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The SNAFU Phase of the Recession

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There’s really nothing comforting about job losses and downsizing if it happens to you or someone you love is effected; however, from a macroeconomic point of view only, the current round of business reactions is something of a return to cyclical normalcy. From that perspective we have moved to the ‘situation normal, all fouled up’ (or something stronger) stage of the business cycle, where the degradation of demand dictates that businesses cut expenses to attempt to remain profitable, or stem the red ink.

Again, not good news, but given the chaotic beginnings of this recession, the layoffs are the beginning of a predictable response to the rythym of the cycle, and mark the response by business that is needed to begin the recovery.

The out-of-sequence part of this downturn was the credit disaster. What normally occurs is that slowing cyclical demand begins to cause inventory problems (for example building too many offices slows demand, which eventually leads to too many cans of paint, sheets of drywall, etc, in warehouses). As inventories stagnate, payment slows down and defaults occur. In response to higher defaults and longer credit cycles, the banks and financial institutions tighten (and sometimes freeze) credit. The slowing economy, coupled with a lack of credit, forces layoffs, consumer belt-tightening, and general austerity until demand becomes so pent up that expansion begins anew.

Because this cycle started with credit extended on the basis of rising home values that stopped rising, the unwinding of the financial support for real estate and construction began before the normal erosion of demand. Now that businesses are recognizing that 2009 will be tough and are responding by reducing overhead, the process of reaching the bottom (and therefore the beginning of recovery) can begin.

This is no consolation for the pain we’re experiencing, and there is no assurance that bottom isn’t still a ways off, but the single biggest issue facing the investment side of the economy has been the terrifying uncertainty that has prevented investors from assigning value to risk, and to the financial system. Construction relies on investors assessing the risk of development relative to the lost opportunity of missing out on demand. Judging demand is tough enough, but when investors can’t be secure about how likely the debt they are buying into can be repaid, they will pass on the opportunity.

It’s no different with jobs. When even a thriving business can’t be sure if its customers will really be buying in six months, there’s little chance it will hire or expand.

When the wheels come off and people lose their jobs or their houses, that’s a fouled up situation, but in the course of an economic contraction, it’s also normal.

More Dollars, Fewer Projects in 2009

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One of the few pleasant surprises of the New Year is the volume of bidding in January. Normally a slow month for bids and contracts, January was expected to be a continuation of the dead fourth quarter of 2008, especially as more and more developers put projects on ice. Instead a couple hundred projects went out, and work began on most of the projects that were awared at the end of 2008.

That surprise aside, non-residential construction in 2009 is going to be slower, both nationally and in the region. Here in western PA, however, the numbers won’t show the slowdown because of the unusually high volume of large proejcts again. Throughout the past decade median annual contracting volume was between $2 billion and $2.5 billion. During the height of Plan B, when PNC Park, Heinz Field and the convention center were all started, the volume reached $4 billion in 2000. For the past two years contracting volume was right at $3.5 billion, and the economic woes should be expected to reduce the volume in 2009 by a billion dollars, but the volume may actually grow by more than that, even potentially topping $5 billion.

The graphic below shows 15 projects that are either starting or that will start this year. While all of the biggest projects are listed, it’s likely that there are a number of others between $20 and $50 million that aren’t on this list.

A sampling of 15 of the largest projects expected to start in 2009 in the metropolitan Pittsburgh area
A sampling of 15 of the largest projects expected to start in 2009 in the metropolitan Pittsburgh area

The total of these projects alone equals the volume for the last two years, around $3.5 billion. The disparity between the high dollar volume of big work (even though it’s a few projects the volume still requires the resources to complete $3.5 billion) and the rest of the market underscores how trying 2009 could be. With a little simple math it’s clear that even a $5 billion year will leave most of the market scrambling to compete for $1.5 billion in work.

That should make 2009 feel a lot like 2002.

