Irrational Exuberance?

Inflation’s so high, it’s got everyone low (and it’s resulting in construction bids being triple what designers estimated they would be just 90 days ago). The S&P is down 15% year-to-date. (And with it, your dreams of retiring early. Also, you’re going to have to set your sights on a smaller boat.) “Tanking” barely does justice to what’s happening with small business and consumer confidence. Gallup’s Economic Confidence Index just registered its lowest reading since the tail end of the Great Recession in early 2009. Hard landing or soft landing? Place your bets. The chief economist for Moody’s Analytics last Tuesday said there was a 1 in 3 chance of a recession this year and “even odds” for one within two years. U.S. new-car sales dipped below an annualized 13 million vehicles in May, prompting analysts at RBC to say they are at “recessionary levels.” Jamie Dimon, CEO of JPMorgan Chase, says he is preparing the bank for an “economic hurricane” on the horizon. Anxiety abounds. Doom and gloom are the watch words. Except—apparently—in the AE industry.

What, me worry? February saw the publication of the Q1 2022 Engineering Business Sentiment study—yet another excellent product by the pioneering ACEC Research Institute. Six hundred-plus respondents representing engineering firms of all sizes and disciplines from around the country participated. The survey uses a “Net Ratings” system in which the negative responses are subtracted from positive responses. A positive Net Rating indicates optimism, and a negative one indicates pessimism. The higher the number, the stronger the sentiment. The overwhelming majority of firm leaders are “extremely optimistic” about the current state of their firms and the engineering industry. The Net Rating for the current state of firms’ overall finances is a staggering +88 and +82 for the engineering and design services industry today. As a comparison, in the first sentiment survey conducted in October 2021, those numbers were +83 for firm finances and +74 for the industry. This sense of optimism was palpable at last month’s ACEC Annual Convention in Washington D.C. Not only were attendees thrilled to connect in-person with peers at one of the industry’s most important events, they were also more than happy to discuss how great 2021 was for their firms and how there was no slowdown in sight. (There was no sighting of Jamie Dimon at this year’s conference.)

A more informed view, surely: But the ACEC Research Institute’s Engineering Business Sentiment study gathered its data in mid-January. Maybe that’s why the sentiment about the future was so upbeat. Possibly the participants were doing their best to honor their New Year’s resolutions to “be more optimistic” when they completed the survey. Or maybe the flashing economic warning signs were too distant, too faint to be factored fully (or at all?) into forecasts. A more recent survey of industry decision-makers would likely yield more conservative forecasts. Right? Nope. Last month saw the publication of the 43rd annual Deltek Clarity Architecture & Engineering Industry Report. The optimism of the almost 550 architecture and engineering firms participating in the survey practically leaped off the pages like a greeter at Disney World. The median net revenue growth forecast from the survey was 17.6%! This was not only the highest forecast recorded in the survey in over a decade, but it was almost three times the highest annual forecast from any of the prior 10 years. Of note, medium-sized and architectural firms were especially bullish on the future, forecasting 21.6% and 18.8% increases in growth, respectively. Take THAT, pessimists!

Squaring the circle: So, what gives? Why, in the face such immediate short-term economic turbulence (inflation, stock and bond markets simultaneously roiled) and longer-term headwinds and concerns (rising interest rates), do firm leaders in our industry feel so optimistic? I see four reasons why the optimism maybe overstated.

Feds to the rescue: Driving the optimism for many engineering firms is the passage of the Infrastructure Investment and Jobs Act (IIJA) and its promise of future infrastructure funding. Industry firms will undoubtedly benefit directly and indirectly. However, with IIJA there are two critical questions in terms of industry economics. The first is timing. Moving quickly is manifestly not a core competency of government. Recessions, on the other hand, don’t wait around. They operate on their own destructive timetables. If a recession hits prior to IIJA funds flowing, things could get dicey for more than a few firms. The second question is that with rising inflation, IIJA funds are able to purchase less and less bang for the buck meaning monies are directed to a smaller number of larger, better-placed design firms. For sure, the IIJA will help mitigate the effects of a more challenging economic environment on our industry, but it won’t fully protect it.

“Youth is wasted on the young”: While the last “economic”—as opposed to “pandemic-driven”—recession was a doozy, it’s almost ancient history in the minds of many of today’s firm leaders and business line managers. Many of them have forgotten the direct and painful coupling between recessions and our industry. Regardless of the trigger (2001’s bursting of the dot-com bubble or 1992’s savings and loan crisis), the design industry is typically one of the first sectors to feel the impacts of a recession and one of the last to recover. Related, it’s worth noting that the most recent AIA Architecture Billings Index indicated that, while conditions remained strong in April for designers, “scores for both new project inquiries and design contracts moderated slightly.”

It’s not just a river in Egypt: Denial, that is. I remember running strategy engagements for multiple ENR 500 clients in early 2009. The economy was already in free-fall. The housing market had collapsed. Credit had evaporated. Everything pointed to months of sharp, painful contraction (with no real way back then to figure out the bottom) and a long, slow recovery. Despite all of this, clients were seemingly hard-wired to project and plan for growth—starting in 2009! Why? An unhealthy—but not necessarily unexpected—blend of denial and inertia. “Denial” because it was hard for those leadership teams to face the world for what it was—that the good times were over—especially after such an extraordinary economic expansion before the crash of 2008 when many firms were doubling in size every five years—whether by design or not. “Inertia” because leadership teams knew that the only tool available to them to manage the new recessionary environment was to cut costs—which meant layoffs. Firms had been running full bore up to the crash; employees were working 50-plus hours a week regularly; and the sense of camaraderie and spirit of teamwork—that “we’re like a family here” culture—abounded in the industry. Leadership knew the only way to navigate the economic crisis was to break up the family.

Straight-line strategy: Far too many strategic plans in our industry are based on teams taking the “here and now” and straight-lining it five years out. Regardless of how much trend analysis, inputs from “futurists,” or scenario planning, most leadership teams are content to take the environment that they find themselves in and assume it will continue. So, when times are super-good (like now), that tends to be the forecast.

The boy who cried wolf: Nobody wants to be this kid. (I’ll bet he grew up to be a really successful risk manager.) And nobody wants the good times to end. But leaders need to factor the larger economic outlook into their strategic plans and business models. What goes up…

Morrissey Goodale is a CFE Media content partner.

Original content can be found at Morrissey Goodale.

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