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October 2012
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Market’s Just ‘Muddling Along’

Experts at last month’s MSCI forecast summit offered a muted outlook for a U.S. economy that continues to disappoint.

By Tim Triplett, Editor-in-Chief

The economy has “muddled along” in the past year, managing to avoid a double-dip recession but showing no strong growth. Inflation remains under control, but the nation’s huge unemployment problem has seen little improvement.

“The good news is the U.S. economy is probably the strongest in the world right now,” said William Strauss, senior economist and economic advisor with the Federal Reserve Bank of Chicago. “The bad news is the U.S. economy is probably the strongest in the world right now.” In other words, weakness in the world economy is a concern to the U.S., as well, especially as American companies look to increase their exports.

Since the Great Recession technically ended in June 2009, U.S. GDP has continued to disappoint, Strauss told the crowd of steel executives Sept. 11 at the Metals Service Center Institute’s economic summit in Schaumburg, Ill. Unlike past post-recession periods when the economy surged, the last year has seen growth of only about 2.3 percent—near trend but not nearly enough to add jobs.

Pointing to the Chicago Fed’s National Activity Index, Strauss noted that the economy continues to underperform. [Editor’s note: The index’s three-month moving average released Sept. 24 showed a decrease to -0.47 in August—its lowest level since June 2011 and its sixth consecutive reading below zero, indicating that growth in national economic activity is below its historical trend.] “The third quarter is not looking very strong. Growth is continuing, albeit not at a level the economy is capable of.”

One symptom of the economy’s weakness is the high level of excess reserves held by the banking sector. “That is not how banks operate. They tend to lend out all their excess reserves,” Strauss noted. Conservative lending by the banks reflects their uncertainty about the economy.

Another headwind to economic growth is the rise in the personal savings rate. With so many people concerned about their jobs and their futures, they are saving more and spending less, which in the short term deprives the economy of much needed fuel. “There is a risk the savings rate will rise even higher,” Strauss added.

Of major concern is the slow recovery of the housing sector. Experts project about 750,000 single-family home starts this year and 890,000 next year—about half what would normally be needed just due to demographics and the number of new people seeking homes.

Consumer behavior has changed in housing, as more individuals share space or move back in with their folks to economize. “Young people saw their families and friends get burned by the housing crunch and may not be as anxious to buy their own house,” Strauss noted.

Housing now represents just 2 percent of GDP, down from a historical level over 4 percent. While homebuilding may see double-digit growth, it will still be years before it can take up the slack in the market. Construction of multi-family housing, which is more steel intensive, may benefit from the trend, Strauss added.

Commenting on specific sectors, Strauss pointed to positives in energy, especially the nation’s vast reserves of natural gas. “Natural gas is a wave we should be able to ride,” he said. “The U.S. has become the low-cost energy producer in the world.”

Manufacturing has recovered about 77 percent of its lost output. Industrial output is growing at a 5.1 percent rate, but is slowing, and Strauss doubts it can sustain growth levels on its own. “Future growth in manufacturing has to be led by growth in the economy,” he said.

The auto industry remains a relative bright spot, with 2012 sales forecast at 14.3 million vehicles and 2013 sales at 14.8 million. But the growth rate in auto sales also is slowing from levels of the past few years, he said.

U.S. monetary policy remains very aggressive. The Federal Funds rate is expected to remain at historic lows until the end of 2014. “We have the pedal to the metal in terms of federal monetary policy,” Strauss said, adding that policymakers are keeping a close watch to make sure the economy does not suffer a speeding ticket in the form of inflation. Inflation is not an immediate concern at 1.8 percent in 2012 and 2.1 percent in 2013.

The economy has added 1.8 million jobs in the past 12 months, and about 4.0 million since the recession ended, but still has a long way to go to replace the 8.7 million lost in the downturn. At the current pace, taking into account population growth and new employees entering the workforce, it could take 16 years for the labor market to recover, Strauss said. Even with another year of an improving economy, the nation’s unemployment rate at year-end 2013 will still be around 7.8 percent, a level the economist characterized as “horrible.”

Leading forecasters expect GDP growth for 2012 to limp in at 1.8 percent, followed by 2.4 percent in 2013. “This trend rate of growth is very disappointing in light of what should have occurred compared to past recessions,” Strauss said.
 
While the Fed expects the economy to continue expanding at a rate near trend with little near-term risk of inflation, the manufacturing sector is likely to slow unless growth gains some real steam—not what the metals executives were hoping to hear.

