Despite Ongoing Industry Recovery, Many Challenges Remain

On November 15, 2021, President Joe Biden signed legislation that will add $550 billion in additional infrastructure spending to previously authorized sums. The legislation will inject $110 billion into roads, bridges, and other major projects. It will direct $66 billion to freight and passenger rail. It will invest $39 billion in public transit systems. It will supply $55 billion to improve water systems and replace lead pipes.

In short, it’s a blockbuster. Given that and the fact that construction financial executives tend to be upbeat during the tail end of calendar years, one could reasonably expect that Confindex readings would rise during 2021’s final quarter. But as has been the case with much of the economic data gathered during the lingering pandemic, reality defied expectations.

During the fourth quarter, the Overall Confindex reading came in at 116, down 2.5 percent from the previous quarter. In other words, industry confidence was higher prior to the passage of the infrastructure package than after. True, the overall reading is 24.7 percent higher than it was a year earlier. It is not that construction financial leaders are unusually pessimistic, it’s that they are less upbeat than expected.

Reasons for this are reasonably apparent. For months, contractors have been indicating that demand for their services has been plentiful. Challenges have emerged from the supply side of the equation, with contractors wrestling with surging materials prices, equipment and parts shortages, and a dearth of available human capital. Many respondents indicated ongoing frustration with the state of the labor market and expressed concerns that stepped-up infrastructure outlays will draw even more talent away from them as infrastructure-involved construction firms get even busier. This helps explain why the proportion of respondents who are very or highly concerned by skills shortages rose from 80 percent to 81 percent. 

This strongly suggests that significant wage pressures will continue. Confindex respondents also tend to believe that construction materials prices will remain elevated. When asked if materials prices had improved over the past year, precisely 0 percent of respondents said yes, while 68 percent indicated that prices had significantly worsened. Nearly half of respondents expect materials prices to worsen further during the year ahead, while 30 percent expect them to be unchanged, which means that the expectation among this group is that prices will remain at lofty levels. About 20 percent of respondents indicate that materials prices will decline over the next year, though very few expect them to improve significantly.

Thus, while contractors expect to remain busy, they anticipate a challenging year in terms of managing construction delivery costs. That’s not where the story ends. Higher construction delivery costs can induce some project owners to postpone or even cancel projects. This may be why nearly one in five Confindex respondents indicated that they were concerned about demand for construction. Macroeconomically, there is plentiful demand for construction services, but some of that demand may not be realized because of challenges meeting project owner budgets and allowing project pro-formas to pencil out.

In terms of profit margins, roughly a third of Confindex respondents expect margins to improve over the year to come, but that’s almost precisely counterbalanced by the third of respondents who expect margins to deteriorate. According to many respondents, there has already been some negative impact on margins from the current inflationary environment. More than 52 percent of respondents indicate that their margins are slightly or significantly worse than they were a year ago when the pandemic was raging and vaccines were unavailable.

All of this helps explain why the Business Conditions Index declined 5.4 percent during the quarter. This represented the largest quarterly decline in any of the indices. The Current Confidence Index also declined by nearly 2 percent. Both of these readings are meaningfully higher than they were a year ago, but the point is that the past year has ushered forth a set of issues that has many construction financial professionals unnerved.

The Financial Conditions Index was unchanged in the fourth quarter. This has been the most stable of all indices during the public health crisis. The cost of capital remains low and liquidity remains abundant. Even higher inflation has failed thus far to have a meaningful impact on interest rates. 

The all-important Year-Ahead Outlook Index declined 4.1 percent from the prior quarter and is up approximately 10 percent from a year ago. The implication is that construction industry performance has generally been better than anticipated from the perspective of early pandemic stages, but recovery from the pandemic hasn’t been especially smooth. Moreover, despite the passage of the long-expected infrastructure bill, the proportion of respondents indicating growing concern regarding public policy’s impact on the industry actually rose in the fourth quarter. During the third quarter, one in four respondents were concerned about public policy’s impact on construction. One quarter later, the proportion was closer to one in three, with a number of respondents concerned about the shifting regulatory environment.

Looking Ahead

It is conceivable that circumstances will work out far better than many expect. While labor force challenges are poised to remain in place for years to come, it is conceivable that the bottom will fall out of certain commodity prices, whether steel, aluminum, or copper. Economists like to say things like “the cure for high prices is high prices”. The notion is that not only do high prices truncate quantity demanded, but they also motivate suppliers to expand quantity supplied to markets, whether by adding shifts or physical productive capacity. If materials prices decline from current lofty levels, this would likely translate into thicker profit margins than presently projected.

But any economist worth his or her salt will also point out that things could work out very badly. COVID-19 continues to mutate, and while Omicron doesn’t appear to have shaken up financial markets unduly, other, more problematic variants could appear. What’s more, asset prices have risen dramatically during the pandemic, and what goes up can come down. Make no mistake, there are real risks out there, which means that perhaps we should not have been so surprised that Confindex dipped lower as 2021 faded into memory. 

But any economist worth his or her salt will also point out that things could work out very badly.  COVID-19 continues to mutate, and while Omicron doesn’t appear to have shaken up financial markets unduly, other, more problematic variants could appear.  What’s more, asset prices have risen dramatically during the pandemic, and what goes up can come down.  Make no mistake, there are real risks out there, which means that perhaps we should not have been so surprised that Confindex dipped lower as 2021 faded into memory.