North America: Back to growth

US GDP grew +2.8% in the final quarter of last year, the best performance of 2011. Initial evidence for 2012 is encouraging, although GDP growth is likely to slip in the first quarter as inventory rebuilding slows.

On top of this, a better-than-expected employment report for January added to the good news, and there are hints that a virtuous cycle may be building where employment, incomes, and consumer spending move up together. The manufacturing evidence looks particularly strong, with production likely to be up very sharply in January.

There are of course caveats to this. For example, high oil prices mean gasoline prices are climbing again and will squeeze consumer spending power this spring. However, these are just reasons not to get too carried away - they do not overturn the underlying improvement.

IHS Global Insight expects GDP growth of +2.1% in 2012, following on from the +1.7%, climb of 2011. There should be acceleration to +2.3% growth in 2013. One of the reasons for this modest growth is the overhang of excess debt and excess housing, which will suppress domestic demand.

Assuming there are no mistakes in US policy-making, the risks of recession hinge on the Euro-zone. While the European Central Bank's Long-Term Refinancing Operation has pumped in liquidity and reduced the risks of a major banking crisis, sovereign-debt problems have not been resolved. But the continuing run of better domestic data, combined with reduced fears of European banking collapse, has reduced US recession risk to 25%, from 30%.

Construction prospects

However, the construction market continues to suffer from an excess inventory and weak demand. While the outlook is improved, employment growth is still lagging for this point in a recovery and it will still take some time for housing inventories to be depleted, excess commercial and industrial space to be absorbed and for state and local budgets to return to health.

But there is pent-up demand building-up in the market. Improvements in employment figures will spark a revival in housing activity and housing starts are forecast to hit 741000 this year, compared to 607000 in 2011.

Of the 134,000 unit gain expected in housing in 2012, two thirds (90000 units) will come from the multi-family segment. Supporting gains in single family starts will build momentum as the decade progresses. Total starts are expected to recover to 990000 units in 2013, surpassing the 1.5-million-unit tally in 2015, and approach a demographics-driven 'normal' near 1.7 million units in 2016 and 2017.

However, on the business structures side, spending on buildings fell back -11.1% in the fourth quarter. This represented a correction after two strong quarters rather than the start of a new downtrend, but a sustained strong improvement is not expected until 2013.

The broad commercial category contracted -6.6% in 2011, but it now seems to have hit bottom. However, with significant vacant space and unemployment relatively high, IHS Global Insight projects growth of less than +1% this year, much of that going into retro-fitting of existing space. Stronger spending is expected in 2013 and 2014 as the economy gains steam.

The weak link in the near term is the office sector, which is expected to shrink another -6% in 2012 after contracting -9% in 2011. There is simply not enough job creation in office-intensive industries to absorb all existing space, and the trend with renovation is to put more employees into less floor space. Recovery for this segment will come late in 2012, with growth projected at better than +7% in 2013.

Lodging bore the brunt of the recession, having been badly overbuilt before the financial crisis struck. This sector will contract -28.5% again in 2011, and while IHS Global Insight expects the rebound to begin in 2012 as consumers spend more and business travel picks up, the levels of activity seen in 2006 will not be hit again before 2025.

Retail space will also struggle in 2012. Although consumer spending will recover, there are too many negatives to allow a robust spending recovery - a weak (though improving) labour market, high debt burdens, falling house prices and inflation moving ahead of wage growth among them. These and other factors are mean retail construction will fall about -3% this year, before returning with double-digit gains in 2013.

Construction in the manufacturing sector will recover by about 5% in 2012, taking it close to the level achieved in 2006.

Manufacturing orders are increasing, driven in part by spending on business equipment and cars. External events will prevent the rebound from being even stronger - weak demand from a Euro-zone in recession, combined with a stronger Dollar.

Uncertainty

The largest uncertainty for construction comes from the public sector. Support from federal stimulus has been winding down, and state and local government budgets are under pressure. Total state and local spending will shrink -1.7% in 2012. Key fiscal deadlines loom at the end of 2012 and if nothing is done, automatic spending cuts will kick in at the beginning of 2013, and the Bush-era tax cuts will expire. There is likely to be some kind of deal done on these points between the two political parties, and the balance of power will hang on the outcome of the November elections, which are hard to call at this point.

The result will be pressure on institutional and infrastructure spending. The broad infrastructure segment contracted -5% in 2011, although the power sector did show gains. Further declines are expected for highways and streets, water and sewer and transportation construction as federal funding uncertainties and state and local fiscal restraint take hold.

There is some sentiment in Congress for increased infrastructure funding, but the difficulty in passing even a popular tax cut illustrates the problems of any potential spending increases. Federal Aviation Administration (FAA) and Federal Highway Trust Fund and other transportation-related funding will likely be re-authorised, but significant expansion is not likely.

Taken as a whole, the U.S. construction market will see a slow 2012. However, the worst is in the past and some growth will return to key segments. Growth should return in a meaningful way in 2013, lead by the residential sector.

Once growth returns, the recovery should have legs - it will take some time to reach prior peak values, but a strong, steady improvement appears to be on tap for several years.