[The third quarter is not looking very strong. Growth is continuing, albeit not at a level the economy is capable of.” William Strauss, Federal Reserve Bank of Chicago]


Industrial Sector Shows Signs of Slowing
“The U.S. is the best house in a lousy neighborhood,” said Eli Lustgarten, senior analyst with Longbow Research, Cleveland, Ohio, describing the United States’ relatively strong position in a weak global economy. Lustgarten offered his forecast on the economy and the heavy equipment market to MSCI forecast summit attendees Sept. 11.

The industrial sector has led the U.S. recovery, he said, but there are signs manufacturing’s momentum is waning. Industrial production is expected to be flat at around 2.9 percent next year. “Companies are taking a wait-and-see attitude in the second half, which will add to slowing industrial production,” he said.

Overall, the outlook for U.S. heavy equipment is positive for the next three to five years, he said, driven primarily by energy, agriculture and a recovery of construction.
The U.S. has several factors in its favor. Recent global weather issues have lowered crop yields, dramatically raising commodity prices and giving farmers the capital to upgrade their equipment. New sources of low-cost natural gas have made the U.S. a net exporter of energy. New-home construction could hit 1.6 million units in the next several years, still well below the 2 million peak of the past, but a twofold improvement from 2009.

And the move to shorten global supply chains and regionalize manufacturing is bringing production back home. “The reshoring/nearshoring phenomenon is real, enhancing a renaissance of American manufacturing,” Lustgarten said.

Meanwhile, economic and political uncertainty weigh heavily on the market. “If we can survive the next 18 months, the U.S. has a very favorable three- to five-year economic outlook,” he added.

[If we can survive the next 18 months, the U.S. has a very favorable three- to five-year economic outlook.” Eli Lustgarten, Longbow Research]


Rest of the Decade Looks Promising for Auto
The auto industry experienced the worst downturn in modern history during the Great Recession, but that collapse in vehicle sales has created pent-up demand that could fuel the auto sector for the rest of the decade, said industry analyst Dennis DesRosiers, president of DesRosiers Automotive Consultants Inc., Richmond Hill, Ontario, who spoke at MSCI’s Forecast 2013 summit.

Future vehicle demand is a function of three factors, he explained: ownership, usage and durability. In 2007, vehicle ownership in the U.S. topped 100 percent, meaning there were more vehicles than drivers. Due to the economic downturn, ownership has declined to less than 96 percent. That 4-5 percent decline represents 8-9 million vehicles that were not replaced. Ownership growth in Canada and Mexico has offset some of the decline in the U.S., but it remains to be seen when Americans will return to prior ownership levels, DesRosiers said.

Societal changes are working against more vehicle ownership, including social media such as Facebook and Twitter that allow people to socialize without driving to visit. But the impact of this trend is often overblown, he said. “The biggest reason youths don’t drive is they don’t have jobs.” Demographics and the increase in the driving age population will stem the decline in ownership, he added. “North American vehicle ownership levels are likely to remain stable for the next decade.”

Vehicle usage is also showing the effects of the economy. The average annual miles traveled is around 13,000 today, down from 13,300. While that may seem like a small change, it translates into nearly 40 billion untraveled miles when multiplied by the enormous number of cars and light trucks on the nation’s highways. The weaker the economy and the higher the price of gas, the fewer miles people drive, and thus the longer their vehicles last.

The auto industry’s focus on quality over the past few decades has added enormously to vehicles’ durability and useful lifespan. In the 1960s, people typically had to replace their car at around 90,000 miles. Today, vehicles can easily travel twice that distance before they wear out.

Nevertheless, DesRosiers is bullish on prospects for the auto industry, pointing to forecasts for North American light vehicle production of 15.6 million units this year and 16.4 million in 2013—a major rebound from the 8.7 million during the recession in 2009. The market should return to previous peak production levels by 2016. “The bad news is behind us. Vehicle demand will be positive in the second half of this decade,” he said.

Massive investment in U.S. production facilities by the traditional import brands means that more vehicles will be made here and fewer imported—good news for domestic suppliers of metals and other materials. The market will be evenly split between Detroit nameplates and the New Domestics by 2015-16 with about 8 million vehicles each, DesRosiers said.

Where should metals suppliers position themselves to serve this growing demand? Mexico and the southern U.S. will be the big winners. “Canada and the U.S. North are vulnerable and will participate in less of the upside, although they will still be positive in unit growth,” he added.

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