The Dynamics of `Soft Landing'

Economist Says Truck Market Faces a Natural Correction, Not a Depression

The sky is not falling.

The truck market is not even in a recession. The operative catch phrase, which applies not only to the truck industry but to the entire economy, is "soft landing" - a slower, more sustainable pace of growth that will put a lid on prices without triggering widespread job losses.

That was the message delivered by Eli S Lustgarten, managing director of HC Wainwright & Co Inc, at the NTEA's End Use Market Review seminar in Dearborn, Michigan.

"The truck market is going to come back down to normal," Lustgarten said. "What is happening in our view is that the market was superheated, not sustainable. That is why every truck-related equity in the stock market has a single-digit multiple - because it knows it's not going to put that number out again. It's been waiting for the downturn, and the downturn is here. The truck market is coming down, and emissions standards are not going to save the industry.

"But it's not a terrible market. This is an industry where we are watching the normalization of the truck market, we are watching the normalization of the industrial market, we are watching the normalization of the US economy, we are watching the normalization of the stock market. That's actually quite good. Because when you get back to normal, you grow."

In the medium-duty Class 5-7 market, Lustgarten said higher interest rates, higher fuel prices, and a slowing domestic economy will weaken demand. While bulk materials (aggregates, building materials, and farm products) should do well, the demand for manufacturing goods will slow. He said the strip chassis sector will be damaged by higher interest rates and energy prices, which will lower the demand for RVs.

Class 5-7 Production Down Production of Class 5-7 vehicles in the US was expected to decline 8%, from 219,900 vehicles in 1999 to 201,000 in 2000. The decline in North American figures is expected to be less - 6%, from 240,800 in 1999 to an estimated 225,700 in 2000 - because the Mexican market is growing. Lustgarten said most of the American companies are establishing plants in Mexico to supply the Latin American market.

He said the positives in the 1997-99 truck market were not sustainable, particularly the 1% annual shift in freight from rail to truck - resulting in an additional 15,000 trucks sold - caused by the problems associated with the Union Pacific merger and Conrail/CSX integration problems.

"God bless Conrail and Union Pacific and all those great railroads," he said. "Every trucking company should insist that the railroads consolidate. It was the best thing that ever happened to your industry. The railroads messed up because of the consolidation, but eventually they get to operating a little more efficiently and take a little back."

Other factors that point to a downturn: NAFTA benefits of increased Mexican and Canadian trade will wane; energy prices and interest rates are rising; and truck prices that had been stagnant are now rising.

The dot.com boom did not translate into increased truck spending and infrastructure expansion by the companies in the pickup/delivery business, primarily because there is potential consolidation. The US Postal Service is offering to provide last-mile delivery on some FedEx packages. In return, FedEx would deliver the Postal Service's Priority and Express mail. That is being met by resistance from UPS, which is lobbying in Washington to stop that alliance.

Used Truck Market Glut Lustgarten said a used truck market glut was created between 1995 and 1999, when over one million trucks were sold, boosted by guaranteed trade-in value packages that provided incentive for quicker trades. But used truck prices have fallen 30% since the beginning of 1999. The ones taking the heavy hit are three years old, with low mileage, 350 hp to 425 hp, and a raised-roof sleeper.

The production of Class 8 trucks peaked at 330,000 in 1999, and was estimated at 250,000 for 2000 and 210,000 for 2001.

"You don't have to be a rocket scientist to know that if you have a truck industry that shipped 330,000-plus trucks last year and is producing a 300,000 rate in the first half of 2000 and has 12 months of orders at a 200,000 rate, then truck production is going to fall," he said.

So while demand is slipping under 210,000 for the first time in five years, it is still a long way from 1991, when the market bottomed out at 100,000, completing a four-year downturn.

"You want to talk a recession? You're talking 150,000 trucks or less," he said.

