2008 economic outlook

A strong commercial construction market and steady manufacturing sector bodes well for distributors next year

by Rich Vurva and Clair Urbain

Economists who follow the U.S. manufacturing industry expect growth next year, but it’s not likely to outpace the overall economy. The general consensus among experts contacted for this story is that the business climate should remain upbeat for the months ahead, which should translate into a good year for distributors.

“My outlook for the rest of this year and next year is that manufacturing growth will be more in line with the economy as a whole,” says Dave Huether, chief economist for the National Association of Manufacturers. “I think you’re looking at growth in the manufacturing sector near 3 percent. It’s an improvement of what we’ve seen in the last six months, but not as strong as what we saw a couple of years ago.”

Cliff Waldman, an economist with Manufacturers Alliance/MAPI, agrees that manufacturers should expect to see growth throughout the end of 2007 and into 2008.

“Our forecast is for manufacturing to continue growing this year, but at a much slower rate than last year. Last year it grew 4.6 percent. We think it will grow at 2.0 percent for 2007 and 2.9 percent in 2008,” he says.

Both economists agree that the housing downturn had a negative effect on manufacturing in 2007. If housing rebounds in 2008, it will mean good news for manufacturing as well.

Looking back to the first quarter of 2007, economic sectors such as motor vehicles, furniture, wood products and non-metallic mineral products were all in a recessionary mode, Huether says. Except for motor vehicles, they’re all closely connected to housing. Midway through 2007, those sectors started to show positive signs.

“This tells me the impact the housing downturn has had on manufacturing may have run its course. They’ve all moved from a recession to some form of recovery,” he says.

Waldman agrees the housing market’s downturn had a negative impact on manufacturing, but manufacturers benefited from business investment and commercial construction.

“In the fourth quarter of last year and the first quarter of this year, we saw a distinct softening in activity. Manufacturing was flirting with a contraction. There were a lot of reasons for that, but the housing bust had a lot to do with it. It softened growth and created softness in markets important to manufacturing,” he says. “We see slower but continued growth for manufacturing this year and somewhat better growth as long as the housing market recovers in 2008.”

Distributors that serve high-tech manufacturers will benefit the most in 2008. Economists expect industries such as computers and electronics, aerospace, medical equipment and supplies, and plastics and electrical supplies to be among the strongest performing industries.

“They’re all being driven by good domestic growth but, more importantly, by exports,” says Huether. “In the last year or so, manufacturing exports have grown by more than 10 percent, which is twice as fast as the growth in imports, which was at about 4 percent. So, the trade situation has improved measurably for manufacturers in the past two years.”

Exports and business investment are the two biggest demand drivers of American manufacturing, adds Waldman. “The global economy demands high-tech capital and technology that makes production on the factory floor more efficient. Sectors that produce high-tech capital goods will do quite well.”

Strength in the commercial construction market should continue through the long term, according to U.S. construction economists. However, inflationary pressure from tighter supplies, increased transportation fees and higher prices for raw materials persist, driving up building costs that could squeeze profits for contractors caught in the middle.

“Construction tends to follow a 20 year cycle, but in most cases, commercial/non-residential construction doesn’t boom and bust at the same time as residential. Residential has slowed in 2004, 2005 and 2006 and will be slow until the end of 2008. Then housing should begin a rebound,” predicts Jeff Taylor, economist at Associated Builders and Contractors (ABC).

“Commercial construction will begin to slow down after 2008, but won’t be as dramatic as residential because the market isn’t nearly as speculative as the residential market, which tends to get ahead of itself. There will be a slowdown in some areas, but unless the consumer market falls hard, we won’t see a meltdown in commercial construction,” he says.

Residential, non-residential outlook
Although the popular press has heralded the collapse of the residential market, Put-in-Place numbers from the U.S. Census Bureau suggest that while there has been a drop in residential construction, 2007 still posts the fourth highest year of activity.

“We are predicting a recovery for residential construction in 2008, but it could be as late as 2009. We believe that 2008 will bring residential a 3 percent growth rate, which played against inflation, is flat or no growth. In fact, in 2007, nonresidential and non-building construction was slightly larger than residential construction. Residential will take the lead again after 2009,” predicts Heather Jones, construction economist at FMI.

The graph above charts the anticipated growth of Put-in-Place construction by sector. Clearly, the economists at the U.S. Census Bureau believe that residential will recover and that nonresidential work will continue to march to new, higher numbers.

