PCA Lowers Growth Projections

The Portland Cement Association has reduced its projections for near term economic growth and job creation. The reduction in the job creation outlook translates into a longer wait for a construction and cement consumption recovery.

Due to a slowing economy, the Portland Cement Association (PCA) has reduced its projections for near term economic growth and job creation.

According to the PCA, job creation is key to generating household formation and favorable homebuyer affordability, lowering nonresidential vacancy rates and raising returns on investments (ROIs), and reducing state deficits. The reduction in our job creation outlook translates into a longer wait for a construction and cement consumption recovery.

Edward Sullivan, Portland Cement Association vice president and chief economist noted that typically, a slower economic and jobs outlook implies weaker conditions for construction and cement consumption. The last recession, however, was construction focused. Residential, nonresidential and state discretionary construction levels collapsed.

Edward Sullivan, Portland Cement Association vice president and chief economist.

Despite an economic recovery, large structural issues characterize each construction segment and these have prevented a recovery from materializing in the construction sector. As a result, construction levels remain near floor levels and PCA believes further downside risks are small.

Highlights of the 2011 Portland Cement Association Fall Forecast include:

Economic Outlook

A year ago, the economy seemed poised for stronger, sustainable economic growth. Due largely to the European sovereign debt crisis, consumer and business confidence waned. Private sector growth, as a result, entered a period of slowdown. Furthermore, ARRA stimulus decreased as a positive for economic growth, forcing the Federal Reserve to enact a new round of monetary stimulus (QE2) to avert the potential of a double-dip recession.

By late 2010 and early in 2011, the European debt crisis was temporarily resolved and faded from the public mind-set. This, coupled with the ''payroll tax holiday'' and Fed actions, led to a revival in economic activity. Real GDP, job growth and confidence recovered. Seemingly, the economy was on a sustainable path of stronger growth and job creation in excess of 200,000 a month. Once again, however, this has proven to be a false start to stronger, sustained growth.

The economic recovery from the Great Recession will be led by a strengthening in business, consumer and bank confidence. Lacking a sustained and decisive improvement on this front, private sector fundamentals such as job creation, investment and easing in lending standards will not be released in full force and commit the economy to a path of tepid improvement. Such a path suggests the continuation of a fragile economy and one that remains vulnerable to even mild economic shocks, which could lead to a contraction in economic activity. This is the precarious condition the economy has been in for two years.

This first quarter of 2012 could represent a significant challenge to economic growth. The payroll tax and extended unemployment insurance benefits will expire year-end. Federal aid to the states has already expired. Furthermore, The EIA expects energy prices will rise. These conditions, and others, could result in significant first quarter weakness. Pressure could mount for additional stimulus. PCA assumes the payroll tax holiday and extended unemployment benefit will remain in place through 2012 - providing consumers with some cushion to offset rising energy and food prices. PCA also assumes unemployment insurance will be extended throughout 2012. Keep in mind, the current political realities suggest significant opposition to fiscal spending actions. Tax cuts, however, are appealing to both political extremes.

Taken together, PCA believes a synchronized recovery remains in place - reflecting the self-sustaining momentum and the interplay of marginal increases in demand, prompting job gains, feeding consumer, business and bank optimism - leading to further marginal gains in demand. While job gains and the process of economic recovery are expected to continue, it may not continue at the same pace as previously expected. The pace at which this scenario unfolds has been scaled back and suggests more moderate economic growth rates for 2011-2012.

Construction Outlook

PCA's slower economic outlook implies a slower recovery in construction. Furthermore, there is a disconnect in timing between economic and construction recoveries explained by the existence of structural wounds generated by the construction focused recession.

Despite economic growth, for example, the residential sector will continue to be plagued by a large volume of foreclosures, tight lending standards and weak new home prices. Aside from difficult access to credit markets, potential investors in commercial buildings are likely to wait until occupancy and leasing rates improve and asset prices appreciate. Finally, the impact of the stimulus is winding down and state fiscal conditions remain weak.

