It's Always Darkest at the BottomBy Eli Lustgarten
Article Date: 06-01-2009
Copyright(C) 2009 Associated Equipment Distributors. All Rights Reserved.
U.S. recovery timeline unknown, but expect more months of inventory adjustments as industry scales down to suit reduced construction activity.
Recent economic data still points to a very difficult industrial environment. The domestic ISM index is still mired in the mid 30s, though it is showing some signs of stabilization. The comparable Euro-zone ISM index is still falling, suggesting that the deterioration continues abroad. Only China seems to show some signs of improvement, aided by its more focused stimulus program. However, China’s ability to stimulate world economic growth is uncertain.
The recent Advanced GDP report for 1Q09 showed more bad news about the lack of economic growth. The reported GDP of -6.1 percent was only marginally better than the 4Q09 decline (-6.3 percent) with a huge drop in business spending and residential investment (both down 38 percent) and exports (down 30 percent). The silver lining is that businesses have been slashing inventories at a record rate (down $103.7 billion in 1Q09 reducing GDP by 2.8 percent) setting the stage for the eventual stabilization of GDP growth sometime in 2009. Inventory adjustments and the associated production cutbacks typically account for at least two-thirds of the drop in GDP activity. As inventories come back into balance with sales, companies start ordering again, and production stops falling, setting the stage for renewed economic growth.
Unfortunately, machinery and equipment is one area where the inventory adjustment will drag on for a while. Most manufacturers didn’t fully appreciate the magnitude of the global economic slump until late in the fourth quarter. Recent data shows that the February 2009 manufacturer’s ratio of inventories to sales for machinery and electronic equipment was the highest since the early 1990s recession as producers couldn’t cut production fast enough compared to the dramatic fall-off of sales. Factories are slashing production through extended shutdowns and reduced schedules but it seems that the inventory liquidation program in manufacturing will carry through at least the first half of 2009.
The construction equipment sector has embarked on a massive attempt to reduce bulging inventories on a worldwide basis. The global recession, the collapse of commodity prices, the continuing housing debacle, and the near shutdown in credit markets everywhere have severely impacted construction activity, causing a dramatic drop-off in demand of all types of machinery – especially construction equipment. The first quarter of 2009 saw a 50 percent decline in global heavy construction equipment sales (North America off 42 percent) and a 61 percent decline in global sales of light construction equipment (North America down 52 percent). Virtually every major construction equipment manufacturer has severely curtailed production both here and abroad at least through mid-year in an attempt to bring inventories under control.
While the economic environment for most manufacturing will be exceptionally ugly through the first half of this year, there are indications of improving signposts, which we view as key for the U.S. recession to come to an end. These include the U.S. housing data beginning to stabilize; the global purchasing manager’s indexes beginning to stabilize and rise; the financial risk metrics beginning to normalize (these include Bond spreads, TED spreads, ABX index, VIX, and non-zero 90 day T-Bill yields), commodity prices beginning to rise; and an improvement in global equity markets. The U.S. recession appears to be approaching a bottom, though the timing and magnitude of any economic recovery in the U.S. (or abroad) is uncertain.
The severity of the economic decline has caused us to sharply revise downward our projections for the construction equipment sector in 2009. Sales of construction machinery were off 22 to 24 percent in 2008. Our revised forecast for 2009 is for a further decline of 35 to 40 percent for all types of equipment (prior projection was for a 15 to 25 percent drop) because of the depth of the decline in the first half of this year. Export sales wane under the strain of global recession and a relatively stronger dollar; overall, nonresidential construction is still expected to fall 5 to 15 percent in 2009 and likely a similar decline in 2010.
Our forecasts for construction equipment demand outside North America has also deteriorated and we expect further declines of about 40 percent or more (was 20 to 25 percent) virtually everywhere including Europe (40 percent plus), Latin America (45 percent plus) and Asia (30 to 40 percent or more).
The light at the end of this bleak forecast for the construction equipment sector is that we are probably approaching the bottom of the cycle by mid-year 2009. However, with all the slack capacity in the industry, it is our belief that the near-term impact of expected spending under stimulus programs in the U.S. and elsewhere will be minimal for equipment suppliers until at least 2010.
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