He said that economists used to describe normal GDP growth as over 4%; now they label it at 3%. He said the message is this: Everything is going back to normal. That is the definition of a "soft landing": above normal to normal. He said investors have understood this, and are asking: "Am I seeing normal, or is it overheated and I've got to be careful of going back down to a lower level?"

Primed for a Fall He used the farm-equipment market as an example. He said he conversed two years ago with some Caterpillar managers and told them that the probability of an "earnings accident" was 100%. Lustgarten didn't know exactly why it would happen, only that it would.

"They looked at me like I was nuts," he said. "They had a new chairman, and he got up at a meeting and said, `We've got a plan. We know how we will run our business and maintain profitability for the next couple of years.'

"They got embarrassed four times in '99, watching earnings go from $4.11 to $2.63. It's not that economic analysts are so bright. It's that statistically, he was in trouble, because Cat was earning a return that was twice that of normal, and 50% better than the returns in the semiconductor industry."

He said the most important message to be learned about where the US is in the economic cycle is that there is a concept called "normal," and the market returns to it.

Domestic growth has continued to defy the economists, with a GDP of over 4% this year, and subdued inflation. For the fifth straight year, the forecast of a slowdown was wrong.

Although the overall economy was up for 112 consecutive months, there were signs below the surface that a slowdown was coming. Industrials faltered in 1998 and 1999, catching many companies by surprise. The farm and semiconductor equipment markets collapsed, and a sharp downturn in energy, commodities, process, and automation markets was exacerbated by a downturn in exports, intense import competition, and price deflation.

Manufacturing Sector Fails to Grow He said signs of a slowdown finally became visible in the third quarter of this year. The manufacturing sector failed to grow in August, with the index falling 2.3%. The production index declined 8.8% - its first decline in 19 months. For the second straight month, the order index failed to grow. The backlog index declined for the fourth consecutive month. Although new export orders are still growing, the rate is slower.

A strong US economy is expected to slow modestly, based on these factors:

- Real GDP growth remains positive - an estimate of 3.5% in 2001.

- Capital spending is expected to fall from a 10.8% growth rate in 2000 to 6.7% in 2001, based on reductions in structures (3.5% to 1.9%) and all equipment (12.7% to 8.8%).

- Manufacturing output will fall from 5.5% to 3.4%, which he still characterized as "solid."

- The CPI will fall from 3.2% to 2.4%.

He characterized the industrial sector outlook as "getting somewhat better."

"The big difference between '97-98 and today is that global growth is accelerating," he said. "The Asian crisis is over. That is the most important statistic for industrial America. All the forecasts across the board are for better growth over the next couple of years. The industrial sector is not entering, but emerging from, a downturn.

"Inventory de-stocking has ended. The key sectors of strength over the past 12 months - aerospace, automotive, construction, consumer durables, trucks - have peaked and are beginning to weaken."

New Model for Business Lustgarten said there is a new business model for the new millennium, with most companies relying on global sourcing for materials, manufacturing in areas of core competency while outsourcing the rest, minimizing fixed assets, and adopting flexible distribution to encompass e-commerce.

Lustgarten said capital appropriations are being delayed and/or reduced by low capacity utilization, industry consolidation (particularly in commodity markets), and supply-chain inventory reduction used for incentive compensation.

Then there's the implementation of Six Sigma, a quality-improvement methodology structured to reduce product or service failure rates to a negligible level (roughly 3.4 failures per million opportunities). To achieve these levels, it encompasses all aspects of a business, including management, service delivery, design, production, and customer satisfaction.

Lustgarten said the US had an "appalling" statistic: 440,000 defects per million parts products.

"That is incredible, when you think about it," he said. "Trouble is, if you begin the process of improving quality and lowering defects, it's going to effect a capacity increase. If you go to quality improvement, you, in effect, get more capacity because you have more coming out and you don't have to spend as much money."

But he said the future of industrial America is bright for the new millennium because the US industrial sector should continue to outperform the GDP and the capital spending boom continues, driven by technology and the imperatives of pervasive global competition.

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