The combination of rapidly escalating oil prices, soft consumer spending growth, dramatic reductions in net employment gains, and a new aggressiveness by the Federal Reserve aimed at raising interest rates has caused concern that economic momentum was fading fast. Second quarter economic statistics were poor and reinforced these concerns.

These statistics prompted some economists to drastically reduce their GDP projections for this year and next. Indeed, a survey of economists raised the likelihood of a recession in the next six months from a 5-percent to a 30-percent probability. PCA, in contrast, remains steadfast in it projections for relatively robust economic growth for the remainder of 2004 and throughout 2005.

Most responsible for the economic slowdown has been anemic consumer spending activity. Higher energy prices, an easement in auto incentive activity and a "tired" consumer have been cited as the causes of the consumers spending retreat. PCA agrees with some of these assessments.

PCA believes many analysts missed a critical ingredient for the slowdown in consumer spending activity. The source of funds for consumer spending was, and continues to be, in the midst of a transition from debt financing to income financing. Source of funds is the fuel for consumer spending growth. During such transitions, pauses in economic activity often occur. These pauses are transitory and pose no long-term threat to PCA's strong economic growth scenario.

Furthermore, the key underpinnings of consumer spending activity remain strong and should play a key factor in the recovery of this important sector of the economy. Consumer sentiment has generally followed a sustained path of improvement and is expected to continue to improve throughout 2005. Consumer balance sheets reflect improvement with declines in debt ratios, lower bankruptcy rates and the edging down of delinquencies. Finally, nearly 1.4 million new jobs have been created since the beginning of the year. While the rate of job creation slowed during the summer months, various survey reports indicate strong corporate hiring intentions during the next six months, suggesting stronger job reports lie ahead. In addition, the latest labor report showed a significant improvement — on par with PCA expectations for job growth.

The consumer is not going to fade for a sustained period of time anytime soon. PCA continues to believe that consumer-spending activity rests on solid underpinnings. The combination of a healthy consumer with relatively strong investment spending activity suggest that overall economic strength will be maintained and accelerate from current levels despite recent economic reports that suggest otherwise.

There are, however, serious risks to PCA's economic outlook. Oil prices remain near the $50 per barrel level. If this level is sustained through 2005, overall economic growth is expected to be reduced by at least one-half of a percentage point. As a result, job creation will be hindered — reducing PCA estimates calling for 2.3 million new jobs for 2005 to roughly 1.9 million — slowing the 2005 job creation pace by 400,000 to 500,000 jobs. Furthermore, higher inflation will materialize and lead to a weakening of the dollar, more aggressive monetary policy and a larger than expected increase in long-term interest rates.

For quite some time PCA's economic outlook has been predicated upon the assumption that oil price instability would eventually fade and the price of oil would settle into OPEC's desired target range. Unfortunately, this assumption has resulted in a continued underestimation of oil prices. Supply instabilities originating from Iraq, Nigeria, Russia, Venezuela, and elsewhere are probable going forward. These supply disruptions must be considered in the context of raging international demand. Strength in the demand for oil is in part due to the economic recoveries in Europe, the United States and Japan. Emerging, lesser-developed countries around the world are rapidly becoming a source of new demand pressures — such as China and India. In light of this new perspective on international oil markets, PCA's upcoming fall forecast is expected to add $10 per barrel to summer estimates.

High oil prices are often associated with the onset of recession. The overall economic context in which the oil price run-up occurs, however, must be considered before jumping to the conclusion that dismal economic times lie ahead. Relatively fragile economic conditions characterized past instances in which oil price increases precipitated a recession. That is not the case today.

The economy is performing strong enough that it can grow at relatively strong rates even in the context of higher oil prices. A recession is simply not in the cards. High oil prices, however, will take some zip out of economic growth. Largely as a result of the oil factor, PCA expects to lower its real GDP projections for 2004 and 2005 from 4.4 percent to 4.0 percent for 2004 and from 3.8 percent to 3.4 percent for 2005.

Fueled by a continuation of low mortgage rates and robust single-family construction activity, overall construction demand remains strong and roughly on par with PCA growth projections. Year-to-date total U.S. construction activity stands 2.7-percent above 2004 levels, based on inflation-adjusted estimates prepared by PCA.

PCA had expected that rising mortgage rates would surface by the beginning of the fourth quarter, prompting a significant and sustained decline in single-family starts activity. Despite Federal Reserve tightening, mortgage rates have not increased to the levels expected in our summer forecast. Low inflation rates, easing mortgage demand brought on by the collapse of refinancing activity and lackadaisical stock market performance have contributed to the resistance of mortgage rates to pursue an upward path.

PCA expectations regarding Federal Reserve actions and inflation generally remain on target. Stock market performance, however, has come in well below PCA estimates. Typically during a recovery, strong stock market performance siphons funds from the bond market resulting in reduced supply and a run-up in long-term bond rates and hence mortgage rates. This contributing factor to mortgage rate increases has not materialized since there remains significant uncertainty regarding growth prospects for stocks — keeping investors in the bond market, inflating supply and delaying the anticipated increases in mortgage rates.

Nonresidential construction activity has reached an inflection point. After recording successive declines in May and June, nonresidential has posted two consecutive months near 0-percent growth. While two months do not represent a trend,

PCA believes that nonresidential construction will sit near 0-percent growth for the next several months before a sustained upward trend is established lasting through the end of our forecast horizon.

Through the first eight months of 2004, hotel (+6.8 percent), office (+5.2 percent), and amusement and recreation (+2.5 percent) categories have all recorded gains over weak 2003 levels. These gains have been more than offset by year-to-date declines in industrial (-8.8 percent), education (-11.3 percent), retail (-2.8 percent), and religious (-9.9 percent) construction activity.

