The Bottom Line Hasn’t ChangedWritten By: ELI LUSTGARTEN
Article Date: 04-02-2007
Copyright(C) 2008 Associated Equipment Distributors. All Rights Reserved.
Despite government misinformation, the mid-cycle forecast holds.
There is much confusion in the economic data, and businessmen and investors are feeling the brunt of it. Whether it's the government report on GDP growth, jobs growth, inflation or even productivity, the government information initially reported has been highly misleading and subject to substantial revisions and/or adjustments to get a more accurate, realistic understanding. Look at GDP growth in 2006. The first quarter of last year was reported at a robust 5.6 percent, which made the United States one of the fastest growing advanced economies at that time. But that quarter was really a one-time payback for the unusually slow, hurricane affected Q4:05 GDP growth of 1.1 percent. The quarter was also full of technicalities (e.g. smaller trade deficit, increased energy costs), which insured the strength was not sustainable. The average of the two quarters (Q4:05 and Q1:06) of 3.4 percent was probably more representative of true economic activity, and more in line with the consensus view of the longer-term growth of the U.S. economy.
Then after numerous revisions, Q2:06 GDP was reported at 2.6 percent; Q3 GDP was only 2 percent as the slowdown of domestic economic growth became much more visible. However, just as businessmen and investors were coming to grips with a slowing U.S. economy and all its implications, the government reported the Q4:06 U.S. GDP grew at a robust 3.5 percent.
The stock market took off led by more cyclical issues, investors began talk of the short-lived slowdown being over and a potential V shaped recovery on the horizon, and the financial rhetoric changed from interest rates cuts to a potential increase due to the stronger economy and potential higher inflation. However, business skepticism remained high as corporations began to retrench in their spending wondering if what the government reported was real.
It wasn't! The Q4:06 GDP was revised downward from 3.5 percent to 2.2 percent, only the 7th time in 30 years for such a major revision. The slower growth principally reflected updated inventory data (December inventory fell 0.5 percent rather than increasing 0.6 percent), a wider than originally estimated trade deficit, slightly lower consumer spending and federal government outlays, and reduced business spending, which actually fell 2.4 percent in Q4 rather than the originally reported 0.4 percent decline
All of a sudden, the slowdown was not only back, it had never disappeared. Rather than continuing the optimism of a V-shaped recovery, those markets that are softening are all likely to remain weak well into 2007 and the economic data will have further headwinds from inventory liquidation, which clearly began as Q4:06 came to a close. It's no wonder the financial markets became volatile.
To further the confusion, the payroll data reported monthly has clearly been misleading with huge revisions each month. To place it in perspective, the benchmark for jobs between March 2005 and December 2006 was revised by a whopping 1 million jobs to 4.3 million jobs instead of 3.3 million jobs created during that period. So should January jobs of 110,000 or nearly 30 percent less than the revised 153,000 monthly average for 2006 (down from 165,000 in 2005 and 175,000 in 2004) be believed? Moreover, the impact of the statistical problems of the housing sector skewed the key inflation measure, Personal Consumption Expenditure upward (PCE reported up 2.2 percent in 2006 and above the FED target of 2 percent) and productivity (2.1 percent compared to 2.3 percent in 2005) downward.
This year will likely be that mid-cycle year where top-line growth falls to low to mid-single digits at best; 7 percent to 10 percent bottom line growth is good. The first half of 2007 will be dicey - weak housing, auto, light construction, farm, and truck and a mini-inventory correction. Look for improving domestic economic growth in the second half of 2007 and beyond spurred by an interest rate cut in the second half of the year.
Construction spending should remain about flat in 2007. We look for housing to stabilize in late 2007 with housing starts falling at least 15 percent to 1.55 million from 1.82 million in 2007 before recovering modestly to perhaps 1.64 million in 2008. The offset is that non-residential construction should continue to grow about 8 percent to 10 percent per year.
For the construction machinery sector, our forecasts also remain largely unchanged. Demand has peaked at historic highs, and that cooling that is under way in most markets will be much more pronounced in smaller and medium machines and in areas that have benefited from the extra-ordinary housing bubble. It's becoming clear the suppliers to the residential construction sector have begun to right-size their fleets of compact equipment to a lower level of future activity.
Purchase intentions in the rental sector continue to point toward at least modest expansion of fleets in 2007; 58 percent of our survey respondents expect to buy more equipment in F2007; 33 percent expect to buy the same amount next year and 9 percent expect to purchase less. Anecdotal evidence is beginning to suggests that skid-steers and perhaps aerial-work platforms sales will decline in CY2007 due to higher levels of inventory in the field and the slowdown in the residential construction sector.
The bottom line hasn't changed: 2007 is likely to be a much more challenging year. If the Fed will cooperate and cut rates in the next six to nine months, this expansion may have legs to last to the end of the decade.
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