Recession’s Over, What’s Next?
While most experts agree the market has finally hit bottom, they also forecast a long, slow climb back to prosperity.
By the Staff of Metal Center News
Consensus can be difficult to come by in any group of experts, particularly in an environment where visibility is best described as limited. Yet the various analysts and economists assembled by the Metals Service Center Institute for its Economic Summit: Forecast 2010 conference last month near Chicago had a surprisingly similar take on the state of the economy.
Their general belief is that the recession, which has proven to be one of the worst of the past century, has run its course. GDP may have turned positive again, but recovery will be painfully slow, they say, with persistent unemployment, sluggish consumer spending and the costs of government stimulus programs weighing heavily on future growth.
Regalia: Recession May Be Over,
But Recovery will be a Long Slog
It may not be official yet, but Martin Regalia says the historic recession has run its course. “It will be a year at best before it’s official, but they’ll place the end of the recession in the third quarter of this year,” the senior vice president for economic and tax policy at the U.S. Chamber of Commerce told attendees in his opening remarks at MSCI’s forecast conference.
Despite initially writing off expectations of its severity as hyperbole, Regalia admitted that the just-concluded recession was indeed the worst economic downturn since the Great Depression. The duration of almost two years, the drop in GDP and the increase in unemployment all match or exceed other recessions.
Those declines are largely behind us, however, due in large part to four factors:
n Both the price of oil and inflation have declined. “Those are major reasons for the economy naturally beginning to repair itself,” he says.
n Public policies have worked reasonably well. Regalia said the TARP program and other economic stabilization attempts did what they were designed to do, for the most part. Though there were flaws, the policies were fairly effective in helping to navigate “uncharted waters.”
n The stimulus has also performed its essential task. Like the stabilization efforts, the administration’s stimulus pack-age was not perfect. “It was supposed to be timely, temporary and targeted,” Regalia said, noting it would only meet the first definition. Moreover, the Chamber would have preferred more tax cuts as part of the package. But like the earlier efforts, the government was required to act quickly. “We can find fault with the individual pieces, but it was done in the heat of a significant economic downturn.”
n The housing market has reached bottom.
But just because the economy has begun a turnaround after two tough years does not mean all is rosy. “You should expect to see somewhat less than normal speed of recovery,” he said. “It’s going to be a long and slow slog uphill.”
The crucial factor that will inhibit rapid growth is the slow rebound anticipated in consumer spending. The real loss in personal wealth, coupled with an unemployment rate that will remain high through at least first-quarter 2010, will make the generation of disposable income difficult. On top of that, even if some citizens were inclined to spend, “the banks wouldn’t lend to them anyway. Banks are much less likely to finance a boom in consumption.”
Also slowing the recovery is the lingering effect of the housing crisis. While the market has hit bottom, there remain too many foreclosures and delinquencies outstanding, plus a stock of unsold homes. “There are still a few areas where we’ll have to wait another six months to a year to put it behind us,” Regalia said.
With consumer spending unlikely to rebound quickly, that will dampen the enthusiasm for investment, which also helps drive growth after a recession, he added.
The global scope of the recession has limited the potential for significant improvement in international trade. While economies around the globe were mired in recession, more and more investors flocked to the security of the U.S. dollar. Despite the ongoing recession here, the U.S. dollar stabilized against other currencies.
Going forward, there will be some downward pressure on the dollar again, but slow growth among typical trading partners will mitigate that effect. “In the near term, exports won’t give us the boom our own consumers are not,” Regalia said.
In the long term, the labor market is one of the more challenging issues the U.S. economy faces, Regalia said. The country has lost seven million jobs since the recession began, a number that will continue to tumble by close to two million through the first quarter of 2010. Additionally, the official unemployment numbers understate the depth of the problem, as 750,000 more Americans have been reclassified as discouraged workers, those not actively seeking employment.
