The Big Idea
The economy’s best-kept secret
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Financial markets have focused this year on the difficult outlook for US office space. It would be natural to presume that the part of GDP that includes office construction, business investment in structures, is one of the weakest right now. But there is plenty more to this component than just the building of new office space. The desire of firms after Covid to bring their supply chains closer to home is generating a boom in construction of manufacturing and warehouse facilities. That is helping to keep overall business investment growing despite tightening monetary policy and uncertain economic prospects.
Office construction
Investors and analysts across a range of markets are warning of a wave of troubles coming for US office space. It is becoming increasingly evident that the incidence of work-from-home is going to persist long past the pandemic. Offices are about half as full today as they were before Covid, which has led to some massive valuation drops for certain big office buildings, especially in the central business districts of large cities.
This has not translated into substantial economic weakness just yet. In fact, while certain property owners and their creditors are beginning to see major repercussions, it is likely to take a while for new construction to dry up. Just to use a prominent example, every day that I work in New York City, I walk by the new JP Morgan Chase headquarters building on Park Avenue in Manhattan. The project was launched in 2018, and the building is scheduled to be completed in 2025. The broad point is that the life cycle of large office construction projects tends to be measured in years rather than months or quarters. So, the stress currently spreading in the sector may not be fully reflected in new construction activity for several years, as much of the current activity derives from projects started long ago.
This helps to explain how office construction can still be rising, despite the frequent negative headlines. The nominal value of office construction sank sharply during the pandemic but recovered last year and has been up modestly so far this year (Exhibit 1). It is worth noting that the real value of activity is actually down noticeably from peak pre-pandemic levels. Still, the full fallout from the structural downshift in office space demand has barely begun to be reflected in GDP.
Exhibit 1: Office construction expenditures rebound from pandemic
Source: Census Bureau.
Bringing supply chains home
Another major shift in the structure of the economy resulting from the travails of Covid is that global companies are seeking to create simpler, shorter supply chains. The far-flung global operations that resulted in falling costs for years suddenly became a major problem during the pandemic, when shipping restrictions resulted in widespread supply disruptions.
Many companies that sell their goods in the US have reacted by eagerly seeking to create more of a domestic operation base. The result is a boom of manufacturing and warehouse facility construction. Construction of manufacturing facilities was relatively stagnant until last year and has seen a massive run-up over the past year or so (Exhibit 2). In fact, the April reading released on Thursday was up by 105% year-over-year.
Exhibit 2: Manufacturing construction expenditures accelerate
Source: Census Bureau.
For what it is worth, the largest part of the run-up in manufacturing construction in recent months has come in the “computer/electronic/electrical” category and likely reflects in part the focused efforts by the federal government to boost domestic semiconductor production through the CHIPS Act and other policy initiatives. That category has seen a nearly threefold rise from a year ago and accounts for just over half of overall manufacturing construction.
In addition, the logistical crunch in 2020 and 2021 has sparked a rush to beef up domestic warehouse capacity. This is a trend that started before the pandemic but has been sustained and, if anything, has accelerated over the past year or two (Exhibit 3).
Exhibit 3: Warehouse construction expenditures continue to rise
Source: Census Bureau.
Economic impact
The GDP component “business investment in structures,” which includes nonresidential construction as well as oil and gas drilling, was on a substantial downtrend through 2020, 2021, and most of 2022. By the third quarter of last year, the level of real activity had fallen 25% from its end-2019 level. However, as manufacturing construction ramped up last year, the category has turned dramatically.
In the fourth quarter last year, real business investment in structures jumped at a 15.8% annualized pace, adding four tenths to real GDP growth. Considering the revisions to February and March data released on Thursday, real growth in the first quarter this year could have been even stronger, perhaps close to a 25% annualized rate, which would add half a percentage point to overall real GDP growth in the period. Given the continued growth in nonresidential construction activity in April, it looks like the category could post another double-digit annualized gain in the second quarter as well.
Quietly, the domestic building boom is boosting the economy noticeably in recent quarters, offsetting weakness seen in higher profile sectors of the economy such as housing and business equipment outlays.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
Important disclaimers for clients in the EU and UK
This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.
This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.
This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.
This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.