Revenge of the Old Economy - Business Outlook
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Revenge of the Old Economy

By Eli Lustgarten

Article Date: 06-01-2008
Copyright(C) 2008 Associated Equipment Distributors. All Rights Reserved.

'Recession or No Recession' is just semantics; the industrial sector will muddle through 2008.

Eli LustgartenThere are blinking yellow lights in industrial markets in 2008. Q4:07 through Q2:08 looks like an instant replay of year-end 2006 and early 2007 - financial markets remain extremely nervous from the ongoing effects of the sub-prime crisis, and weak automotive and housing/construction markets continue to weigh heavily on the economy. The U.S. economy appears to be in a second round of a mid-cycle correction.Industrial America and the domestic economy came back to life in the second quarter of 2007 after a seven-month slowdown that began in September 2006 (to April 2007 - ISM PMI index was barely over 50 percent, the demarcation of growth). The slowdown, defined as a mid-cycle correction, saw top-line growth fall to low to mid-single digits at best, and corresponding earnings growth for the best companies struggled to reach to reach double digits.After five months of reasonable growth, the industrial economy again faltered with the PMI falling to stagnant levels of around 50 percent from September through January 2008, 48.3 percent in February, and 48.6 percent in March and April. New orders and production weakened and inventory levels rose, suggesting an involuntary inventory build at the customer level that needs to be brought under control.The GDP report for Q4:07 and Q1 of 2008 of just 0.6 percent verifies the stagnant nature of the domestic economy and has sparked an ongoing debate as to whether the U.S. economy is in recession. What we should recognize is how different conditions are today from the 2001/2002 recession, which was characterized by a sharp decline in the manufacturing sector led by a massive inventory correction - even if 70 percent of the domestic economy didn't feel it. This time it's the 70 percent of the economy that in fact may be in recession. The key may be whether the 30 percent represented by the "old economy" can carry the load. Statistically that will be difficult without continued very strong international performance.We may not know for quite a while whether we officially have a recession. The technical definition is not two negative quarters of GDP growth, but rather "a significant decline in economic activity across the economy lasting more than a few months normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales," according to the NBER. So far, only the employment data meets the test.Whatever the economic community decides, the industrial sector shows all the signs of muddling through 2008 with relatively flat domestic performance and continuing growth outside the U.S. Indeed exports are help keeping the domestic economy growth positive and has more than fully offset the decline in the residential construction sector. (See box below.) 
  Residential Construction Exports
Q1:06 to Q4:07
$Billions -173.4B +$183.4B
% of Change -39.5% +42.0%
Q4:06 to Q4:07
$Billions -96.7B +$104.1B
% of Change -34.4% +36.9%
Further, the government stimulus package with bonus depreciation may help domestic economic growth in the second half of the year - possibly accelerating some buying decisions.The bottom line is we are in the second round of a mid-cycle business pause:
  • H1 of 2008 is dicey with weak auto, housing/light construction, truck and a mini-inventory correction. Expect improved domestic economic growth in H2:2008.
  • The upturn however will be a two-tier recovery. The weak markets of 2008 may stabilize but not much more.
  • Housing will likely fall another 25+ percent to less than 1 million starts, with hope for stabilization toward the end of the year.
  • Auto outlook continues to be soft with retail sales likely to fall to 15.0 to 15.5 million from 16.1 million in 2007. NAFTA auto production outlook has deteriorated and now looks like 14.5 million units at best in 2008, down from 14.9 million in 2007.
  • The truck sector looks relatively flat in the first half of 2008 compared to H2:2007 with a moderate upturn in the second half of this year. We still look for NAFTA heavy class 8 shipments in 2008 of 220,000 units plus compared to 212,000 in 2007. 
  • Construction equipment domestic retail sales are likely to fall another 15+ percent in 2008 as nonresidential construction spending slows. However, industry production of construction equipment should be relatively flat in 2008. International sales should remain robust.
  • Farm machinery sales should rise 10 to 15 percent this year, reflecting the high level of commodity prices; mining and oil field machinery demand should also pick up given near record metal and energy prices; aerospace demand looks solid, as do most electrical equipment markets.
  • The real strength for industrial America will continue to be driven by international demand.
CED Web exclusive: ISM PMI Index
  Q1:06 to Q4:07 Q4:06 to Q4:07
$Billions % of Change $ Billions % of Change
Residential Construction -$173.4B -39.5% -$96.7B -34.3%
Exports +$183.4B +42.0% +$104.1B +36.9%
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Article Categories:  Business Outlooks  »  Economic Outlooks