Forecast's Cloudy with a Chance of Gain
By Tim Triplett, Editor-in-Chief
It’s official. The National Bureau of Economic Research has declared that the Great Recession, which began in December 2007, actually ended in June 2009. Sure doesn’t feel like it. A handful of top economists, speaking at the Metals Service Center Institute’s annual Economic Summit in Chicago Sept. 20-21, explained why.
‘Definitely Not Taking Off with Any Gusto’
The economy has gained ground since the official end to the recession in large part because of gains in manufacturing, said William Strauss, senior economist and economic advisor for the Federal Reserve Bank of Chicago. “With 3 percent growth, we should be feeling pretty good—but we’re not.”
Why? For one, 60 percent of that 3 percent growth in GDP was due to rebuilding of inventories. “Final sales—GDP minus changes in inventories—is abysmally low, one reason we don’t feel good. It’s definitely not taking off with any gusto,” he said.
Due to the continuing uncertainty and lack of demand, banks are hoarding cash, Strauss said. While this is depriving the economy of fuel for growth, “it means there is opportunity for future lending.”
Consumer spending represents two-thirds of the economy, but consumers are saving more and spending less, motivated by the same fears and uncertainties as the banks. The personal savings rate has increased from an average of 1 percent to 6 percent of income. This “paradox of thrift” is troublesome in the short term, but good for the long-term health of the economy and individual households as people look forward to retirement.
U.S. home prices have declined by 25 percent, which means people cannot rely on the equity in their house to the same extent for retirement. Based on a show of hands, virtually no one in the room was confident that home values would rise in the next five years. Similar fears are weighing down the stock market, which has made gains since March 2009, but remains well below previous levels. “Most people don’t feel their homes will get them there, and most don’t feel the equity markets will get them there,” Strauss observed, “so people are paying themselves, paying off their debt.”
Most economists forecast GDP growth of around 2.9 percent in 2011, up a bit from 2.4 percent in 2010, but still not far enough above the long-term trend for any significant job creation. Coming out of the recession of the 1980s, the economy grew at twice that rate. With 100,000 new individuals entering the workforce each month due to population growth alone, the economy has to create 1.2 million jobs just to break even, before it can begin to improve the current labor woes.
Manufacturing output has increased by 8.5 percent in the past 14 months, recovering nearly half of the ground it lost during the recession, led by the automotive and primary metals sectors. Capacity utilization at around 73 percent remains well below the 80 to 90 percent levels that indicate robust growth, however, he said.
U.S. automotive production is forecast to grow from about 11.5 million units this year to 12.7 million in 2011, still well below the 16-million-vehicle peaks of the past. Light vehicle sales declined by 21 percent in 2009, but carmakers cut production by 34 percent, putting themselves in position to benefit incrementally as demand improves. Pointing to the plants established by the foreign car brands in the United States over the past two decades, Strauss noted that three-quarters of the vehicles sold here are made here. “The belief that it is best to get closer to the customer will continue to attract manufacturing here,” he added.
Following a 3.8 percent decline in 2009, overall industrial production will see growth of 5.6 percent in 2010, but then slow to a 4.1 percent rate in 2011 as the economy continues to fight some headwinds, Strauss said. Among the gustiest is the housing market, which plummeted to levels last seen during WWII when the population was half its current size. Housing starts in August were well below an annual rate of 600,000 units, projected to increase to only 760,000 units next year, about half the typical 1.5 million.
Housing affordability is way up, but consumers’ attitudes are way down. “People are not enthused about buying homes, even with prices and mortgage rates so low. It will be years before we get back to that 1.5 million,” Strauss said.
Summing up his outlook, Strauss forecasts growth at a solid but disappointing pace compared to past recoveries, with low inflation but only a modest improvement in the labor market.
“I think the stimulus money will continue to make a significant difference. It will continue to moderate the downturn this year and help turn it positive next year,” he said.
Global Recovery to Avoid the Double-Dip
Offering a world perspective on the economy, James Sweeney, director of the global strategy team at Credit Suisse in New York, said the alarming pause in the first-half recovery most likely will not lead to a serious double-dip.
Today’s economic growth, viewed from a historical perspective, is not that bad, he said. Since 1890, the U.S. economy has averaged an annual growth rate of 2.1 percent, “so the current economy is not way off track,” despite the weak output. “Unemployment is, but the economy is not.”