“The outlook for the construction market is optimistic,” says Ken Simonson, chief economist at Associated General Contractors (AGC). “We touched the bottom of economic growth and it should be upward from here. We should have several quarters of 2 percent and 3 percent growth, which is much better than .66 percent growth charted in the first quarter of 2007.”

“In 2006, we saw nonresidential public and private spending reach 13.6 percent growth and, in the first four months of 2007, that growth continued, posting as much as 17 percent growth for private and 9 percent for public construction spending, says Simonson. But governmental bodies are getting more cautious, especially when it comes to property tax receipts. School construction and other projects that rely on this type of money will be carefully evaluated,” Simonson says.

“On private construction, there is a shifting mix. There is good growth in big box stores and commercial properties, but those segments are vulnerable to what’s happening in the housing market. Anecdotally, Wal-Mart recently reduced its projection of new stores in 2008. “Overall, I think construction of stores that serve homes or residential areas will slow and small suburban office construction will dwindle with reduced residential sales. However, Class A office space will increase due to buyouts/mergers,” reports Simonson.

The economic experts predict that health care, lodging, transportation and public safety will be especially hot markets in 2008 and beyond.

The U.S. Census Bureau currently expects healthcare to lead in construction growth, achieving double-digit growth rates through 2011. “Health care is growing strong. Hospital construction makes up 66 percent of this market and medical offices make up 26 percent. Special care, which includes nursing homes, makes up only 8 percent,” says Jones.

“Much of the hospital construction is at established city hospitals that are upgrading facilities. There is a growing trend toward private rooms, and hospitals are building facilities in suburbs to leverage their name and personnel into areas that need hospital coverage,” says Jones.

“Nursing home construction is a small piece of the pie and forecasters predict it’s a longer-term market, and should become a bigger piece of the pie in 10 or 15 years.”

There will be a special care construction explosion, but it won’t eat market share from other healthcare segments. “That whole pie will continue to get bigger,” predicts Jones.

Transportation is another double-digit construction category through 2011. The Aviation Bill that was passed will supply money for some significant improvements in primary and many secondary airports. Presently, the Transportation Bill for funding highway and bridge construction hasn’t passed, but it will. And, public safety projects will continue strong, says Jones.

“There are many state and federal prisons being built in the West, Southwest, South and Mid-South of the country where population continues to grow. Border patrol construction is very active. Locally, communities are adding fire stations and police stations in new residential areas. All of this is because our population is mobile, but our facilities are not. As the population moves, facilities need to be built in those areas gaining population from net migration.”

Lodging continues to grow but will level off in 2008 and beyond. Much of this construction is development in Las Vegas but there is a considerable amount of rebuilding casinos and hotels in hurricane-ravaged New Orleans and Gulfport, Miss. “For example, the Beau Rivage project is $1 billion in Biloxi that’s nearing completion,” says Jones.

Highway hotels are also expanding. “This is part of the growing suburb phenomenon of the past few years. Residents in these communities are older and have more disposable income. There is a demand for overnight lodging near these new suburbs,” explains Jones.

Manufacturing construction is also seeing a rebound. Spending for manufacturing construction hit a high in 2007 that hasn’t been this high since 1998. “But that is comparing 1998 dollars vs. 2007 so in real terms, it probably has yet to surpass it. Across most manufacturing sectors, they have all been very active,” says Jones. “These are building-only projects, not the process equipment.”

Energy-related construction, while relatively quiet, will gather steam, says Simonson. “There are projections that there may be as many as 100 conventional power plants on drawing boards. Plus, there is more environmental retrofitting going on at plants to reduce emissions.”

Jones concurs. “Power generation and distribution will remain flat at 5 to 7 percent growth until 2011 when power plants will take off. Most will be coal plants that use cleaner technology and will tend to be smaller than some of the mega plants that are being built today.

“Nuclear plants are a big ‘if.’ Exellon Corp. is filing nuclear plant construction permits for two units in Texas costing $4 billion. These will be the first nuclear power plants built in the United States in nearly 30 or 40 years. We won’t know if these permits will go through until 2009 or 2010,” says Jones.

Geographically, the construction continues where there is population growth. “It seems hottest in the Mid-Atlantic area of Virginia, South Carolina, North Carolina and Florida. Demand is solid,” says Taylor.

The industrial Midwest continues to be weak but there are some bright spots as ethanol plants and biodiesel plants continue to be built, bringing good-paying jobs to rural areas.

This article originally appeared in the September/October 2007 issue of Progressive Distributor. Copyright 2007.

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