How a newly re-elected president and shifting Congress will deal with a still-slow economy and overwhelming federal debt is anyone’s guess.
Although cement consumption and overall U.S. construction activity increased significantly more than expected in 2012, these gains would be immediately erased in 2013 if the “fiscal cliff” is not resolved in a timely manner. A forecast from the Portland Cement Association (PCA) expects a 7.5 percent jump in cement consumption in 2012, up 50 basis points from its summer forecast. However, the instability of the political landscape makes projecting 2013 consumption more challenging.
The fiscal cliff came about from dual economic objectives reflecting the need to inject fiscal stimulus into an inert economy and the need to deal with burgeoning federal debt. Packaged together as the Budget Control Act of 2011, tax increases of $400 billion coupled with $200 billion in federal spending cuts are scheduled to go into effect January 1, 2013.
If Congress resolves the fiscal cliff during its lame duck session in 2012, PCA expects the economy to continue to grow and cement consumption in 2013 to increase 6 percent. A late, or no agreement during 2013, could plunge the economy into recession—with cement consumption falling to past recession trough levels. A wide array of consumption outcomes are possible for 2013 depending upon political decisions.
Guidance from PCA’s Washington, D.C. office is perhaps the most pragmatic advice in conducting an economic forecast scenario. According to PCA-D.C., there is a 50 percent chance of a lame duck outcome and a 50 percent chance of a end-of-first-quarter outcome. Little chance was given to a late outcome, which would spiral the economy into recession. Given this advice, PCA ran two economic scenarios—one with a lame duck solution and one with a first-quarter solution, attaching equal weight to the probability of each outcome. This averaged risk methodological approach is quite different than usually used by PCA and results in a lower 2013 forecast projection compared to the summer forecast.
PCA Chief Economist Ed Sullivan theorizes that forecasts are based on assumptions and are typically more accurate when the assumptions made are “weak”—or based on very plausible outcomes. Forecasts often err wildly when “strong” assumptions are made—or based on uncertain outcomes. The politics surrounding the fiscal cliff outcome and its timing are highly uncertain. The implication is that drawing a line in the sand and accepting “A” version of the fiscal cliff outcome carries huge risk. A lame duck assumption, for example, carries large downside risk. A “no deal in 2013” assumption carries large upside risk. During the past several weeks, dozens of political “experts” have voiced widely different conclusions regarding the outcome and timing of the fiscal cliff.
Going by this technique, even if Congress addresses the policies by the first quarter of 2013, the delay will cause significant economic harm and a 2.7 drop in cement consumption, Sullivan observes. “Because we believe the odds for either outcome are even, we have adopted a forecasting approach that minimizes up and downside risk,” he said. “Our baseline scenario blends the two possible outcomes and projects a 1.8 percent increase in cement consumption in 2013.”
Sullivan also reported that the longer Congress delays in addressing the fiscal cliff, the greater the adverse affect on economic growth and construction activity in particular. “If no action is taken by mid-2013, the country could be headed into a severe recession.”
The PCA report also said cement consumption through September 2012 had increased 10 percent compared to last year, with 16 consecutive months of growth. Sullivan attributes this growth to the return of consumer confidence, a strong housing market and most importantly, growth in employment.
Echoing Sullivan’s concerns about the fiscal cliff, McGraw-Hill Construction’s report, 2013 Dodge Construction Outlook, forecasts U.S. construction starts for 2013 will rise 6 percent to $483.7 billion, slightly higher than the 5 percent increase to $458 billion estimated for 2012.
“[N]ew construction starts in 2010 edged up 2 percent, followed by another 1 percent gain in 2011, and 2012 is headed for a 5 percent increase,” said McGraw-Hill Construction [part of The McGraw-Hill Companies] Vice President of Economic Affairs Robert Murray. “This still leaves the volume of total construction starts 32 percent below the 2005 peak on a current dollar basis, and down about 50 percent when viewed on a constant dollar basis. The modest gains experienced during the past two years have in effect produced an extended bottom for construction starts, in which the process of recovery is being stretched out.
