Posted on: July 4, 2022 Posted by: AKDSEO Comments: 0

This week, the prospect of a recession got real. Scary real.

Nearly six months into the stock market’s tumultuous ride, investors woke up Monday to see the claws of the bear now too late to duck: 40-year-high inflation for six months and the prospect of a quick spike in interest rates to tame it.

The S&P 500 fell into a bear market, defined as a 20% decline from its peak, and fell further Tuesday. Meanwhile, the 30-year fixed mortgage crossed the 6% threshold for the first time since 2008, sending mortgage applications in May to a 22-year low.

“Federal Reserve policymakers will continue to aggressively combat inflationary pressures,” said Anirban Basu, chief economist for the Associated Builders and Contractors in a statement, forecasting a recession later this year or next. 

An ominous confirmation: The yield curve for government bonds — the difference between interest paid on 2-year and 10-year Treasuries — is getting closer to bending in the wrong direction, a widely recognized signal of an impending recession.

While the blood ran thick on Wall Street — 495 of the S&P’s 500 underlying stocks ended lower Monday — nonresidential construction companies could be a safe haven against broader economic headwinds.

For instance, while the S&P 500 has lost 22% this year, the ISE Global Engineering & Construction Index, which tracks 56 large, multinational construction companies, has lost about half that — 12%.

There are several reasons these firms may show resilience in the face of a broader sell-off and sagging economy, including new project pipelines worth billions and plenty of future prospects to bid for in the $1.2 trillion Infrastructure Investment and Jobs Act.

And multi-year projects lead to “late cycle” profits in a downturn. Many key players, like AECOM and Jacobs Engineering, are pivoting to a less-risky business services model and away from the uncertainties and vagaries of physical construction.

To be sure, interest-rate sensitive sectors, such as income-producing properties, are likely to take hits. But on the nonresidential construction side, observers see reason for optimism. 

Big backlogs

“In the headlines, we’re hearing more and more talk about recession risk,” said Sean Eastman, senior equity research analyst at financial services firm KeyBanc Capital Markets. “Meanwhile, most of the engineering and construction companies I cover just reported record or near record backlog levels in the first quarter.”

The ABC’s Construction Backlog Indicator, which measures jobs contractors have won, but not started, hit nine months on Wednesday, the highest since September 2019 — before the pandemic and when commercial construction was near its peak.

“It is simply remarkable that contractors continue to add to backlog amidst global strife, rising materials prices and ubiquitous labor force challenges,” said Basu in a statement. “Backlog is up in every segment over the past year.”

Investors seek a safe haven

The firehose of infrastructure funding, which has just started to pump and will continue for five years, gives observers plenty of evidence that nonresidential construction firms could weather a recession.

“I’m still bullish on construction … Public construction spending, at least, is likely to hold up even if the economy slows dramatically,” Ken Simonson, chief economist at the Associated General Contractors of America, told Construction Dive.

Their stocks could be safer bets for investors trying to shed risk, especially construction and engineering firms with more public infrastructure business.

“The growth prospects are a little bit more locked in and are not as uncertain in a market that’s looking for a safe haven,” said Andrew Wittmann, senior analyst at financial services firm Robert W. Baird.

While many would like to forget the Great Recession that hammered the housing sector, profits in commercial construction were buffered longer because of the long lead times and government contracts.