The climb back feels worse than past recessions because the hole was so much deeper, he said. “We think this recovery has a lot of life left in it on the production side.”
Global industrial production has rebounded by 16 percent, after a 23 percent decline, led by activity in the emerging markets. “China bounced hard and early,” he said.
Growth in the U.S., Europe and the UK hit a peak in April and then began to roll over. “A period began in April when we saw the data get worse everywhere,” he said. The PMI, durable goods orders, consumer confidence and asset prices all had a downward trajectory through July. “The double-dip concerns were suddenly very real.”
Since then, conditions have begun to improve, making a return to recession unlikely. “Key global stabilization will come near year end, in our view,” Sweeney said.
Price uncertainty is slowing the growth rate as consumers and investors await some clarity on whether government monetary and stimulus moves will prove inflationary or whether prices decline as the economy stalls.
Credit-Suisse is more upbeat about consumer spending than some. Many economists say consumers are working down excess levels of household debt rather than spending on goods and services, but Sweeney does not see dramatic cutbacks. “This whole deleveraging is about the subprime mortgages,” he said.
In fact, he sees a bounce back in consumption of goods, though spending on services continues to lag. Softness in the services sector, which represents 50 percent of GDP, does not bode well for the labor market. “Our hypothesis is that there are weaknesses in the services sector, but let’s not assume the problem is deleveraging by households, which would be a different obstacle to recovery.”
In response to a question from the audience regarding unfair trade, Sweeney noted that aggressive retaliation against Chinese currency practices could have undesirable consequences. “The financial markets would hate outright policies against the Chinese, which could result in a significant selloff of risky assets. We could get into lots of ugly scenarios if we tried to pursue something aggressive against the Chinese.”
Lack of Bank Credit Leads to Feeble Recovery
“We are experiencing a feeble recovery from the longest and deepest recession in the post-war era and won’t see growth rates reach prior levels until first-quarter 2011,” said Paul Kasriel, senior vice president and chief economist with The Northern Trust Co. in Chicago.
Prior to the bursting of the real estate bubble, people used their homes like ATM machines, he said, borrowing from their equity to buy all manner of goods and services. In total, the sum of consumer and residential investment exceeded after-tax income. “Mortgage debt became the single biggest category of debt,” Kasriel noted.
Then, making matters worse, bank credit contracted in 2009. “A banking system unable to create credit leads to a weak recovery,” Kasriel said. Over the past 50 years, bank credit has correlated closely with growth in aggregate demand for goods and services. Despite the Fed’s moves to slash interest rates, bank credit has continued to contract. “Fiscal stimulus without bank credit growth is not very stimulative,” he added.
Today, banks are sitting on $1 trillion in cash reserves, reluctant to lend due to all the regulatory uncertainty and expectations of future losses. “It is generally thought there is a second wave coming in defaults on commercial real estate,” Kasriel said.
Now that new banking regulations have clarified how much cash banks are required to keep in reserve to offset the risk from their outstanding loans, Kasriel expects some easing of credit and lending terms, which will fuel growth.
The long-term health of the economy still faces some serious challenges, however, including the excess supply of homes on the real estate market, budget deficits on the state, local and federal level, the long-term cost of federal entitlement programs, and of course unemployment. To create new jobs, the economy must grow at a rate considerably higher than 3 percent, he noted.
Bright Spots for 2011: Manufacturing, Exports
“Manufacturing in the United States is not going away,” said David Huether, chief economist with the National Association of Manufacturers in Washington, D.C., but it is facing growing competition from producers overseas.
The United States performed 28 percent of the world’s manufacturing in 1990. Today, that figure is down to 21 percent. Meanwhile, China’s share has grown from the low single digits to 12 percent over the past decade. In the 1970s, U.S. imports and exports were about even at 7 percent; today the U.S. exports about 20 percent of its output, but imports 37 percent. “More than one-third of what we consume is imported today,” Huether noted.
Manufacturers in Asia, Europe and other parts of the world are more export-intensive than those in the United States. “Smaller manufacturers in the U.S. are less globally engaged. It’s both an opportunity and a long-term problem,” he said.