“The fiscal cliff poses a significant downside risk to the near-term prospects for the U.S. economy and the construction industry. Assuming that efforts to cushion the full extent of the fiscal cliff are successful next year, keeping the U.S. economy from sliding back into recession, then there are several positive factors to benefit construction, including low interest rates and improving market fundamentals for several project types.”
Lame duck agreement or fiscal cliff diving
Regardless of the fiscal cliff political outcome, cement consumption is expected to record declines throughout the first quarter of 2013 and perhaps a bit longer. This is expected due to comparisons against strong first-quarter 2012 cement consumption levels brought about by very favorable weather conditions. During that period, cement consumption averaged more than a 79 million metric SAAR (Seasonally Adjusted Annual Rate)—or roughly 7 percent above the most recent three-month average. Absent political uncertainty, PCA expects first-quarter comparisons will run roughly 6 percent behind 2012 levels. If the fiscal cliff is not solved during the lame duck session and political uncertainty remains in place, first-quarter cement consumption comparisons could run roughly 11 percent behind 2012 levels.
Even this late in the year, tremendous uncertainty exists for 2013 cement consumption, according to Ed Sullivan. Huge risks are implied in corporate planning efforts if a lame duck or fiscal cliff outcome are assumed. One thing is likely: one of the general scenarios will materialize. Since PCA has used an unusual blended risk approach regarding its fall forecast, this implies it will be off, but less so if it opted for the single wrong assumption. PCA has promised a new forecast as soon as the political environment becomes more clear.
According to the Lame Duck Agreement Scenario, Congress recognizes the urgency of achieving an accord to avoid the disruptive impacts on the economy. Political compromise trumps political ideologies. This implies that an agreement on the fiscal cliff would be reached immediately after the election—during the lame duck session. Further, PCA assumes that such an accord would minimize the short-term costs to narrowing the deficit and enact a somewhat more aggressive, longer-term combination of tax and fiscal spending policies that would avert troubles now facing several European economies. It also assumes that the federal debt level issue will be addressed at the same time of the agreement.
Given these assumptions, the near-term disruptive economic aspects associated with the fiscal cliff are significantly reduced and real GDP growth would be only marginally impacted during the forecast horizon. Consider the following:
• Real GDP growth strengthens to 2.5 percent in 2013, with stronger growth materializing in the second half of the year.
• Recent strengthening in job growth continues and accelerates during the second half of 2013 creating roughly 2 million jobs in each year. Unemployment rate remains and gradually declines to 7.5 percent by year-end.
• State fiscal conditions healing process continues. Surpluses emerge for fiscal 2014-2015.
• Improvements in nonresidential vacancy rates and net operating income continue. The nonresidential construction recovery is sustained.
• Residential construction expands to 950,000 starts, with single family construction near 700,000 starts during 2013 and reaches over one million starts in 2014/2015.
• Cement consumption grows at rates consistent with 2012 levels, perhaps stronger.
While there is considerable uncertainty regarding the timing of Congress’ action, the acceptance of this scenario is centered on several observations. First, faced with the possibility of the United States’ default on federal debt, the extension of federal debt limit during 2011 was eventually resolved. While the resolution came at the 11th hour, and at the expense of a burgeoning economic recovery, severe adverse consequences to United States’ economic growth in the face of default was averted. Second, Congress recently passed a bipartisan, two-year highway bill. While the bill was funded at levels well below what is required to meet current and future economic needs, it represents a bipartisan accord. Third, in the post-election timeframe, much attention has been fixed on this issue and such limelight may prompt at least a temporary agreement. This scenario’s projections assume an eleventh hour accord.
According to this scenario, the economy grows slowly during the remainder of 2012 and gradually through 2013 with real GDP averaging roughly 2.5 percent annually. Roughly 2 million jobs are created this year and next. Structural impediments to a construction recovery gradually heal in the context of slow job growth. Housing starts record large percentage gains, but in the context of gains off near historic lows. Nonresidential continues to achieve volume gains. Gains in the residential and nonresidential sectors more than offset expected public sector drags.