Office construction spending has recorded seven straight monthly year-over-year gains. Frankly, PCA is surprised at these sustained gains in office construction, even given the fact that these gains are measured against soft 2003 levels. PCA believes that high prevailing vacancy rates will keep forthcoming gains extremely modest.

Office employment growth is now advancing at a 2-percent rate. This rate is faster than the 1-percent rate estimated in PCA's summer forecast. If the more rapid growth rate of office employment can be sustained, then vacancy rates will decline at a faster rate than previously expected — potentially leading to a more rapid and meaningful recovery in office construction activity. While recognizing upside risks, PCA at this point is unlikely to ratchet up its forecast for 2005 office construction in light of high prevailing vacancy rates.

Manufacturing construction continues to post modest declines in activity. Recent statistics, however, point to some positives. Manufacturing capacity utilization rates, for example, have recorded more than one year of sustained increases and now stand at nearly 77 percent compared to a low of 73 percent. Furthermore, manufacturing employment has recorded six straight months of gains and added nearly 100,000 net new jobs since the beginning of the year.

Despite this good news, industrial vacancy rates remain high. PCA economic research suggests that manufacturing capacity utilization must reach 80 percent before a significant revival in industrial construction spending materializes. According to PCA's macroeconomic outlook, this condition will not be met until mid-2005. As a result, current forecast estimates appear to be on the mark. It should be noted that once manufacturing capacity utilization hits the 80-percent mark, manufacturing construction activity does not record creeping increases — rather, the growth rates are typically double-digit gains.

Year-to-date retail construction activity is 2.7-percent below 2003 levels. Recent monthly statistics, however, indicate that retail construction has reached a trough point. PCA expects strength to emerge in this sector soon. Retail construction is driven largely by conditions affecting the consumer. While recent statistics indicate a pause in consumer spending growth, PCA believes this pause will be short lived. The consumer has too many factors currently weighing in its favor for the pause to be long lasting. Furthermore, once an indication of sustained consumer strength is clear, retail construction responds in a rather quick fashion. PCA's summer projection for retail construction activity appears overly optimistic at this point, given a turning point was expected by July. A downward adjustment in retail construction is expected for 2004. PCA believes, however, that the 2004 adjustment is a result of timing rather than outright logic and therefore continues to believe relatively strong retail construction activity will materialize during 2005.

Educational construction spending is down 11.3 percent during 2004 compared to last year's levels. In a large part, soft educational construction spending is a result of difficult budget conditions facing state governments. Keep in mind, public educational construction accounts for roughly 82 percent of total educational construction spending. typically, fiscal stress at the state level results in significant reductions in educational spending during and at one year following state deficit conditions. The states have now recorded a full year of budget surpluses. This suggests that the declines in educational construction spending are nearing a trough point. PCA believes, however, that at least another two quarters of surplus budget conditions at the state level are required before an educational construction spending revival materializes.

Educational construction spending has been in a downward spiral since mid-2002. During this period, demographics and the need to improve education quality via lower student-teacher ratios has created continued increases in the demand for new classrooms and hence construction activity. State deficits, however, prevented the expansion of educational facilities to match increased classroom demand. In other words, pent-up educational construction demand has been generated during the past two years. By late 2005, in the context of sustained state surpluses, PCA expects a release of this pent-up demand — generating rather strong gains in educational construction activity.

Hotel and motel construction activity has expanded by 6.8 percent year-to-date. During the past three months the category has grown by a 17.4-percent annual growth rate. Five factors play important roles in the outlook for hotel construction activity including: the threat of terrorist acts, a weak dollar, a relatively strong job market, increases in business travel, and low air fares. Combined, these factors have worked to reduce hotel vacancy rates. Each of these factors is expected to exert similar positive influences on hotel demand throughout 2005.

Year-to-date, public construction activity is down nearly 1 percent from 2003 levels. Gains in highway (+1.5 percent), conservation (+1.2) and sewer systems (+3.4 percent) have been more than offset by declines in public building (-2.9 percent), military (-10 percent) and water supply systems (-6.0 percent).

Overall, PCA remains bullish on the outlook for public construction spending. Our optimism is centered on the assessment that state deficits are gradually eroding and will eventually be replaced by large state surpluses. During difficult fiscal times, state governments streamline and raise taxes and fees. The revival in job creation implies an improvement in the state revenue base in the context of a higher tax environment — resulting in significant improvement in state revenue collections. By 2006, PCA expects nearly all of the states to record significant surpluses. State expenditures, including construction spending, will increase. Furthermore, projects that have been postponed or delayed during the past two years due to deficit conditions are expected to be released in the era of state surpluses. The improvement in the state fiscal picture, coupled with a new TEA in the area of $300 billion, adds considerable fuel to the outlook for public construction spending. Keep in mind, roughly 50 percent of total U.S. cement consumption is tied to public construction.

Street and highway spending stands 1.5-percent ahead of 2003 year-to-date levels. During the March–May period, the category recorded an average annual growth rate of more than 8 percent. Strength in highway construction during this period, coupled with strong single family construction played an important role in the particularly strong demand conditions experienced in late spring (SAAR cement consumption levels averaged more than 120 mmt during this period).

According to some, the burst in the spring's highway spending activity is a result of cleanup projects that have been on the books for some time. In recent months, highway spending has recorded negative growth rates. PCA believes this is a reflection of continued budgetary constraints at the state level. The state budget picture, however, is improving rapidly. This will eventually result in an increase in discretionary highway spending — expected to be clearly evident by the second half of 2005. Keep in mind, discretionary highway spending has a much higher asphalt intensity and much lower cement intensity. This implies that highway cement intensities will decline during 2005 and beyond. This further suggests that the percentage gains in discretionary highway spending will exceed the gains associated with cement consumption.