Government stimulus programs such as the home buyer tax credit and cash for clunkers did help boost residential investment in cars and appliances and business investment in computers and capital equipment. Most of this fiscal stimulus is in the rearview mirror now, he said. The question is, going forward, can business create jobs and sustain the recovery?
So far, the rate of recovery has been marginally better than following the downturns of 1990-91 and 2001, but is only half the pace of 1974-75 and 1981-82. And there was a clear deceleration in manufacturing production this summer, Huether noted.
The labor market, which shed 7.3 million jobs during the recession, is the main problem. The market managed to add 763,000 jobs in the first four months of 2010, but then hiring slowed. After adding jobs for seven straight months, manufacturing employment declined again in August. Today, 42 percent of the unemployed have been out of work for six months or more, a condition not seen since WWII.
Not surprisingly, Huether said, the anemic growth and high unemployment have hurt consumer confidence, which is 52 percent below 2007 levels. Sentiment today is 37 percent worse than immediately following the 9/11 terrorist attacks.
Surveys of NAM members reveal several areas of concern, including possible regulatory changes coming out of Washington, expiring tax cuts for small businesses, high corporate tax rates, the possible return of the estate tax, expiring R&D tax credits, new environmental restrictions, the uncertain cost of health care, and stalled free-trade agreements that will hurt future export opportunities.
GDP is decelerating to the 1.5 to 2.0 percent range in the second half, but should improve to over 2.0 percent next year. U.S. manufacturing exports, growing at double-digit rates for the past four quarters, will continue to be a bright spot. Unemployment, however, will continue to be a drag on growth and could still be as high as 7.5 percent in 2012, Huether said.
Spillover from Spill Slows Oil, Gas Growth
Suppliers of line pipe and other oil country tubular goods can expect a slower pace of growth for the next few years as a result of the disastrous Macondo oil spill in the Gulf of Mexico earlier this year. Gulf output is likely to be 250,000 barrels per day less in 2011 than the 1.42 million barrels per day that was expected before the spill. By 2015, output is likely to be 400,000 barrels per year less than the 1.50 million barrels per day expected before the spill, reported Marie Fagan, senior director of the Global Power Group at IHS Cambridge Energy Research Associates, Cambridge, Mass.
Deepwater Gulf of Mexico oil production was growing at a 13 percent annual pace prior to BP’s Deepwater Horizon mishap, which released an estimated 4.4 million barrels of oil into the Gulf waters. In response to ongoing concerns about the safety of other wells, the federal government placed a six-month moratorium on deepwater drilling in the U.S. Gulf of Mexico effective May 28.
The effects of the moratorium are amplified over time and go well beyond the Gulf of Mexico projects that are put on hold, Fagan explained. Each delay has a ripple effect as drill ships leave the region to take jobs in other areas. In addition, new regulations will add time and cost to drilling projects. Higher costs will force many of the smaller independent operators out of the market.
The environmental disaster has fostered a wait-and-see attitude in other parts of the world, which could affect OCTG exports. Norway, for example, has withdrawn some deepwater blocks from a bidding round set for November.
Drilling of the shale plays for natural gas is a game-changer in the U.S. energy market, she continued. “The gas business is in the early stages of an upward cycle of productive capacity growth.”
Gas production is 20 percent higher today than in 2007. That increase was driven by “unconventional gas” production primarily in shale plays across North America. Unconventional gas resources require horizontal drilling and “fracc’ing” to get at the gas, which involves pumping fluid into the ground to induce fractures in the shale. “They are going to need pipe to connect new supply areas to markets,” Fagan noted.
Drilling in the shale plays is bringing new activity to specific regions, including the Marcellus play in Pennsylvania and nearby states, the Haynesville play in Texas and Louisiana, and the Montney and Horn River shales in Canada, among several others.
CERA forecasts that gas prices will average $4.20 per mcf next year, down from $4.50 this year, depending on weather conditions. Long-term, analysts forecast mid-$5 prices for gas, which means it will continue to be cost-effective to develop more shale sources. Gas producers will need new infrastructure, including pipelines and gathering and processing facilities, Fagan said, which bodes well for the carbon and stainless steel pipe and tube industries.
Single-Digit Gains Forecast for Construction
U.S. GDP is seeing steady though modest gains, but weak construction spending continues to hamper growth, with no end in sight to the enormous surplus of retail, office space and multifamily housing, said Ken Simonson, chief economist for the Associated General Contractors of America in Arlington, Va.