National Economic Woes Begin to Dampen Local Construction

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Metropolitan Pittsburgh’s good economy could not overcome the fear that gripped the consumer in October and November, sending housing starts here to the lowest levels in two decades. Permits for new construction virtually stopped from mid-October through the end of November. You could literally follow the panic that was gripping Wall Street and see people here put the brakes on. Even with significantly higher activity in December the number of single-family detached homes started was 397, the lowest for any quarter since we began tracking activity in 1994.

During the full year of 2008, permits were issued for 2006 single-family detached units, down 20.5% from 2007. The market for single-family attached and multi-family units was off similarly, with 1,342 units started compared to 1,640 started in 2007. The overall housing market was down 19.6% compared to 2007, and by more than 35% compared the cyclical high in 2004. I attribute the depth of the slowdown to the fact that most builders in the region are small and very well-connected to the market demand. Time and again, we see Pittsburgh’s builders react quickly when a market softens, which prevents the build-up of any significant oversupply of houses.

The other noteworthy development is the continued growth of new construction in the City of Pittsburgh, which experienced the second highest total of detached new units in the region, saw its overall new construction total increase by 24.6%, and issued permits for twice as many units of new housing as Cranberry and Adams Townships combined.

Non-residential construction remained at a high level in 2008, with $3.48 billion contracted for the year, less than a one percent decline from 2007. Contracting in the fourth quarter slowed dramatically, with volume being driven by three large projects. Setting aside UPMC East, Dick’s Headquarters and the Oakland VA jobs, there were less than $400 million contracted in the last three months. With more than $3 billion expected to be invested in the dozen biggest projects in 2009, this trend appears to be extending out for another few quarters, with less work for most of the market to pursue.

We are forecasting a modest increase in housing in 2009, with single-family growth of a couple hundred units, and an overall volume of 3,700 units for the metropolitan area. Because of the large investment in industrial projects like Allegheny Technologies Brackenridge plant, AK Steel and the USS Clairton Works, non-residential contracting should exceed $4 billion in 2009, but I expect the underlying commercial market to decline by more than 30%.

The totals listed below represent the number of new housing units for which building permits were issued, excluding mobile homes and elderly care complexes. The top areas were:

The top Pittsburgh sub-markets for housing construction in 2008
The top Pittsburgh sub-markets for housing construction in 2008

Some Green News

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December 9, 2008 was celebrated as Rebecca Flora Day in Pittsburgh. Rebecca has been an incredible positive force in the region, first working with South Side Local Development and especially for the past decade as Director of the Green Building Alliance. Her energy and dogged determination to make regional leaders understand that ‘green’ building wasn’t a fad but a sustainable economic reality, put western PA in the forefront of sustainable design and construction worldwide. Rebecca Flora Day recognized those efforts, which resulted in two of Pittsburgh’s buildings, the David Lawrence Convention Center and PNC Firstside Center, being the largest public and private LEED-certified buildings in the world at the time of construction.

Rebecca’s leadership put her in the role of US Green Building Council board chair during 2008, and unfortunately put her on a national stage, to which she will be heading full time in January. It is a loss for the region but great stuff to have one of Pittsburgh’s green pioneers working to head up education for USGBC. Congratulations and best wishes to Rebecca.

The GBA will conduct a national search for a new executive director. During the interim, Geoff Stillson will serve as director.

On the construction front, another innovative green project is moving forward, with the sleection of a design/build team. To recognize and leverage Pittsburgh’s leadership in sustainable design, a collaboration of public & private groups, collectively known as the Pittsburgh Green Initiative, has selected the team of Mascaro Construction, DLAstorino/Horizon Architects, CJL Engineering & Klavon Design Associates to help develop a “Living, Learning & Earning Center.”

Pittsburgh Green Initiative involves participation from CMU, Penn State, Pittsburgh Gateway, the URA, Reps. Doyle & Ferlo, Operating Engineers Local #95, and others to create a center, using one of the region’s abandoned industrial/institutional buildings, that will celebrate our green leadership & foster sustainability as a force in design, lifestyle & economic development. The team is just beginning analysis of sites, and will be designing and building next year.

