living has much to do with an accompanying lack of productivity growth. The dearth of trained workers easily remains the leading complaint among America’s construction firms regarding the nation’s business climate.
For the balance of 2017, most nonresidential construction firms can expect reasonably stable backlogs and satisfactory profit margins. As has been the case in recent years, strength in certain construction segments will only be partially countervailed by weakness in others. There are indications of mini-bubbles forming in certain commercial real estate markets, which along with lingering policy uncertainty renders the 2018 outlook far murkier.
Anirban Basu is chief economist of Associated Builders and Contractors. For more information, visit abc.org/economics.