2-2009 Business Topics
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‘A Lot More Pain Before Any Gain’
 
By Tim Triplett, Editor-in-Chief
Lustgarten, senior vice president and senior analyst with Long­ bow Research, Independence, Ohio, offered this assessment of America’s troubled economy during the Metals Service Center Institute’s Tubular Product Division Con­ ference January 16 in Indian Wells, Calif.

The U.S. economy and the steel market are facing some serious challenges, but the disastrous fourth-quarter results don’t necessarily foretell a similarly disastrous 2009, Lustgarten told the gathering of service center and mill executives last month. “Don’t use December and January data to extrapolate the year,” he emphasized. “This was a compressed reaction to get the economy sized for the change of environment.”

Putting the recent downturn in perspective, Lustgarten noted that the U.S. industrial sector has outperformed the S&P 500 since the year 2000. The recent downturn takes the sector back to the level of three years ago, but it remains substantially stronger than eight years ago. “We’ve given back the improvement of the last three years, but not the improvement that started at the beginning of the decade,” he said.

Indeed, the last four years was a period of above normal performance for industrial America and for the industrial sector globally. “We are simply reverting to the mean,” he added.

Weakness in the U.S. economy in late 2007 and early 2008 was masked by exceptionally strong exports. The federal tax rebate checks—a one shot incentive—made conditions appear better than they actually were. Modest growth in consumer spending driven by the stimulus checks, on top of increased government spending and higher corporate capital investment, enabled U.S. GDP to remain positive in the first half of 2008 despite significant economic headwinds from the ongoing decline in residential construction and inventory liquidation, Lustgarten explained.

By fall 2008, consumer spending was weakening as the effect of the rebate checks waned. Both consumer and business confidence were deteriorating. The housing outlook was uncertain as the subprime mortgage crisis spread and tightened the credit markets. The dollar strengthened 20 percent vs. the euro, ruining demand for U.S. exports. Economic growth outside the United States, particularly in Europe, also contracted. U.S. manufacturing capacity utilization dipped to the mid-70 percent range. The absence of credit and the failure of various financial institutions quickly dragged the industrial sector into full-fledged recession.

“The hope that the manufacturing sector could muddle through was shattered by the financial meltdown,” Lustgarten said. “When the credit markets shut down, everyone got pulled into this morass, no matter how creditworthy. The credit crisis quickly spread around the world, curtailing global manufacturing activity.”

The current question: How severe will this global recession be, and how long will it last?

With credit remaining tight globally, manufacturing activity will soften well into 2009 as companies curtail production and employment while they liquidate inventories and match activity to the reduced levels of demand, Lustgarten said.

Responding to the global financial market’s need for a major capital infusion, the U.S. Federal Reserve and Treasury, as well as the central banks around the world, are making funds available to refinance the banking system and guarantee debt of all types.

“The injection of liquidity and the coordinated global move to cut interest rates are all focused to free the financial sector from the current spasm that has threatened to halt global economic growth,” Lustgarten said.

No doubt the banking industry is facing a period of increased government regulation, he noted. The common belief that the financial markets would self-regulate with minimal government oversight has proven seriously flawed.

The federal government is embarking on a massive effort to stimulate economic recovery over the next two years, investing $775 billion to $900 billion in the form of tax breaks, infrastructure development, jobs creation and additional Troubled Asset Relief Program funds for bank bailouts and government backing of mortgage and consumer debt.

“We’re throwing money at the problem, but the next two to four quarters will be very dicey for industrial America,” Lustgarten said. “Domestic economic growth will be negative at least through the first half, if not all, of 2009.”

Most European economies will remain in recession, and economic growth in developing regions such as South America and Asia will slow this year. The strengthening dollar will curtail exports and weaken demand, putting further pressure on corporate profits. The only relief in sight is the falling price of commodities, which will reduce manufacturing input costs. “Virtually every end market will be under pressure in 2009. Virtually every end-user of steel will face lower demand in 2009,” Lustgarten said.

He offered the following forecast for leading markets in the year ahead:

n Housing is likely to decline another 15 to 30 percent, to perhaps 750,000 new-home starts. “Hopefully some stabilization [of housing] will become visible over the next two to four quarters.”
n Automotive “remains ugly,” with production expected to drop to the 10 million to 11 million unit range, from about 12.7 million vehicles in 2008. Even lower levels are possible, depending on the potential bankruptcy or bailout of Detroit’s Big Three.
n Construction equipment production and sales—down over 20 percent in 2008—are likely to slip another 10 to 15 percent in 2009 as export sales wane and non residential construction spending falls an additional 5 to 15 percent.
n The heavy truck sector, which declined modestly in 2008, is unlikely to benefit from any pre-buy, ahead of new 2010 emissions standards that will raise the cost of engines, due to the unfolding recession and lack of credit. Heavy truck production in 2009 is likely to fall another 15 to 30 percent to 160,000 units or less, with perhaps another 10 percent decline in production of medium trucks.

Even sectors that were originally expected to hold up in the weaker economic environment now find themselves under pressure from the credit crisis:

n Farm machinery sales, which saw a 15 to 25 percent rise in 2008, will be flat in 2009 as the recessionary environment takes a toll on commodity prices.
n Mining and oilfield machinery demand should hold up fairly well in the near term, but several 2009 mining projects have been postponed, while demand in the Mideast is weakening.
n Similarly, the electrical equipment market shows signs of weakening due to the credit crunch and double-digit declines in non residential construction starts.

“The linchpin of any decisions today, whether for business or investment, hinges on the timing of the financial market’s stabilization,” Lustgarten said. “If we can unfreeze the credit market and allow normal borrowing to function, then markets will have the ability to show some improvement in the second half of 2009.”

Most experts predict little or no growth for the U.S. economy in 2009, or a GDP of plus or minus 1 percent. The betting puts 2010 at just 2 percent growth. Industrial America’s golden age of above-normal earnings may have come to an end, Lustgarten said.

“Global growth is quite slow. We’re not going to get any help from our neighbors. It’s going to be a tough 2009,” he concluded, adding, “You can’t stop the problem, but you can recognize that what happens in 2009 is not the end of the world. It’s basically a recalibration.”

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