Lots of New Data, No Real Direction

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Sixty days ago the financial markets were in the midst of a 30% decline during a ten day period that rocked the world’s economy. That ‘crash’ in world sotck markets triggered a staggering decline in the price of commodities, and more importantly, in the confidence of consumers. It’s ironic that the trigger for that crash, the approval of the $700 billion TARP bailout, was supposed to restore calm in the markets, but instead the government intervention sparked a panic that ultimately drove most investors to the sidelines.

Americans have short attention spans anymore. That includes American business owners. As Christmas approaches the panic that existed in early October seems to have given way to an acceptance that the economic downturn is real and most have begun to alter their planning accordingly. Almost everyone I know has taken an attitude of “I guess I’ll just work five more years than I planned after all.” And American consumers have also adjusted, slowing their spending noticeably, and expecting to spend less on themselves in the coming year.

American business owners are also consumers. In the two months since the ‘crash’ it’s becoming clear that in a more measured way the business owner has reacted to the crisis by anticipating next year’s tough business climate. Job cuts are beginning across all industries, and corporate spending has been curtailed signficantly.

The bad part of our collective short attention span is that we seem highly susceptible to economic new that is a regurgitation of the panic from October.

Since none of our economic tracking sources, especially not the government, is capable of being more timely than a month in advance (meaning that today’s announcements about some part of the economy reflect November actions in the best case), all the data we have seen of late has been a reflection of the fear that gripped us during the ‘crash.’ Today’s business section of the Post-Gazette is an especially good example, as the data reported is the November jobs and consumer spending. In October the fear was so great that banks were experiencing withdrawals and redemptions like the runs of the 1930’s. Is it any wonder then that consumers would spend less or employers would reduce hiring or cut jobs in November? For the same reasons, prospective homeowners have delayed buying decisions, businesses have cut advertising and captial spending, and travel spending became almost nonexistant.

This sentiment may have already receded. Certainly the initial Holiday spending data has been much better than anticipated (although most media seem to view that as a signal that it will be much worse later in the season), and businesses have begun to assess the prospects for 2009 more objectively, and most have come out of the bunker mentality already.

The danger for the remainder of the year and the first quarter of 2009 is that the economic data will still be mostly an echo of that very abrupt and traumatic two weeks in October. Yet, none of that data will really give us a clear picture of whether or not the recovery can begin soon, or whether we’re just at the beginning of an even deeper decline. This past week some of the nation’s best economic thinkers declared the recession to be a year old already. Using most economic historical trends as a guide, that means that the recovery is between three days and one year from beginning. How’s that for a clear signal?

Watch the data over the coming months but be careful to make your decisions after talking with your customers and vendors first. Be especially careful about listening to ‘experts’, especially those getting paid for their opinions. Try this litmus test: check out the experts’ opinions on the energy markets last summer. The most optimistic of that group was willing to say that oil was heading for $100/barrel after speculation cooled off; most were talking about $250/barrel and $8/gallon at the pump. If your ‘expert’ was in the latter camp in July, how reliable is his forecast right now?

Housing Market May Have Found the Bottom

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One of the more perverse (and comforting) realities about doing economic forecasting is that you can get a reputation for wisdom by merely being wrong less than your audience. So emboldened I am going to go out on a limb and predict that the national decline in housing values has hit bottom, or at least the trend has. By that I mean that the indicators of housing sales have reversed themselves within the past 90 days, and that housing values should begin to firm and move upward by the early part of 2009.

 There’s alot of reasons that should sound like a damn fool forecast, not the least of which is the almost certainty of recession symptons (if not the official recession) in 2009. Higher unemployment, stagnant wages and potentially higher prices for necessities don’t make for good buying conditions; however, remember that the seeds of the decline were sown when the economy was flying at its highest in 2006.

Here’s what has finally pushed me to the side of the recovery signal: Pending home sales in August spiked over 9% compared to July. Now there’s no assurance in that, and in fact, the data probably includes alot of bad anecdotal news, like “vulture buying” and price capitulation in overbuilt markets. But the diamond in the rough of the August data was that the increase marked the third straight incidence of an increase following an earlier increase/pullback. That probably sounds confusing. What that shows is that the increase in pending home sales bounced back, tested the bottom and bounced back higher again. That happened in April over February, June over April, and now August over June. If this was a stock chart you’d be calling it a buy signal.

