Improved corporate profits, new activity could be key to future performance
Posted by Nick Kalivas, Senior Equity Product Strategist on Feb 24, 2017
Infrastructure spending has been a hot topic since the November elections. Building and construction stocks have been buoyed by the outlook for infrastructure spending - most Democrats in Congress and President Donald Trump agree that additional spending is needed to improve our infrastructure. The Dynamic Building & Construction Intellidex Index rallied 17.73% between Nov. 8, 2016, and Feb. 21, 2017 - well ahead of the S&P 500 Index, which rose 11.23% during this same period.1 A cyclical recovery in the economy is also creating tailwinds for leading indicators of construction activity.
Here are three reasons I believe building and construction stocks have moved higher:
1. Corporate profits are recovering
Construction spending tends to follow the cycle of corporate profit growth, which looks to have bottomed. The chart below displays the relationship between construction spending and year-over-year growth in corporate profits, as defined by the Bureau of Economic Analysis.
The chart's data indicate that corporate profit growth tends to lead construction spending by about six quarters. Profit growth can spur corporate investment and signal healthy economic activity, which, in turn, raises government tax revenues and helps support public spending on infrastructure. Increased capital spending can also spur consumer demand for houses and apartments. The correlation between corporate profits and construction spending is not perfect, but is a significant 0.66.1
Source: Bloomberg L.P., as of Dec. 31, 2016. Corporate profit data reported by Bureau of Economic Analysis. Data represent three-month averages.
2. Leading indicators of construction activity have turned higher
The Dodge Momentum Index tracks new construction activity in the US and includes residential and nonresidential building activity. The index tends to lead construction spending by about a quarter. The correlation between the index and construction activity is a robust 0.77.1 In recent months, the index has seen some of the most vibrant growth rates since the early 1990s, which should augur well for a pickup in construction spending over the coming months, in my view. The index level has been above 140 for four of the past five months - levels not seen since early 2006.
Source: Bloomberg L.P., as of Jan. 31, 2017. Data represent three-month averages.
Another leading indicator of construction activity is what's known as the Architectural Billings Index. This index is based on a participant survey that asks architectural firms whether billings have increased, decreased or stayed the same in the past month. A value of over 50 indicates an expansion in billings. The survey tends to lead nonresidential construction activity by nine to 12 months.
This Architectural Billings Index has, on average, been above 50 during the first two months of 2017 - suggesting an accelerated outlook for construction activity.1 I believe architectural billings strength in early 2017 will bode well for construction spending in the second half of 2017. The correlation between the index and construction activity is 0.77, making the Architectural Billings Index a worthy predictor of construction spending, in my view.1
Source: Bloomberg L.P., as of Jan. 31, 2017. Data represent three-month averages.
3. Existing single-family home inventories are unusually low
In February, the National Association of Realtors reported 1.46 million single-family homes listed for sale nationwide.2 This level of supply is historically low and could contribute to a tight housing market. I believe that, all else being equal, limited home supply should support home prices and the need for new construction. Current inventory levels are nearly the opposite those of the 2006 and 2007 housing boom and ensuing mortgage crisis. In my view, a pickup in homebuilding should be favorable for building materials and construction companies.
Source: Bloomberg L.P., as of Dec. 31, 2016
Investors interested in building and materials stocks might wish to consider the PowerShares Dynamic Building & Construction Portfolio (NYSEARCA:PKB).
- Bloomberg L.P., Feb. 10, 2017
- National Association of Realtors, February 2017
Blog header image: WDG Photo/Shutterstock.com
The American Institute of Architects' monthly Architectural Billings Index is a leading economic indicator for nonresidential construction activity, with a lead time of approximately nine to 12 months.
The Dodge Momentum Index, a monthly measure of first reporting of planned nonresidential building projects (excluding manufacturing), is a leading indicator for US construction activity and has been shown to lead nonresidential construction spending by 12 months.
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