The worst is over for construction, so when will supply chains loosen up?

By Jenny LescohierSeptember 21, 2021

Charles Dougherty, vice president and economist, Wells Fargo Securities

All things considered, construction and the U.S. economy have bounced back with force in the face of a worldwide pandemic, and the future looks bright for the next few years, but the road to recovery is not without potholes.  

According to Charles Dougherty, vice president and economist with Wells Fargo Securities, who spoke at the ALH Conference on Sept. 14, consumer confidence and consumer sentiment are showing steady growth in the United States.

Those indicators, however, are tempered by economic headwinds including supply chain bottlenecks resulting in commodities price increases, as well as a shortage of labor, to name just two. The good news is some of the challenges are expected to simply work themselves out. 

“The United States economy and a lot of industrialized economies around the world are primarily based on services, so service sector activity really drives the economic outlook,” Dougherty said. “This is why we have recently taken our forecast for overall gross domestic product (GDP) growth back a little bit.

“We’re still going to see really strong rates of economic growth over the next few years, but the rise of Covid-19 and the Delta variant is probably going to make growth a little bit softer than what we were expecting at the start of 2021.”

Dougherty noted real GDP growth rate contracted severely in 2020 - somewhere around 30% - but rebounded shortly thereafter and has shown very strong rates of growth since.

“If you go back and look over the past few years, before the pandemic, we were averaging 2% growth in real GDP,” he said. “What we’re expecting for this year and next is still very robust growth, somewhere around 4.5% this year, maybe 3% next year. Historically speaking, those are very strong rates of growth. And we’re still digging ourselves out from the Covid-induced decline that we saw last year.”

He continued, “Overall, right now in the United States we are essentially where we started from at the end of 2019/early 2020. When are we going to get back to where we ought to be if we didn’t go through this pandemic-induced decline? It’s going to be sometime in 2022.”

Growing pains for U.S. economy

Supply chain bottlenecks around the world are creating long lead times for manufacturers, and in a lot of cases, businesses just can’t get their hands on the stuff they need, or the labor they require.

“One of the biggest kinks in the supply chain is at the Port of Los Angeles. Even though we have ships coming in with all the stuff businesses need right now, they are waiting a very long time to unload,” Dougherty explained. “This has important implications spanning the entire supply chain. If you can’t get your hands on steel or other raw materials, it’s very hard to make things to move the economy forward.

“We saw the world’s third-largest port in China shut down for pandemic-related reasons, which causes a butterfly effect with reverbations across every supply chain around the world,” he said.

Help wanted in construction

Employment is coming back, but there are still a lot of job openings out there. One of the big mysteries is why there is so much demand for labor and where the supply went.

Dougherty said there are a number of factors.

“You still have Covid-19 and that remains a concern for a lot of folks. Even if they’re not so afraid of catching it themselves, maybe they live with somebody and don’t want to spread it to them. That’s one thing holding back the labor supply.

“The other thing is a lot of folks have decided to retire. The demographics in the United States show a lot of people in the older age brackets, so you have an increase in retirements, and that can weigh on the supply of labor as well. Another thing is childcare. For the past 18 months, many folks have had to deal with home schooling and daycare centers getting shut down.

“Finally, we had an expansion of federal unemployment benefits. Essentially, the United States government was paying an extra $300 on top of state-level unemployment benefits. That works against the return to work.”

Dougherty continued, “The good news is kids are going back to school, so that eases the childcare issue. We have steadily increasing vaccination rates, so Covid concerns should start to recede. Those unemployment benefits have just lapsed, they are no longer available as of early September. All those factors should make the labor supply issue less severe in the months ahead, which is welcome news to a lot of folks in the manufacturing industry and in construction.”

Beware of inflation

Despite widespread trepidation, the overall rate of inflation and commodity prices are showing signs of cooling down or moderating, Dougherty said.

“Right now we’re probably at the peak of the price increases that we’ve seen as a result of all those supply chain bottlenecks and strong demand,” he noted. “Before the pandemic, we were going up 1.8% or 1.9% per year. Right now we’re above 5% per year.”

Inflation remains strong but is expected to come down naturally.

“As more vaccinations are given, as supply chain issues resolve, we’re not going to keep accelerating where you see 7% to10% inflation,” Dougherty said. “We’re going to see 5% and then 4% and 3%, which is still very strong, but at least it’s not going in the opposite direction.

“The moral of the story is interest rates are going to be low for a long time. We see the Fed raising rates maybe in 2023. Overall, they’re going to keep interest rates low for now because the labor market is still wobbly,” Dougherty said. “The Fed believes that inflation pressures are going to resolve themselves over the next year or so.”

Construction sectors react to economic shifts

According to Dougherty, residential construction has seen tremendous growth since the pandemic for a variety of reasons, including the need for additional household space as more people work from home.

“We’ve seen this frenzy in residential construction, but it’s cooled off a little bit due to supply chain constraints,” he said, noting the price of lumber, for example, went up over 100% over the course of a year. “The good news is that has come down, and we think the prices of other commodities are on their way down as well.”

Dougherty said residential construction should continue to slow down due to astronomical home prices that have made things unaffordable for many prospective homebuyers.

“Apartment construction is actually ramping up,” he noted. “As vaccinations have spread worldwide, we’ve seen apartment demand really pick up and that has encouraged developers to move forward with multifamily projects.”

Commercial real estate, for its part, is still improving but is not on firm ground. The retail environment has improved as consumer spending the United States has been a big bright spot over the past year, and household balance sheets have been very strong just from fiscal stimuli.

“Office construction is a big part of nonresidential construction,” Dougherty said, noting the future of office work is still uncertain to a large extent, but one thing seems clear and that is that companies are going to need less office space than before the pandemic.

“Everything is negative in the outlook for nonresidential, with the exception of warehouse construction,” he said. “Consumer spending has been directed more toward online transactions and ecommerce, so of course we’ll need more warehouses and distribution facilities to make that happen.

“Industrial construction, especially warehouse and service centers and distribution facilities, are very strong and we expect that to continue to be the case as more retailers invest heavily in their distribution chains and their value chains shift more of their business away from brick and mortar towards ecommerce. That’s a long-term growth area.”

Dougherty said he expects a return to a pre-pandemic economy in 2022 and 2023.

“We’ve seen the worst of it, and I think construction’s going to improve from here on out,” he stated. “Supply chain constraints are having a huge impact on commodity prices and this is the number one issue.”

USA
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