With more than 10 million out of work by the time the unemployment rate levels out, plus an expected increase of more than 10 million new entrants to the job market in the upcoming 10 years, the U.S. economy will have to create 25 million new jobs in the next decade. The U.S. has never achieved an average of 2.5 million new jobs annually, he said.
Finally, while the government was right to pump liquidity into the market to curb the impact of the recession, it will be equally challenged to pull that money out of the market to prevent inflation and interest rate concerns. It must be timed perfectly to avoid serious repercussions, Regalia said. “It will be a daunting task to back that liquidity out of the system.”
Strauss:Recovery’s Under Way,
But Job Market’s a Major Drag
Nearly all those in attendance at MSCI’s forecast conference feel the market has finally bottomed out. At least that’s how it appeared when William Strauss, senior economist and economic advisor for the Federal Reserve Bank of Chicago, asked for a show of hands.
Supporting the results of the informal poll, Strauss noted in his remarks that the U.S. economy appears to have begun a slow recovery. Much of the effect of the federal stimulus is still to come in 2010 and 2011, he said, forecasting 2.7 percent GDP growth next year.
Changes in consumer behavior will affect the pace of the recovery, he said. With real estate values so stagnant, and credit so tight, Americans can no longer count on the equity in their homes as a source of spending money. In addition to spending less, people are saving more aggressively. Strauss sees an elevated savings rate for at least the next five years. With two-thirds of the economy dependent on consumer spending, this “paradox of thrift” promises to slow the recovery. “The higher savings rate will definitely put a damper on the growth of the economy,” he said.
Historically, recessions have lasted six to 16 months. With the current one likely to span nearly two years, that makes it one of the longest and deepest downturns ever. Keeping it in perspective, however, he noted that it has not nearly approached the depths of the Great Depression, with its 43-month decline, 26 percent drop in GDP and 25 percent unemployment.
Most experts see little risk that inflation or deflation will scuttle the economic recovery. The core rate of inflation has actually moved lower, which allows the Fed to be more aggressive in its monetary policies, Strauss said. Even factoring in energy costs, inflation should remain around 2 percent. “Expenditures for energy are currently well below the historical average when adjusted for inflation, which is good for consumers,” he said.
Strauss noted that the labor market remains a major drag on the economy, with the unemployment rate the highest since June 1983, and climbing. He expects it to peak at over 10 percent in first-quarter 2010, and to linger above 9 percent for most of next year. “Job losses will continue until we get some positive growth,” he said.
On a positive note, the U.S. trade imbalance continues to improve. A 20 percent decline in the value of the dollar has made U.S. products more attractive to foreign consumers and has fueled U.S. exports.
U.S. manufacturing output is on the increase. Capacity utilization by manufacturers is actually too low at this point. Production will need to increase as companies replenish inventories. Capital goods orders have bottomed out and should begin to improve along with the economy, he said.
Car and light truck sales are down 27 percent in 2009; however, automakers cut production by 46 percent. With vehicle inventories so low due to Cash for Clunkers, “they are going to need to rebuild. There will be a bit of a ramp-up,” Strauss predicted.
Competition from import carmakers should not be a concern for domestic metals suppliers. While it is true that the market share of the Detroit 3 has declined to just 45 percent from 70 percent in 1980, the New Domestic automakers have grown their share by 25 percent. “So 70 percent of the vehicles that are sold here are still made here,” Strauss noted.
Residential investment as a share of GDP is half what it was before the crash, though the residential construction market is showing signs of improvement, he continued. “Although lenders still consider mortgages a dirty word, today is a good time to buy a home. We are starting to see a bounce in the sales of both new and existing homes.”
The supply of new single-family homes has declined significantly to about 7.5 months from a high of 12 months. In fact, homebuilders may have cut back too much, he said. Housing starts are now running at an annualized rate of just 500,000 homes, down from a peak over two million, and well below what the population could support. “A year from now you could be reading about a lack of housing. They may have overdone it.”
In summary, Strauss predicts solid growth with low inflation next year, though the persistently poor job market, volatile credit and weak housing remain significant risks to recovery.
