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economicreview1220-1200

U.S. Construction Market Economic Review

Every year MacKay & Company surveys hundreds of owners and maintainers of construction equipment to understand their service and parts buying practices and rationale. The goal is to size the aftermarket for replacement parts and lubricants in our DataMac® CE Parts and DataMac® CE Lube services. MacKay & Company also reviews the current operating populations of the different construction equipment types and their usage, which is directly impacted by the current construction economy.         

With the total economy in the midst of a recession (October 2020), which is mostly the result of the COVID-19 pandemic and partly the result of factors that were adversely affecting the pace of economic growth toward the end of what became the longest expansion of the post-war era, the temptation is to talk about the outlook for construction activity and, by extension, construction equipment in the future. This is not possible (with any real validity) now for two reasons.

The first is that the data upon which one could begin to make projections about activity going forward do not yet exist. The statistical series on which to base a forecast is, for the most part, reported quarterly. The latest complete set of figures we have are for the second quarter of 2020.

The second reason is that all of the reports we have in hand so far describe only the first round of the pandemic's damage. From what we read, there is reason to believe another round of damage is likely. In addition to the structural changes that have already been observed, these changes strongly suggest that making any forecast at this stage would not be helpful. There is a lot to be learned looking at the past, especially how the structural changes are likely to unfold.

Here is the history of the construction activity components we follow as part of our measure of the trucking economy called Truckable Economic Activity (TEA®).

As seen here, construction activity rises and falls with the business cycle. While some recessions, like those of 1990-91 and 2001, have dealt only glancing blows to construction activity, other episodes, most notably that of 2007-2009, have done quite a bit more damage. We will see why as we look at the components of Total Construction.

There are three main components of Total Construction, and their shares of activity over time are displayed below. Nonresidential construction has averaged a 39% share of the total over the history of the series. Included in this category are all forms of building that are not used for habitation. This is where we find factories, oil wells (yes, that is a form of construction), shopping centers, hospitals and the like. Residential construction, which averaged 37% of the total, includes single-family and multi-family dwellings and hotels, dormitories, and other habitation places. Government construction, which accounted for the other 24% of the total, is mostly comprised of state and local government activity. This includes roads and other infrastructure, as well as buildings such as schools. As we shall see in a moment, it is residential construction that has had the most variability since 1967.

Total Private Construction, the sum of the Residential and Nonresidential figures, shows that we had two periods of sustained growth in construction activity starting in 1992, due mostly to demographics. In between, we had one of the most significant collapses in construction. The reasons for both the expansions and the collapse are essential in figuring out where the track of this series will be headed over the next several years.

The bulk of private residential construction is accounted for by how many single-family houses are built. While the multi-family housing industry is important, it is dwarfed by the single-family sector. In the 1990s, the combination of favorable demographics, based largely on the pace of household formation by the baby boom generation, generated strong demand for new housing. When, in the early 2000s, that trend was abetted by changes in the financing practices of major financial institutions, boom conditions quickly came about that culminated in the housing bust you see between 2005 and 2010. Over the past decade, activity rose steadily before reaching a plateau in 2018 and 2019.

Early reports suggest that the negative effects of the pandemic on housing construction activity have dissipated and that construction activity is returning to the pace it had earlier in the year. Were that to be maintained, we could see a total for 2020 that is not much different from that of 2019. Going forward, it appears that the demand for single-family housing is likely to receive a boost from the changes that are taking place in the way office work is being done during the pandemic. More and more employers are using remote working setups. It very well might turn out that a home office is a requirement for certain types of employment.

As seen in the track of Private Nonresidential Construction, there are some cyclical effects, but none as pronounced as those we saw with the residential component. There are two main reasons for this. The first is that the demand for this type of construction is determined by the demand for the activity the building is designed to support.

The second reason has to do with the way this type of construction is financed. Unlike housing, be it single-family or multi-unit, mortgages are not involved. And, the interest rate sensitivity of this type of activity is much less. Until the Federal Reserve adopted its quantitative easing policy during the 2007-2009 recession, the standard tool it used to slow down or stimulate economic activity was the level of interest rates that affected the price and availability of home mortgages. That, in turn, affected the pace of construction activity.

The larger concern for nonresidential construction in the future is the demand for commercial real estate types. From what we know now, it appears that we will need fewer office buildings, fewer shopping malls, fewer restaurants, and fewer hotels. Until we can get a better handle on just how much the demand for commercial real estate will change, we cannot make a reliable estimate of what to expect going forward. Unlike the residential component, where demographics and geography will prevail once the pandemic effects fade, the nonresidential component will have to wait for more news about demand changes. As was the case with private nonresidential construction, recessions do not figure heavily into the pace of public sector construction activity. Again, there are two reasons for this.

The first has to do with what is being built. Highways and schools don't care much about the business cycle. The second has to do with the budget and finance process of doing capital spending. Highways, schools and other long-lived projects are typically financed through bond issues or other long-term finance. Also, the appropriations are governed by the budget cycles of the government entities. These factors, in combination, reduce the variability of the series.

Let's take a look at what happened in the five years following the end of the 2007-2009 recession in State and Local Government construction.

That recession severely disrupted state and local finances. And those problems were made worse by the timing of the disruptions relative to the budget cycles we mentioned earlier. Most states run on fiscal years that end in June. This is a legacy of days when legislatures met during the summer because the roads were passable and the crops were in.

The short version of the story is that it took almost five years for budgets to come back into the kind of order that would allow the resumption of construction activity on a broad scale.

We are concerned that the pandemic's depth and breadth will have similar effects on state and local finances for the next several years – which would suggest that a rebound in activity in this sector could be a long time coming.

The Federal Government Construction chart shows what has been happening at the federal level. This is the smallest of all of the construction components, and it has been in a steady downward trend since the middle of the 1980s. The jump seen following the 2007-2009 recession is the infrastructure program that was part of the stimulus package that was applied in 2009 and 2010. The stimulus package that was enacted in 2020 did not have much in the way of capital spending. Over the next year, we expect to see more concrete evidence of the structural changes that are taking place already and those that are being discussed. While we are sure to go back to a more robust construction environment than that which we now have, it is equally certain that the composition of that activity will differ from what we have now. Once the broad parameters of what will be built and how it will be built are known, the demand for construction equipment will be better defined.


Robert F. Dieli is MacKay & Company's in-house economist, author of MacKay & Company's (www.MacKayco.com) quarterly TEA® (Truckable Economic Activity) Report and is president and founder of RDLB Inc., an economic research and management consulting firm based in Lombard, Illinois. Mr. Dieli left the Northern Trust in 2001 to start RDLB Inc. In addition to being an advisor to firms in the marketing, trucking, management consulting, and financial services sectors, RDLB Inc. also publishes Mr. Model, a monthly series of reports on current and prospective conditions in the U.S. economy, from its website at www.nospinforecast.com 

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