While the recovery process for the construction industry is expected to be long, its beginning is tied to general economic growth and job creation. Job creation will reduce, and eventually eliminate, the adverse impacts of foreclosures, tight lending standards, commercial occupancy and leasing rates as well as the severity of state fiscal conditions.

Because the impediments to a construction recovery are so large, even if an acceleration in economic growth and job creation materializes on a sustained basis, the benefits will not materialize quickly. The slower economic and job creation outlook contained in the current forecast suggests a modest delay in the construction recovery.

Residential Outlook

The expected timing for a recovery in housing starts has been pushed back. Several processes must occur prior to a recovery in starts. These processes will take time. In the context of slower job growth, the winding down of structural impediments for a housing recovery will take even more time.

Homebuilders are unlikely to significantly accelerate construction activity until two critical conditions are met, including: 1) low levels in inventory of unsold new homes reflecting no higher than five months supply, and 2) stable or rising home prices. Both conditions are likely to be required to insure an adequate ROI for homebuilders to spur an increase in building activity. Lacking either condition, a substantive recovery in home building will not materialize.

A significant improvement in residential construction cannot begin until the foreclosure crisis is over. High level of foreclosure activity increases inventory levels and depresses home prices - adversely impacting homebuilders expected ROI.

Mortgage resets are expected to decline dramatically after the first quarter 2012. Unfortunately, the process from reset to foreclosure and finally to bank possession is a long process and continues well after resets have declined. This suggests that high levels of bank-possessed properties will remain on the market through most of 2012 - to the detriment of a significant recovery in starts activity. These excess inventories must then be sold off to an extent whereby the markets' month supply is no more than five months (during the boom time, months' supply was roughly 3 months).

In the context of slow economic growth and muted job creation, foreclosures could be higher and the process of burning-off excess inventories is more prolonged. PCA expects single-family home sales will rise 3.5% in 2012, and another 25% in 2013. Given our estimates for foreclosure activity and a shadow inventory of 3 million units, and assuming a 15-month lag between foreclosure to repossession, desired levels of inventory will not be reached until the 2nd to 3rd quarter of 2013.

The delayed recovery in starts for residential construction will vary considerably by region. Keep in mind, as the recovery unfolds, it is important not to be misled by growth rates. Given the magnitude of declines, double-digit growth is expected in many markets, but on a volume basis, much of the Southeast and Southwest will remain weak despite the potential of high rates of growth.

The housing recovery is beginning to show signs of emergence in the interior U.S. This region did not fully participate in the housing bubble and subsequent overbuild. In addition, the central U.S. has benefited from an economic tailwind due to higher commodity prices. In a corridor from the Dakotas to Texas, this region (with the lowest home repossession rates and relatively strong labor markets) is still expected to lead the housing recovery.

PCA's residential forecast estimates are well below the consensus of construction economists. If the consensus is correct, there is the potential of upside risk to our projections for housing starts activity and cement consumption. Consensus averages for single family starts compared to PCA projections suggests potential upside risk of 0.8 MMT in 2012 and nearly 2.0 MMT in 2013.

Nonresidential

Nonresidential construction activity is driven by expected return on investment (ROI). Without a significant improvement in expected ROI's, commercial construction activity will remain depressed. ROI has two essential components including net operating income (NOI) and asset appreciation potential. Between the two, PCA believes NOI is the more important metric to focus on since it also plays a role in determining asset appreciation potential.

Several issues confront a recovery in nonresidential expected ROI's and construction activity including, depressed occupancy and usage rates, soft leasing rates, declining commercial asset prices, and tight lending standards. Job creation, either directly or indirectly, translates into higher occupancy and leasing rates. Combined, these factors determine the expected return on investment for most commercial properties. Weak economic conditions depress expected ROIs. Only with a significant increase in jobs, will the outlook for commercial construction activity accelerate.

It will take time for these conditions to heal and give way to a nonresidential construction recovery. The speed at which the healing process begins will be largely dictated by the strength in the labor market recovery. PCA maintains the nonresidential recovery process will remain prolonged, with substantive cement volume gains materializing in 2013.