Total construction spending in the U.S. declined by 11 percent from July 2009 to July 2010. That includes a 24 percent decline in private nonresidential construction and an 8 percent decline in public construction. Private residential construction actually increased by 5 percent. Single-family housing starts should continue to increase through 2010 and 2011, as mortgage rates and low prices keep homes affordable. Multifamily construction declined by 52 percent from July 2009 through July 2010, but the sector should be near the bottom and could see some new activity next year as rental demand improves, Simonson said.
Total nonresidential construction spending, running at an average annual rate of $555 billion as of July, was down 17 percent over the prior 12 months, including declines of 35 percent in manufacturing construction, 34 percent in office construction, 23 percent in commercial construction, 19 percent in schools, 12 percent in health care and 11 percent in the power and amusement categories.
Prospects remain difficult especially for private construction. “The developer-funded categories are universally disastrous. The best we can expect is a moderation of the decline,” Simonson said.
Public construction should continue to benefit from federal programs. About half of the government stimulus money for highways has been spent so far, but it all has been allocated, Simonson said. Most of the stimulus funds in other categories have not been paid out yet. Of the $135 billion for construction, $49 billion was targeted for transportation, $35 billion for public buildings, $30 billion for energy and related technology and $21 billion for water and environmental projects. Every $1 billion in investment in construction adds 28,500 jobs, directly and indirectly, to the economy, he noted.
“The stimulus money has definitely made a difference [in public projects], but I am concerned about what happens when it runs out. We should see its effects start to dwindle in the second half next year,” he said.
Use of the funds has not always gone smoothly. Unlike basic highway projects, engineering-heavy projects such as airports and high-speed rail take much more time. In other cases, agencies such as the General Services Administration received more funding than they had the personnel to handle, an “embarrassment of riches,” he said. Buy American requirements have also added to delays in stimulus spending.
Other government efforts to stimulate activity include a five-year carryback of 2008-09 operating losses and a 6.2 percent payroll tax credit for workers hired since March, plus Build America bonds designed to provide cheaper financing for states. “It has lowered their borrowing costs, but I have seen little evidence it has led to additional projects so far,” Simonson said.
After declines of 10 to 15 percent in total construction spending this year, AGC forecasts gains of just 3 to 7 percent in 2011.
Specialty Steel’s Making a Comeback
Specialty steel markets are making a comeback and have good long-term prospects, said Markus Moll, managing director of Austria-based SMR Steel & Metals Market Research, Gmbh.
The world tool steel market took a big hit from the recession, declining 28 percent in 2009 to 1.3 million tons. “I think realistically we can achieve double-digit growth for 2011, but that still won’t get us back to previous levels,” Moll said.
Globally, stainless steel dipped by just 4 percent last year thanks to the strength in China, to 23.3 million tons. On average distributor earnings plummeted into negative territory in the fourth quarter 2008 and stayed there until the second quarter 2010. “They are coming back, but with margins of only 3 percent of sales, nobody can be happy.”
SMR forecasts global stainless demand to increase by 13 percent worldwide in 2010, and 10 percent in North America, excluding the effects of restocking.
In the long term, the market drivers remain positive for stainless steel. It continues to hold prestige as a finish for appliances and architectural products. Urbanization of developing markets in Asia, India and South America, and rebuilding in Russia, promise increased usage in process industries such as food handling and water treatment. “Architecture is one of the areas where stainless has enormous growth potential,” Moll said.
Nuclear power generation is another promising future market, with up to 60 plants proposed worldwide, but Moll remains skeptical that attitudes toward nuclear will allow many to actually be built.
He forecasts growth in all end-use stainless segments next year, including 7 percent each for building and construction, consumer goods and process industries. Use of 300 series stainless products continues to decline as companies continue to seek substitutions, he noted.
Stainless suppliers face several significant strategic issues, Moll said, including uncontrollable costs for raw materials such as nickel, scrap and ferro-chrome; high exposure to cyclical demand for capital goods; and increasing competition in flat-roll from China and in long products from India. Imports of stainless steel products grew by 26 percent in 2010, though U.S. consumption only grew by 10 percent.
Innovative new products promise a bright future for stainless, he said, pointing to a company that makes stainless swimming pools. Stainless-clad rebar, which resists corrosion and makes roads last far longer, could grow from a 50,000-ton market today to several hundred thousand tons over the next decade, he said.