PHSI chart shows pending sales since 2005
PHSI chart shows pending sales since 2005

What’s also good in the August data is that the biggest gains regionally were in places previous in the worst shape: Naples FL, Las Vegas, Central California.

Regardless of the discounting that may be involved, the removal of housing from the inventory is the first step in reducing supply before prices can start to rebound. The realistic prediction is that recessionary forces will probably keep demand from growing for the next 6-18 months, but a decline in supply will firm housing prices ahead of renewed demand, whenever that may occur. And don’t forget that it’s the decline in home values that exposed the weakness of the lending standards and started this whole financial crisis 15 months ago.

Month Pending Home Sales Index
Aug-05 124.4
Aug-06 111.9
Jul-07 92.8
Aug-07 85.8
Sep-07 87.8
Oct-07 89.8
Nov-07 86.9
Dec-07 85.9
Jan-08 86.2
Feb-08 83.8
Mar-08 83
Apr-08 88.9
May-08 84.5
Jun-08 89.4
Jul-08 86.5
Aug-08 93.4

Third Quarter Housing Starts Plunge on Recession Fears

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The tidal wave of bad financial market news that began in July seems to have spilled over into western PA in the third quarter. Pittsburgh’s economy is as solid as it’s ever been, but the fear of the national recession seems to have put enough fear into the market to drag it down. Even though job creation is positive in western PA, it is understandable that potential home buyers would look forward six to twelve months with some uncertainty.

 

During the January through September period 1,609 permits were issued for single-family detached units, down 12.6% from the same period last year. The market for single-family attached and multi-family units was down further, with 1,056 units started compared to 1,270 during the first three-quarters of 2007.  The overall housing market was down 14.3%.  Activity was a mirror image to 2007 when housing permits increased over the second quarter. Permits granted in third quarter 2008 for detached housing totaled 458 units compared with 587 last year, and the overall totals were 873 compared to 1,217 in 2007. That represents a 22% and 29% decline respectively.

 

The one submarket that seems to be immune to the downturn is within the city of Pittsburgh. There has been two-and-a-half times the new construction in the city as in the next most active suburb.

 

Non-residential construction remained strong in the quarter, with more than $1 billion in contracts awarded.  Contracting during January-September was $2.7 billion, a 13% increase over the first nine months of 2007.  The difference between this year and 2007 is that the pipeline is clearly drying up.  The fourth quarter should have another half-billion or more in new contracts, but a lot of that is already on the books. Bidding between Labor Day and early October is off significantly. This is usually the time when last-minute bids go out for construction before the weather breaks. The steep decline in the capital markets has pulled the rug out from under a strong market, and it’s looking like a lot of projects are being deferred until there is more certainty about the economy.

 

Energy and manufacturing projects are still advancing rapidly, and should fuel a couple of billion dollars worth of work in 2009, but those markets are served by relatively few firms. The mainstream commercial and institutional projects are increasingly being shelved. And some of the bigger institutional owners are paring back. West Penn Allegheny Health System has delayed the construction of a new ER at the Alle-Kiski facility in Natrona Heights, and UPMC has cut back capital budget spending, although the new $200 million Monroeville center appears to be moving ahead this quarter.

 

The totals listed below represent the number of new housing units for which building permits were issued, excluding mobile homes and elderly care complexes.  The top areas were:

 

Municipality

#SFD

#SFA

Total

Single-Family Detached

 

 

 

North Huntingdon Township

78

16

94

Adams Township

76

55

131

Pittsburgh

73

263

336

Peters Township

69

2

71

Moon Township

63

8

71

South Fayette Township

55

4

59

North Strabane Township

54

31

85

Franklin Park

52

15

67

Cranberry Township

46

45

91

Jefferson Hills

45

4

49

 

 

 

 

Single-Family Attached

 

 

 