Morici: Recovery Hinges on
Fixing Banks, Foreign Trade
To Peter Morici, a professor at the University of Maryland’s Robert H. Smith School of Business, the cause and the solution to the recession of 2009 begin and end with two simple issues. The lax mortgage and lending policies of U.S. banks, and the huge U.S. trade deficits and foreign borrowing, are the chief culprits.
The trade issue starts with oil, he said. U.S. energy and environmental policies have caused an excessive dependence on foreign oil, the first step toward a trade imbalance. On top of that, China’s undervaluing of its currency and its export-led development strategy have resulted in a tremendous trade disparity.
From 1994 to 2007, the U.S. trade deficit increased from 1.3 percent to 5.3 percent of GDP. “For every dollar we earned, we’d spend 95 cents here and 5 cents elsewhere. To keep going like that, we had to spend 105 percent of what we earned,” Morici noted.
Such unsustainable practices were only being encouraged by the nation’s bankers. The increased use of risky lending practices, with loans aggregated, bundled, sold and swapped to entities with little interest in their performance, was a recipe for disaster. Ultimately, thousands defaulted on loans they could not afford, banks and investors were stuck with declining securities and the credit market seized up.
The consequences for the economy include housing values that have fallen by 30 percent, banks that cannot securitize loans and have a shortage of funds for mortgages and businesses, and an unemployment rate headed for 10 percent.
While Morici, like the other economists who addressed the MSCI audience, acknowledged that the recession is behind us, he emphasized that much work remains. Fixing the banks and reducing the trade deficit are imperative to jumpstarting the economy, along with a restructured stimulus package.
Morici’s primary problem with the stimulus plan enacted by the Obama administration was the modest level of direct infrastructure spending—only about $100 billion of the $789 billion total. Additionally, much of the tax cut portion of the package has gone into savings, generating little stimulative effect. The package will still increase GDP and create two to three million jobs, but other issues must be addressed to prevent a slide back into recession.
Though the initial wave of government action included plenty of bailout money for banks, more work needs to be done on that front. “Banks need more assistance, but not those on Manhattan Island,” Morici said, noting that the regional banks are in the greatest danger. More than 400 regional banks are on a watch list for institutions in jeopardy of failure. Fallout still to come from risky commercial loans will only compound the banks’ problems.
Most important, said Morici, is fixing the trade deficit. While it dipped a bit in 2008, the deficit with China has begun to grow again, and imports outnumber exports 5-1. The reason behind the disparity is simple, he noted: “We let in what they make, but they won’t let in what we make.”
Boosting export sales will be critical to U.S. economic recovery, especially if consumer spending continues to lag. But that won’t happen unless China is forced to revalue its currency. “If we don’t fix the exchange rate, nothing else matters,” Morici said.
Lustgarten: Muted Recovery in 2010;
‘New Normal’ in 2011 and Beyond
While this has been a severe recession, “we’ve had a pretty good bounce off the bottom at this point,” said Eli Lustgarten, senior vice president of Longbow Securities, Independence, Ohio, who focused his remarks on the heavy equipment markets. Lustgarten forecasts a “muted recovery” in 2010, followed by “new normal” levels of economic activity in 2011 and beyond.
The massive U.S. government stimulus of $789 billion over two years, combined with stimulus programs by various foreign governments, will certainly help pull the global economy out of the doldrums, he said. Indeed, the recession most likely technically ended with an uptick in GDP in the second quarter. “The economic statistics say things will continue to get better for the rest of the year.”
Virtually every end market has faced lower demand in 2009. Housing fell over 30 percent to about 900,000 starts in 2008 and is still looking for a bottom. He predicts another 40 percent decline to about 550,000 units this year. New-home construction is showing signs of stabilizing, however, and will improve to 750,000 to 800,000 units in 2010, and 800,000 to 1 million or more in 2011.
The automotive outlook remains ugly, he said, with production in the eight to nine million vehicle range for 2009, down from 12.6 million produced in 2008.