Globally, SMR forecasts end-use market volume will exceed 40 million tons by 2020, up from 27 million tons this year.
Equipment Production to See Good Gains
“The industrial equipment market is the best place to be in this economy,” said Eli Lustgarten, senior vice president and senior analyst with Longbow Research in Cleveland.
Much of the recovery to date has been fueled by supply chain restocking and rebalancing, with a modest inventory rebuild. The transition from 2010 will be more dependent on real demand growth as the market searches for a “new normal” in 2011-12, he said.
Since the Great Recession ended in June 2009, the U.S. has seen a gradual economic recovery with manufacturing, notably capital goods, leading the way. The pace of that recovery continues to be dogged by concerns over financial instability in world markets, sluggish consumer spending, state budget deficits, banks’ exposure to a possible new wave of defaults on commercial real estate loans, and questionable federal fiscal and monetary stimulus.
Banks have plenty of cash to loan, and credit is loosening, but not for everyone, Lustgarten said. “While there is plenty of money available for big companies, it is still very tight for small to midsize companies.”
Productivity gains have been significant since 2009, producing surprising earnings given the so-so market conditions. Productivity jumped over 6 percent in the last three quarters of 2009, while costs declined, as companies used both temporary measures (pay cuts, furloughs, travel restrictions) and structural measures (layoffs, plant closures, automation) to reduce overhead. Some of those costs will return as business picks up, but most structural changes will be permanent and hiring will be kept in check, he said. “Most industrial companies are back to near peak profitability, even though their volumes are down.”
When the recession hit in fall 2008, industrial production plummeted, capacity utilization dropped to the mid 60s and inventories were liquidated to an unprecedented level. As manufacturing has recovered, suppliers have benefited from the “bullwhip effect,” in which companies anticipating an increase in production tend to buy more material than they ultimately need. “They had to rebuild the supply to handle the increase in production. That effect has peaked and will likely be over by the end of this year,” Lustgarten said.
Growth in 2011 will depend on real demand as inventories stabilize and the effects of government stimulus programs wane without a new round of incentives. Various markets will seek their own “new normal”—automotive production is likely to level out at 12 to 14 million vehicles, down from over 16 million in the recent peak; housing starts will trend slowly toward 1.3 to 1.6 million units over the next several years, rather than 2.0 million; and class 8 truck production of 175,000 to 225,000 units will be well below the 300,000 of the past, at least until new emissions restrictions spur the next pre-buy.
Commenting on various equipment markets, Lustgarten noted that purchases of farm equipment track with commodity grain prices, which are subject to weather conditions and highly unpredictable. Through June, prices for corn, soybeans, wheat and cotton were softening, but recent weather may push them dramatically higher. Farm cash receipts are near record levels, which means farmers have the money to purchase new tractors and combines. Longbow Research forecasts at least 5 to 10 percent gains in farm equipment sales worldwide in 2011.
In the power generation market, excess capacity, lack of a clear government energy policy and environmental regulations will dampen demand for coal, natural gas, wind and other new power sources. “You can’t get a new power plant approved because no one knows what the rules are. And there is no pressure to approve anything because we don’t need the capacity yet,” Lustgarten said. Planned capacity additions will dip from about 27,000 MW last year to less than 14,000 MW in 2011, before resuming growth in 2012, he added.
Recovery of the North American construction equipment market still faces an agonizingly slow comeback. Housing construction, which plummeted to an annual rate of about 550,000 homes during the recession, has finally stabilized and will top an estimated 610,000 units in 2010 and perhaps 750,000 to 800,000 in 2011. Nonresidential construction spending, down 5 to 15 percent this year, will see only 3 to 10 percent gains next year, he said.
Construction equipment sales were driven by foreign demand in the first half of the year with light equipment sales in emerging markets up 69 percent and heavy equipment up 97 percent in the rest of the world. In the United States, however, light equipment was up just 7 percent and heavy equipment was down 1 percent. “Current sales of construction equipment are well below replacement levels, even with the current weak level of construction activity,” Lustgarten said. “2011 will likely be a better year for all classes of machines with sales and production rising at double-digits, 10 to 15 percent, assuming sustained growth in the global economy.” n