Pittsburgh

73

263

336

Adams Township

76

55

131

Cranberry Township

46

45

91

Slippery Rock Township

9

40

49

Slippery Rock

4

40

44

South Park

10

40

50

 

 

 

 

Total Pittsburgh MSA 2007:3

1,841

1,270

3,111

Total Pittsburgh MSA 2008:3

1,609

1,056

2,665

% Change

-12.6%

-16.9%

-14.3%

 

 

 

 

By County

SFD

SFA

Total

Allegheny

730

615

1345

Beaver

91

31

122

Butler

213

218

431

Fayette

89

12

101

Washington

228

94

322

Westmoreland

258

86

344

Don’t Panic

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September 29th marked at least the third ‘worst day in banking’ this year. With six or seven different ways for the average citizen to find out simultaneously that the House of Representatives turned down the so-called ‘bail-out’ and that Wall Street didn’t like that, it is easy to understand how fear could well up in such a short time. The worst thing any investor can do is to sell into a market panic, unless minimizing your portfolio is the goal.

Remaining calm when all around you is chaos is easier said than done, but there are a couple of things you can do to practice calming your nerves.

First and foremost, focus on the facts. The media is in extreme competition for your attention, and the current theory is that you’ll pay attention to extreme reporting. That means that every event is a ‘crisis,’ complete with its own title, and that the consequences are reported as earth-shattering every day. With all forms of media shouting doomsday headlines at you every minute of the day, it’s easy to forget that the US economy hasn’t even experienced contraction in GDP yet. Unemployment is at 5%, not the 25% of the Great Depression, or even 10% that we experienced in western PA in the early 1980’s. We are most assuredly in an economic slowdown nationally (probably a recession already), but it’s about time for one of those anyway, just like in 1989-1990 or 2001-2003, or any time we have five or six years of growth.

Focus on your investment objectives. Unless you are trading for short term cash growth (in which case-good luck), these tough days for the stock market will pass. If you have an account managed by a professional, your money is probably being used to buy more stock in undervalued companies that will grow that much more rapidly when recovery comes, whether that’s next quarter, next year or next decade.

Focus on the region. Construction and real estate fundamentals in western PA are better than normal. Vacany rates are declining, rents are increasing, and job creation is accelerating. We have massive investment in industrial construction that will produce manufacturing jobs. Legal and accounting firms here continue to grow as their businesses have grown beyond regional borders. Even our banks have steered clear of the poison that has affected other regional institutions. And we all know how strong the healthcare and technology sectors have become in the region.

There is daily evidence that businesses here will be cooling off their plans for construction projects. Doubtless contracting in 2009 will be slower that the past few years, unless some real clarity about the financial markets happens in the next few months. That’s OK. It won’t be fun to endure a slowdown, but the upside is that contraction is the natural response to an extended period of economic growth, and western PA has had the growth. Moreover, the next wave of growth, be it from more tech jobs, healthcare or energy, is already building to keep the downtown relatively short and shallow.

Industrial Construction Renaissance

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Wednesday’s long awaited announcement from Allegheny Technologies that it had decided to put a new $1.2 billion rolling mill in Brackenridge adds another mega project to the list of industrial construction projects scheduled to get underway in the region during the next 12 months. ATI’s investment in northeastern Allegheny County matches the $1 billion that U. S. Steel is investing in upgrading their Clairton Coke Works, where preliminary work is underway. Another $1 billion project has begun the preliminary bidding cycle in western Washington County, Robinson Power’s Beech Hollow Coal-fired Power Plant.

You can undertand why Allegheny County Executive Dan Onorato fairly bristles at talk of the steel industry in the past tense. For a region with a “manufacturing past” $3 billion in construction is sure a lot of investment.

Add to that the rush to explore the Marcellus Shale formation for natural gas and you have quite a nice boom in the industrial segment of the economy in western PA. Already there are three different projects being planned for natural gas exploration companies, totaling around $50 million in new construction in Westmoreland and Allegheny County. Some of the existing energy companies in western PA (Atlas Energy, Consol) have already invested more than $100 million in the past couple of years. This may be all that’s out there but it says here that this is the tip of the iceberg.

