Near-Term Outlook is Not Upbeat, but Hope Springs Eternal - Articles

Dec. 2020

Shielded both by its enviable status as an essential industry and by a considerable level of backlog coming into the year, a significant fraction of construction activity was able to persist. Some segments actually strengthened, including those related to the nation’s surging e-commerce sector. There was also a significant level of investment earlier this year to bulk up the nation’s healthcare capacity. As if that weren’t enough, there has been a surge in demand for single family homes, further supporting construction activity.

But more recently, the shields that have served to protect the construction sector have begun to weaken. Many projects have been postponed. Others have been cancelled. Supply chain disruptions have rendered certain inputs difficult to obtain. Some materials prices, like those attached to softwood lumber, have been surging during much of the crisis. Project interruptions have been plentiful, including due to COVID-19 infections among workers.

Then there are certain shattered economic fundamentals to consider. Many restaurants have been shuttered. Retailers have gone bankrupt in large numbers, including the likes of JC Penney, J.Crew, Brooks Brothers, and Neiman Marcus. Professional businesses have vacated considerable volumes of office space in the context of madness, mayhem, and remote work, much of it now available for sublease. Financing conditions are tighter than they were a year ago. And the pandemic remains pervasive, achieving a crescendo of public health damage even amidst pronouncements of vaccine breakthroughs. COVID-19 is set to go out with a bang until it meets its eventual demise. In the midst of it all, there were presidential and congressional elections.

The uncertainty that presides over the marketplace is apparent in the latest Confindex readings. True, the overall survey reading rose during the fourth quarter of 2020 as did all index subcomponents, but when one analyses year-over-year patterns, it becomes clear that the prior equilibrium, one associated with rapid revenue and margin growth for many contractors, no longer exists.

During the most recent survey administration, the Overall Confidence Index rose to 93 from the third quarter reading of 87. That represents an increase approaching 7 percent in the Index’ overall value. But even with that improvement, the Overall Confidence Index is down more than 24 percent on a year-ago basis. The quarterly improvement is likely the result of a pace of economic recovery that has been surprising to many. Since May, the nation has recovered more than half of the jobs it lost in March and April. Unemployment, which peaked during the current cycle at 14.7 percent in April, declined to 6.7 percent by November.

Despite that, the U.S. economy is smaller than it was a year ago. Unemployment is roughly double what it was coming into the crisis, and the renewal of economic lockdowns will likely put an end to the initial phase of recovery. All of this helps explain why the Business Conditions Index rose nearly 13 percent during the fourth quarter on a quarterly basis, but remains down an astonishing 34 percent on a year-over-year one. For many contractors, the construction industry is simply more difficult to navigate relative to a year ago, when the obsession among many industry leaders was finding enough skilled workers to support ongoing growth.

Anecdotal evidence indicates that many contractors are worried about project financing. Interest rates remain low, and economic conditions are not nearly as bad as they were in the spring. This set of circumstances helps explain why the Financial Conditions Index rose 3 percent during the fourth quarter relative to the third. But this sub-index is still 18 percent below its year-ago level.

Financing conditions are likely to vary by sector. Residential land developers are more likely to secure equity and debt partners under current conditions than developers of Class A+ office or shopping center space. Despite pockets of strength, many CFOs continue to express alarm regarding financing conditions. The Financial Conditions Index is only 7 percent above its December 2008 level, arguably the most challenging period of the global financial crisis of a bit more than a decade ago.

The Current Confidence Index rose 5 percent from the prior quarter, but remains 35 percent below its year-ago level. This represents the largest year-over-year decline of any of the indices, which is consistent with the notion that many construction financial professions are deeply concerned about near-term dynamics.

With opportunities to bid on new projects having become scarcer in many segments recently, backlog continues to falter among many firms. The near-term economic weakness likely to become apparent this winter will further delay construction’s ultimate recovery. With many firms already staring down diminished backlog, there is cause for concern.

The all-important Year-Ahead Outlook Index rose 7.1 percent during the quarter, and is down 10 percent from the same period one year ago. This is at least in part a reflection of the divergence in near- and long-term outlooks.

While the nation may be facing another economic downturn in the near-term, blockbuster announcements by Pfizer, Moderna, and Astra Zeneca, among others regarding successful clinical trials targeting COVID-19 vaccine development have lifted the longer-term outlook. Based on what is known, it may be reasonable for stakeholders to expect a COVID-19-free summer of 2021. That would set the stage for a boisterous and most welcome economic expansion next year, which presumably will improve circumstances for many within the next 12-month period to come and beyond.