Construction Spending Flat for April

Construction spending flatlined in April after being revised down further to a 1.2% drop in March. The losses were concentrated in the private sector, hitting manufacturing and retail hardest. Residential construction also took a blow with the single-family market holding back gains. A move downstream on the size and price of homes, added to delays in repairs and remodeling due to heavy rains and flooding in the Midwest, added to the weakness in the single-family data.

Disaster relief is another hurdle for new construction. The House of Representatives may pass a $19 billion disaster relief bill including funds for victims of Hurricane Michael, which leveled entire towns in the Florida panhandle last October. The Senate passed a clean, bipartisan bill for disaster relief, but House Republicans held up final passage until all members were back from a break, Today, members of the House are hoping to get the bill passed and start the long delayed process of disbursing funds.

The situation for the manufacturing sector is not likely to get better anytime soon. The Institute for Supplier Management (ISM) index came in at the weakest pace in more than two years in May. The index is now just above the 50% threshold, which signals a slowing but still growing manufacturing sector. Recently levied tariffs will only exacerbate the pain in manufacturing because many tariffs target the vehicle industry. Look for layoffs to increase rapidly in manufacturing, especially if the five percent tariff on Mexican imports goes into effect on June 10. Components cross the border many times before a vehicle is completed, which rapidly compounds the cost of even small changes in tariffs for vehicle manufacturers.

The weakness in retail is both structural and cyclical. Announcements for store closures surged in the first quarter as traditional brick-and-mortar stores continued to struggle to compete with online behemoths. Walmart is joining those ranks as it dramatically expands its online presence to compete with Amazon. This is at the same time that consumer spending has slowed, which has dealt a blow to margins. First quarter profits in the retail sector overall came in at the slowest pace since the Great Recession. Note: Retailers were beneficiaries of last year’s tax cuts, which made it even more difficult to meet year-on-year comparisons for the first quarter. Tariffs are another concern as they would affect most major retailers. Grocery stores and restaurants are likely to feel the pain from an escalation of tariffs on Mexico because it is our largest source for fruits and vegetables.

Separately, construction of warehouses decreased despite the ongoing move to online retail. Vacancy rates have risen in recent months as speculative builders got ahead of themselves, especially as online retailers attempt to hone their same-day delivery service, which requires smaller spaces closer to major urban markets. My own experience is that next-day delivery is dicey. I spotted one delivery driver running his packages up to each house. I can only imagine the risks when all drivers are trying to make a same-day delivery in rush hour traffic. The Federal Reserve has been warning about a bubble in the broader commercial construction sector. It now looks like some of those problems may be coming home to roost.

Public sector construction held up slightly better, with gains at both the federal, state and local levels. State and local gains represent the lion’s share of the public construction market but, even with gains, it is clear how much is slipping. Everything from trains to roads and bridges are in complete and utter disrepair, with little to no prospects for an infrastructure bill before the 2020 election.

Bottom Line
The economy continues to grow but the gains are becoming more uneven. Construction activity is taking it on the chin. The weakness reflects a nasty stew of structural and cyclical issues added to the trepidation that comes with policy uncertainty. Construction activity is only a small part of that weakness. Companies are reluctant to expand when they don’t know what their costs will be in the face of trade wars on multiple fronts. Real GDP is looking weaker by the day in the second quarter. Our current estimate is for 1.6% growth, which is nearly half the pace of the first quarter.

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