January 2013

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Page 72 of 83

Business Outlook Recovery is Underway in the Construction Sector, But How Long Will It Last? As CED went to press, politics was the biggest threat to construction���s ongoing recovery. Eli Lustgarten Recent economic data is becoming more upbeat as we approach the end of 2012. American consumers are becoming more optimistic, with a rise in the consumer confidence index of the Conference Board to 73.7 in November from 73.1 in October; both are the best readings since February 2008. While much of the data is sending mixed signals (revised consumer spending in 3Q12 was still tepid), companies are still ordering equipment, albeit at a slower rate, gasoline prices are falling, the job market has shown some improvement, and home prices are rising in most major cities. The changing leadership in the economy is important, as it is offsetting a global slowing of the industrial sector, which has carried the burden of economic growth over the past several years. Most notable is the recent improvement in the second estimate of 3Q2012 GDP for the U.S. from 2.0 percent to 2.7 percent, driven by strength in federal government spending (up 9.5 percent in 3Q12 vs. -0.2 percent in 2Q12) and a sharp upward revision in private inventory growth from a negative contribution in 3Q2012 of -0.12 percent to a positive increase of 0.77 percent (3Q12 inventory increase was $61.3B compared to $41.2B in 2Q12). Consumer spending was revised downward from 2 percent to growth of 1.4 percent. Construction spending has been the most challenged sector within the U.S. economy since the current recovery began in mid-2009. However, residential construction finally looks to be on a modest recovery path and private nonresidential spending also appears to be improving. Construction fundamentals are clearly improving and driving recovery, but the key question is whether the recovery can survive federal politics ��� the fiscal cliff and debt ceiling crises. Based purely on economic fundamentals, McGraw-Hill is projecting a 6 percent increase in construction starts in 2013, up from 5 percent in 2012; FMI Corp. projects an 8 percent gain compared to the 5 percent improvement in 2012. These forecasts are similar to the recent AIA projection of a 6.2 percent gain in 2013 compared to 4.4 percent in 2012. The National Association of Home Builders states that the housing recovery is on solid ground but believes any big rebound is still a year or two away. That said, housing starts are still projected to exceed 750,000 in 2012 from 612,000 in 2011 and rise at least 20 percent in 2013 to more than 900,000. ARBTA projects that highway spending will remain about flat, but that is a subsector of spending that is caught up in politics. All forecasts ��� the weak, the mediocre and the strong ��� exclude any impact from the fiscal cliff. The Congressional Budget Office (CBO) states, and most economists agree, that the U.S. economy is too fragile to withstand the impact from higher taxes and spending sequestration, should it occur. CBO data says going over the fiscal cliff would mean that F2013 defense spending, including military construction, would fall by 9.4 percent, and nondefense areas such as water infrastructure would decline by 8.2 percent. Most construction equipment manufacturers, like industrial manufacturers, are approaching the end of 2012 with a high degree of caution. With manufacturing activity slowing in the U.S. and flat to down in most regions of the world, most industrials, particularly heavy manufacturing, are undergoing an inventory correction in the second half of calendar 2012 led by a $3 billion reduction at Caterpillar. This reduced activity level will spill over at least into the first quarter of 2013 and will then be dependent on the outcome of fiscal cliff negotiations. The substantial recovery of U.S. construction equipment sales from 2010 to 2012 has been far stronger than underlying activity. It represented a recovery of sales back to a level more consistent with current construction activity after the dramatic two-thirds decline from its peak in 2006, helped by favorable tax policy to help offset regulatory driven price increases. As we enter 2013, we expect construction equipment demand to be similar to down about 5 percent compared to 2012 based on economic fundamentals. Our surveys indicate that rental companies, which bought more than 50 percent of the equipment in 2012, are planning flat expenditures for 2013 with a shift from earthmoving equipment to other products. The only sector that is appearing more difficult is mining; our latest surveys suggest that mining capital expenditures will fall 10 to 20 percent in 2013 compared to prior estimates of only down 5 to 10 percent, with North American coal by far being the most pressured. While equipment demand over the next several quarters may soften moderately, the key to further increases in equipment demand is growth in underlying construction spending. That entails getting past the politics at hand. Eli Lustgarten (elustgarten@aol. com) is president of ESL Consultants, an industrial consulting firm. January 2013 | Construction Equipment Distribution | www.cedmag.com | 71 71_business outlook_KP.indd 71 12/21/12 2:26 PM

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