Upcoming Year Will Be Solid but Outlook Fuzzier Beyond That
Confidence among construction industry chief financial officers remained relatively unchanged in the third quarter of 2017. After declining by more than five percent in the second quarter, the overall CONFINDEX reading edged to 124 in the third quarter, up a bit less than one percent from the second. The overall index is up 1.6 percent from a year ago. CFOs were generally upbeat at this time last year. That hasn’t changed.
During the second quarter, many CFOs expressed frustration that pro-business legislation emerging from Washington, D.C. failed to materialize. Expectations for a large-scale stimulus package working in conjunction with proposed tax cuts had induced a number of CFOs to ramp up their expectations for the broader economy and the U.S. construction industry during 2017’s initial quarter. Just one quarter later, hopes for significant legislative achievement appear to have abated.
Diminished expectations were not the story during the third quarter, however, largely because many construction firms remain busy and enjoy healthy backlog. The Business Conditions Index rose 3.2 percent during the quarter, rising from a reading of 124 to 128. This sub-index is up 4.1 percent on a year-ago basis, the largest year-over-year increase among any CONFINDEX indicator.
The Business Conditions Index largely responds to demand side phenomenon. Despite sluggish public sector construction spending, demand for construction services in the U.S. remains generally strong. Over a recent twelve-month period, the U.S. construction industry added more than 200,000 net new positions. But that has also further exacerbated skills shortfalls, with more than 90 percent of respondents now stating that the lack of adequately trained workers is impacting their businesses and remaining a cause for elevated concern.
Among the sub-indices, the only one to decline during the quarter was the Financial Conditions Index. It fell by nearly two percent during the third quarter, from 123 to 121. This index is unchanged from a year ago.
Most construction firms should probably view the stability of the Financial Conditions Index favorably. After all, financial conditions were reasonably benign a year ago and apparently that hasn’t changed, despite concerns of increasingly overbuilt commercial
construction markets in certain metropolitan areas.
Near-Term Plentiful Demand Influence
The Current Confidence Index rose from 126 to 128 during the third quarter and is up by nearly two percent on both quarterly and year-over-year bases. That should come as no surprise as this is consistent with the notion that the near-term will continue to be one associated with plentiful demand. The U.S. economy itself has picked up in recent quarters after a sluggish 2016. If one embraces the rule of thumb that suggests that nonresidential construction follows the broader economic business cycle by roughly one year, then today’s healthy economic activity should translate into stable construction activity or better in 2018.
This is reinforced by the Year-Ahead Outlook Index, which rose incrementally during the third quarter (119 to 120) and is up by nearly three percent on a year-ago basis. Nearly one in four construction firm CFOs indicate that demand for construction services is not a concern at all. Another 70 percent are watching with some concern, but hardly anyone is highly concerned.
While demand will remain robust for many contractors, rising labor and materials costs continue to constrain optimism among a growing fraction of construction financial professionals. Twenty-three percent of third quarter respondents indicated that profit margins have shrunk recently and another four percent indicate that they have become significantly smaller. That translates into 27 percent of respondents who have experienced smaller profit margins recently, up from 18 percent one year earlier.
However, the recent uptick in demand, including needs related to the damage caused by recent storms, has brightened the outlook for profit margins. Only 12 percent of respondents expect their profit margins to be worse a year from now. That compares to 34 percent who expect them to improve. Given rising input costs, this implies that the typical CFO expects that demand and pricing power will be strong enough to more than fully countervail growing construction service delivery costs.
The U.S. construction industry continues to recover. Job growth remains brisk and private construction spending has continued to climb despite growing concerns regarding overbuilt multifamily, office, and lodging markets, particularly in certain tier 1 cities.
Most CFOs no longer seem to be counting upon major pro-business legislation to accelerate activity further. Were demand more tepid, this would be more problematic. Moreover, it’s not clear whether the industry could secure enough workers to successfully implement a large-scale infrastructure package at this time or deal with a significant acceleration in economic growth induced by other conceivable factors.