Economic momentum gains strength through 2014 and beyond. GDP grows at an average rate of more than 3 percent annually. Job growth averages more than 2.5 million jobs annually. Stronger U.S. and global economic growth translates in to higher oil prices—stealing some economic growth momentum, but resulting in an enhancement in concrete’s competitive position against asphalt.
The key economic impediments to a construction recovery, namely foreclosure activity, high vacancy rates and weak state fiscal conditions gradually subside. These conditions, coupled with the release of pent-up demand, prompt a construction recovery in all residential, nonresidential and public sectors. Cement consumption achieves double-digit growth 2014-2016.
According to the Fiscal Cliff Scenario, Congress fails to reach an accord during the lame duck session. Competing political ideologies hold firm until noticeable harm to the economy materializes. PCA assumes an agreement regarding the fiscal cliff is reached at the end of the first quarter 2013. Lacking any firm understanding regarding the details of the agreement, PCA assumes taxes rise half the level currently prescribed by law. Similarly, spending cuts are assumed to be 50 percent less severe. Furthermore, PCA assumes that Congress will recognize the damage done to the economy due to their hesitancy to address the fiscal cliff and will retroactively apply the new tax and spending rates back to January 1, 2013. This assumption essentially neutralizes any direct fiscal cliff impacts on GDP during the second quarter, resulting in near neutral GDP growth.
Once an agreement is reached regarding the fiscal cliff, investment and job hiring uncertainty will diminish. PCA has estimated the amount of investment activity foregone since the end of the second quarter 2012 due to fiscal cliff uncertainty. PCA assumes that half of the estimate will be released equally in the three quarters subsequent to the agreement. These estimates and assumptions add 0.3 percent to real GDP in these quarters.
Furthermore, weak United States’ economic growth during the first half of 2013, in the context of slowing world growth places downward pressure on oil prices. Oil prices decline to the low $80/barrel range. Gasoline prices follow the decline in oil prices, adding as much as $25 billion back into consumer pockets and offsetting some of the impact of higher taxes.
According to this scenario, first-quarter real GDP growth declines 1.8 percent. Given the adverse momentum generated, first-quarter adversities translate into near-zero growth during the second quarter and tepid growth during the remainder of 2013, leaving overall real GDP growth near zero. The job gains the economy is now achieving are replaced by a gradual decline in job momentum during the first quarter of 2013, near zero growth in the second quarter, followed by modest job creation in the second half of 2013.
The gradual recovery from the first-half 2013 contraction is expected to continue through 2014, resulting in modest economic growth. Shaken consumer confidence gradually improves, while corporate profits and business sentiment also slowly mend. Job creation, as a result, manages only tepid growth, but achieves moderate-to-strong gains as the adversity wears off.
Structural impediments to a construction recovery are worsened during the first half of 2013 as job growth ebbs. Foreclosure activity increases compared to the lame duck scenario. The emerging housing starts recovery now under way is temporarily put on hold and remains near 2012 levels. Vacancy rates increase. Leasing rate competition accelerates. Expected ROI on commercial properties recede. Banks renew its concerns of lending to commercial real estate projects. State deficits worsen with an increase in unemployment and reduction in revenue growth.
According to this scenario, cement consumption declines 2.7 percent in 2013. Momentum is regained in late 2013 as the fiscal cliff impact dissipates, and the economy once again regains its footing. Cement consumption grows 14 percent. While the growth rate in 2014 is stronger than the lame duck scenario, volume lies below the lame duck scenario.
Not all regions are expected to experience the same adversities arising from the fiscal cliff. PCA performed a ranking analysis for each state based on exposure to government spending cuts and the economic momentum that currently exists in each state which serves as a proxy for the ability to withstand fiscal cliff adversity. According to this analysis, the central region may be in the best shape to withstand the fiscal cliff adversities.