He is similarly downcast on the truck market. Despite impending regulations calling for lower-emission engines in 2011, he does not anticipate a large pre-buy of the less expensive legacy equipment in 2010. “Why buy a new truck when you don’t need it. There are too many trucks chasing too little freight already.”
He expects nonresidential construction to fall 5 to 15 percent in both 2009 and 2010. Construction equipment sales and production won’t likely rebound until 2012. “There is a tougher recovery for construction equipment across the board,” he said.
Infrastructure spending will be relatively flat into 2011, or at least until a new federal highway bill is passed. History suggests that growth will resume about a year after the new highway bill has been funded, he said.
The recessionary environment has taken its toll on commodity prices. Lower grain prices combined with tight credit will cause a 5 to 10 percent decline in North American farm equipment sales next year. “When farmers feel the pressure, they usually cut equipment purchases first, then fertilizer. In 2009, they cut fertilizer first. Equipment sales held up OK, which means they could stall in 2010,” he added.
Several mining projects have been postponed this year, prompting sales of mining and oilfield machinery to decline by 25 to 40 percent or more through 2010.
Manufacturing capacity utilization is now in the mid-60’s compared to a more normal 78 to 80 percent. Virtually every industrial sector has excess capacity. Real growth in demand for capital equipment won’t occur until the market can absorb this overcapacity, which is not likely before 2011. Federal stimulus programs will play a greater role in 2011-2012 and beyond than in 2009-2010, he added.
By 2011-2012, Lustgarten sees the various equipment markets settling into a “new normal,” one characterized by lower end-market demand than in the past. The new norm for annual automotive sales could be 11 to 12.5 million new vehicles, rather than 16 or 17 million. The new norm for housing could fall in the 1.3 to 1.6 million range, down from 2 million annual starts. Annual production of class 8 trucks will total just 175,000 to 225,000 units; prior peaks of over 300,000 are unlikely at least until the next change in engine emission requirements. Likewise, construction and mining, engines and turbines, railcars and other heavy equipment face a slow recovery through 2012 to levels likely well below 2006 to 2008, Lustgarten said.
Looking ahead, he called 2010 “a transition year,” and pointed to solid growth in the years to follow. “We are in the midst of a natural recovery, which should proceed unless we do something silly,” he said.
DesRosiers: Troubled Auto Sector
Faces Years of Sales Declines
“There are two fundamental problems at play in the North American auto sector and there is very little that government can do about them,” auto industry consultant Dennis DesRosiers told his audience at MSCI’s forecast conference. One is the cyclical downturn, which is the worst the industry has ever seen. The other is the fundamental structural change the industry is struggling through, made much worse by the timing of the down cycle. “Most of the structural issues involve the Detroit 3 and have become critical because the cyclical downturn took away the time they needed to adjust,” he said.
DesRosiers, president of DesRosiers Automotive Consultants Inc., Richmond Hill, Ontario, was highly critical of the U.S. government’s Cash for Clunkers program, for several reasons: It rewarded people who did not take care of their vehicles, and promoted the irresponsible purchase of new cars by people who would normally upgrade to another used car that they could better afford. The program was also a slap in the face to the many who earn their living in related aftermarket industries such as auto repair, he said, noting that about 500,000 are employed in auto manufacturing, but six million in other parts of the value chain. “Every single vehicle in Cash for Clunkers would ultimately have been replaced within six to 18 months anyway,” he added.
Cash for Clunkers was just a short-term incentive. Several factors are working against improved auto sales long term. Overly generous incentives by automakers caused consumers to overbuy, undercutting current demand. The housing collapse eliminated a prime source of funding. “Three to five million people a year used home equity to buy a car. That money is now gone,” DesRosiers said. At the same time, banks have gone back to more rational credit scoring, which means that millions of people can no longer qualify for a new-car loan. While more responsible lending is a positive for the economy in the long run, he added, it hurts the auto industry today.