Anecdotal evidence is all that we have right now to judge the staying power of this industrial renaissance. An interesting tidbit is that the national construction giant Barton Malow opened an office in Southpointe this summer for its industrial group, not the institutional group (which is building Children’s Hospital and UPMC Monroeville East with P. J. Dick).

One of the long-term benefits of all this investment is that it secures thousands of jobs that most of the region’s pundits thought were dying off. Both ATI & USS are creating better processes without eliminating jobs. The construction jobs alone will be in the thousands over the next three years, and the energy jobs may eventually be seen as the start of a new industrial boom in the region. I realize that sounds like a sunshine pump but the need for natural gas and alternative eletrical generation to reduce dependancy on oil imports is at least as great as the need to drill more oil domestically, and it’s a whole lot more certain. Some of the first land leases have been windfalls for the landowners, many of whom are farmers. There’s even been talk of a coal-to liquid gas facility near Midland, PA. That western Beaver County town is the prototypical post-industrial municipality in our region (even though there is still steel made there).

As one who regularly speaks about the folly of trying to attract “well paid” manufacturing jobs, I’m happy to have not seen this one coming. It is probably more realistic to expect a renewed industrial economy here to attract modest job increases, and provide mostly short-term benefits for the construction industry. It’s possible, though, that renewed industrial investment in a region that has industrial infrastructure could be a home run.

Is the Commodities Chokehold Over?

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At noon today, the spot price for oil had recovered about half its losses to sit at $97 and change per barrel. Earlier the price had plunged to just over $93. Gold was up to $780 an ounce, but that level is some $300 below its mid-summer high.  Copper was down to $3.13 per pound, almost a dollar a pound off its summer high (which was almost a record level). After more than a year of rapidly increasing commodity prices, the world’s cooling economic outlook may finally have broken the fever tht has infected basic materials and buildings products for construction.

About the only thing looking up today is diesel, and even that is trending back. Hurricane Ike had plowed into literally the worst spot in North America for the refining business, the channel that runs from the Gulf, through Galveston Bay and into Houston’s refinery row. But as the storm receded another day it looks like damage will be minimal. Some enterprising sorts in the Gulf and Florida have jumped prices at the pump by 50 cents or more (one group of knuckleheads added a buck on Saturday and are now in possession of indictments from the Florida Attorney General’s office), but locally the price of diesel has gone up a dime or less.

The parts of the world that were driving high prices for oil, steel, copper, aluminum, etc. are beginning to slow down. China expects to become a net exporter of steel by 2009. India’s infrastructure needs to catch up to its growth again. The European Union nations, which consume roughly two-thirds what the US does, is experiencing the same kinds of problems (housing slump, reeling financial firms) our economy is, and will be in a recession by the start of 2009. So there is a real decline in demand for the pereviously overheated commodities worldwide. And, as usually happens, the rising prices spurred expansion of supply capacity, which will come on line just as demand craters for a lot of basic materials.

Don’t be surprised to see oil below $75 after Christmas. If the illiquidity in the financial markets continues until that time, there will likely also be a double-digit decline in non-residential construction nationally, which will further pressure prices. None of this is new, of course. After the last oil crisis in the late 1970’s triggered a global recession, prices of commodities gradually and steadily declined until they hit record lows in the mid-1980’s (remember gold at $300/ounce, oil at $10/barrel?).

In Pittsburgh, some of this nonsense will have an effect on our economy, but overall we have become insulated by skill and luck from this economic wretching. Perhaps PNC Bank is the best example of our good economic fortune: as the rest of the banking business was being clobbered today, PNC’s stock prices fluctuated with 5% of its 52-week high.

There are some potential bad consequences to a commodity bubble bursting, but all-in-all a pull back shows that markets will swing back towards equilibrium. At the very least, falling commodities will mean falling building components. For a region which continues to have demand for new construction at high levels, cooling commodities makes pro formas that much more appealing.

Don’t panic.