Public Sector Buoys Construction Spending

Construction spending edged up 0.1% in July with strong gains in spending at the state and local levels offsetting a small decline in private sector construction activity. Upward revisions to June also make the data look a little better than it first appears. The gains at the state and local levels were concentrated in health care, education and transportation. Many state universities have been adding to their dormitories and teaching capacity to accommodate the swelling ranks of millennials in recent years. It is unclear whether generation Z, which just graduated from high school, will fill as many slots. Some private schools are now matching state tuition to compete for the incoming pool of students and to alleviate their reluctance to take on as much student debt as their older siblings did. The rise in construction in health care is being driven by demographics and the need to remodel and upgrade older hospitals. We saw larger-than-usual-gains in the conservation category for the federal, state and local sectors, but off of a low base. Much of the focus on conservation has been shifted to the balance sheets of state and local government.

Private sector construction dipped 0.1% but losses were widespread. Transportation, most notably trucking, posted increases while manufacturing, which had been weak, is showing signs of picking up.

The steel industry is reopening and retooling idled capacity now that import tariffs are giving them a boost. The problem is their clients, who are still doing well but are hesitant to add much capacity given the crimp placed on margins by higher input steel prices coupled with labor shortages. The Institute for Supply Management's (ISM) manufacturing index jumped to a 14-year high in August, reflecting stronger business abroad. Backlogs are building along with inflationary pressures. The area of concern is tariffs and how they will change the equation. Manufacturers told us that some firms were stockpiling ahead of feared tariffs, which would tend to boost current orders at the expense of orders down the road.

One of the highlights in the ISM report was residential construction, which posted an overall increase despite losses in new, single-family and multifamily construction. Remodeling activity more than made up for the shortfall. Home flippers have returned to the single-family market while older owners have opted to repair and remodel instead of trading up in a market that has become less affordable.

Bottom Line

Construction spending in July was not spectacular but still a positive for the third quarter given the revisions to June. The biggest factor on the private sector side was the ongoing push to repair and remodel existing homes, which is keeping builders busier than new construction these days. The downside is that increases in public sector construction have so far done little to repair and upgrade our basic infrastructure, which remains in tatters.