DesRosiers outlined four possible scenarios for automotive going forward. In all of them, he projected fewer vehicle sales. In the worst case, it’s possible the automotive market could be depressed for decades.
In 2008, the ratio of vehicles to drivers in the United States was about 101 percent, meaning there were more cars on the road than people of driving age. In contrast, the ratio in Canada was less than 69 percent. “We Canadians function perfectly well at less than 70 percent ownership of vehicles,” he noted.
What would happen if Americans’ love affair with cars cooled over the next decade and the ratio trended towards Canada’s? If U.S. vehicle ownership declined to a 75 percent level by 2020, the market would only consume nine to 10 million new vehicles a year, down from 2008 production of 16.8 million vehicles, DesRosiers said. An average of 95 percent ownership and sales of 12 to 13 million cars and trucks per year is his most likely scenario. Even in the best case, Americans will probably buy two million fewer vehicles each year, calling for annual production of no more than 14 to 15 million units.
Ford, GM and Chrysler have seen their market share decline from around 75 percent in 2000 to about 56 percent last year due to gains by the New Domestics. Fortunately, most of the increase in market share by the import nameplate brands has come from their expansions in North America. They have built a substantial local supply base, which has kept most of the manufacturing jobs inside North America
While it was certainly unfair to other carmakers for the government to bail out Chrysler and General Motors, DesRosiers noted, both companies certainly would have failed otherwise, taking dozens of suppliers and thousands of jobs with them. “But government assistance does not solve the revenue and structural problems, it only buys them more time. They still have extremely difficult problems to overcome.
“No one seems to have a solution to get the consumer buying again, yet alone buying more Detroit 3 products. Unless the Detroit 3 can turn around their market share losses, then no amount of government money can save all three of these companies. Best case is we end up with two Detroit-based companies instead of three, and there is a very real scenario where we end up with only one,” he said.
His message to automotive metals suppliers: structure your company to serve a smaller auto industry.
Sullivan: Global Steel Well-Positioned
to Handle Market’s Turbulence
While the near-term economic outlook remains unclear, consolidation of global steel has created a more efficient industry to deal with the market’s turbulence, said Daniel Sullivan, a director at Houlihan Lokey, Chicago, speaking on the carbon steel market at MSCI’s forecast conference.
Industrial consolidation has led to increased discipline by steelmakers, who idled two-thirds of the blast furnaces in the country to match supply with demand. “It was an incredibly fast reaction to the economy, which in our opinion could not have occurred before consolidation.”
Despite the recessionary conditions, there have been just eight steel company bankruptcies this year, and those among small players, which suggests that the steelmaking industry is better structured today to withstand an economic crisis.
Service center inventories are extremely low at this point. “If service centers are to get back to the five-year average inventory levels, carbon steel purchases will have to go up by 20 percent over the next six months. Restocking is necessary, and it’s coming soon,” Sullivan said.
China is projected to increase its steel production by 100 million tons within two years—an increase that amounts to more than the total produced by the United States annually. But China is also expected to remain a net importer, despite widespread fears that its producers could flood the market with cheap steel. Imports into the United States should remain low and help support domestic pricing. “We don’t foresee any meaningful demand for imports,” Sullivan said.
Future steel demand is difficult to predict. Much is linked to consumer confidence, which remains highly volatile. Many are hopeful that the federal stimulus will kickstart the economy, but increased government spending on infrastructure cannot fix the problem alone. Construction cannot recover without an increase in private commercial spending, he said.
Much-needed infrastructure repairs hold promise for future steel demand. Twenty-five percent of the bridges in the United States, a total of 150,000, need replacement, which bodes well for producers of steel beams and plate, Sullivan noted.
Surprisingly few service centers have failed as the economy has declined, but with credit so tight some may struggle to finance expanding operations as the economy recovers. Sullivan forecasts in the years to come there will be a spurt of opportunistic acquisitions of both mills and service centers by well-capitalized players, including foreign buyers encouraged by the weak U.S. dollar.
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