The Blinking Yellow LightBy Eli Lustgarten
Article Date: 03-01-2008
Copyright(C) 2008 Associated Equipment Distributors. All Rights Reserved.
Your guide to surviving Round 2 of the mid-cycle correction.
Caution is the word for the industrial economy in early 2008, which looks like an instant replay of year-end 2006 and early 2007. Financial markets remain volatile from the ongoing effects of the spreading sub-prime crisis, and weak automotive and housing/light construction markets continue to weigh heavily on the industrial sector. The U.S. economy has entered into a second round of a mid-cycle correction.
After five months of reasonable growth, the ISM manufacturing index has again fallen to stagnant levels since September 2007 including a revised 48.4 percent in December and 50.7 percent in January 2008, similar levels to the second-half of 2006 and first quarter 2007. Inventory levels rose, suggesting an involuntary inventory build at the customer level that needed to be brought under control. Only the price index remained very high at around 68 percent in December, surging to 76 in January, which suggests that input costs continued to escalate, potentially setting the stage for a classic cost-price squeeze.
Q4:2007 into Q1:2008 is a soft patch of economic growth for the second straight year, a direct parallel to the GDP growth registered in Q4:06 (2.5 percent) and Q1:07 (0.6 percent). Indeed, the Q4:07 Advance GDP report of just 0.6 percent GDP growth reflected an inventory correction and slowing export demand. GDP growth in Q1:08 is likely to be in the 1.0 to 2 percent range with weak, even negative industrial production driven by a decline in domestic automotive output and the ongoing mini-inventory correction.
There are still positive drivers to the 2008 economic and industrial economies despite a long laundry list of reasons why a recession is possible. We are getting action designed to mitigate many of the concerns:
The bottom line is that we are currently in the second round of a mid-cycle business pause (similar to 1966, 1986, 1995, 2006) with probably no more than a 30 percent chance for a full-fledged recession. The first part of 2008 will be dicey with weak auto, housing/light construction, truck and a mini-inventory correction. We still look for improved domestic economic growth in the second half of 2008 and beyond.
The weaker job market and credit issues have succeeded in pressuring the Fed to swallow inflation concerns and cut interest rates 125 basis-points with the potential for more.
The Fed continues to work globally to try to improve liquidity. This is one key metric to watch over the next few months.
Consumers remain resilient and have not gone into a recessionary retreat. Income growth is still OK with consumer spending in Q4:07 at 2 percent compared to 1.4 percent in Q2 and 2.7 percent in Q3.
Exports should remain strong as global growth remains robust well into 2008.
Inventories are being brought into line and the current mini-inventory correction should soon run its course.
Global growth will subside in 2008 but only toward more normal levels.
The upturn, however, will still be a two-tier recovery. Housing will likely fall another 20-plus percent to about 1.06 million starts with some hope for stabilization toward the end of the year.
Auto outlook continues to be soft with retail sales likely to fall to about 15.6 million from 16.1 million in 2007. NAFTA auto production now looks like 14.5 million units in 2008, down 3 percent compared to 14.9 million produced in 2007. The truck sector looks relatively flat in the first half of 2008 compared to the second half of 2007 with a moderate upturn likely in the second half of this year. We still look for NAFTA heavy class 8 shipments in 2008 of 240,000-plus units compared to 212,000 in 2007 and medium truck shipments up about 5-plus percent, all in the second half of 2008.
Construction equipment domestic retail sales are likely to fall about 5-plus percent after a 15 percent decline in 2007 as 2008 nonresidential construction spending slows to about a 2 to 5 percent gain compared to 16 percent in 2007. Industry production of construction equipment should be relatively flat in 2008, reflecting the significant inventory correction that occurred in 2007. International sales of construction equipment should remain robust. The markets to worry about are those related to rental sectors and material handling.
Many other industrial sectors should do well in 2008. Farm machinery sales should rise 10 to 15 percent, as should mining and oil field machinery, and aerospace demand looks solid. The real strength for industrial America will continue to be driven by international demand.
The upcoming stimulus program calls for a 50 percent bonus depreciation write-off for business in 2008 similar to 2004, when the major beneficiaries were farm equipment, construction equipment, trucks, machine tools and other types of equipment including autos/auto-related manufacturing equipment. We would anticipate a similar market response in H2:2008.
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