THE fundamentals of the US economy remain strong, and consumers can keep it going until business investment picks up, according to G Mustafa Mohatarem, chief economist of the General Motors Corp.
Mohatarem, who heads GM's Trade Team and interacts regularly with officials from the US and other countries on trade-related issues, presented the North American Macroeconomic Forecast at the National Truck Equipment Association's Economic Outlook Conference in Dearborn, Michigan, in September.
He said there is flexibility to implement fiscal and monetary stimulus, and the net worth of consumers remains strong because of the favorable picture painted by the housing market, employment, and low interest rates.
“I still remain optimistic,” he said.
He said there has been a dichotomy between Main Street and Wall Street, with the markets suggesting weakness and real data suggesting recovery.
Mohatarem said there was a significant downturn worldwide in 2001, because the US had been the driver. Now, the question is: “How far can the US pull the world?”
He said as the US declined, so did Mexico. The “remarkable” aspect was that the peso held strong while all other Latin American currencies declined sharply.
The Gross Domestic Product for the US was revised down in both 2000 and 2001. Mohatarem said there was a stock market bubble that was like a “gold rush,” and “when you have a gold rush, you have the potential for fraud.”
He said there was not an across-the-board ethics crisis because Wall Street is still faring better than other countries. He said the fallout from Enron's demise means that there will be “less correspondence discussion, probably less risk-taking, fewer losses, but fewer innovations.”
Mohatarem said there has been a huge spike in the net worth and savings rate, which is good news now, but “will trigger a downturn” if it is too strong for too long.
Real GDP growth has increased every quarter since bottoming out in the third quarter of last year.
“Can it be sustained?” he asked.
He said investment has increased each quarter along with real GDP growth, although some of that was attributable to inventory rebuilding.
“This is the first recession caused by a drop in business spending — particularly in the reduction of inventory,” he said. “It has been forced to rebuild.”
Government spending has been strong, although it did drop slightly in the first quarter of this year after gaining steadily since the end of 2000. “Without the increase, there would be a serious recession. We need deficit spending now.”
Net exports are “a cause for concern,” because of a strong dollar, and the United States' growing market makes it a target for exporters.
There has been no major change in interest rates for a year, which he characterized as “good news.”
Productivity grew during the downturn, and manufacturing costs are not increasing measurably.
Corporate profits are improving after reaching a four-year low in the second quarter of 2001, but are not “where we would like them to be.”
Automobile sales have been “remarkable.” Mohatarem said economists have consistently underestimated them. Cars cost less: about 23 weeks of income. The trend line for sales is 16 million, but 17 million will be sold in a recession because of low prices and interest rates.
Consumer durables are “not strong. They should be stronger, given the strength of the housing market.”
The Japan bubble burst because of deflation, the absence of a good bankruptcy system, and the reality that companies have spent a decade paying for their mistakes, and banks are burdened with non-performing loans.
Few executives who are charged with crimes will be found guilty. “They were operating in a high-risk environment. It isn't illegal to make a bad decision. Those who go to jail will be those who did illegal things to cover up a bad decision.”
End-use: ‘even more cautiously optimistic’
When Eli Lustgarten gave his economic update at the NTEA Convention in March, he subtitled it: “Cautiously Optimistic About a Return to Normal.”
When he gave his End-Use Market Review in Dearborn, he subtitled it: “It's Even More Cautiously Optimistic.”
Lustgarten, managing director of Wainright and Co and a six-time member of the Wall Street Journal All-Star Analyst poll, said the severe valuation correction in industrial stocks has been reversed.
Nearly two years ago, he said, investor ambivalence toward industrial stocks and subsequent single-digit multiples reflected the shadow of the Federal Reserve and signs of an impending slowdown that was finally becoming visible. Since the industrial stock price bottom of September/October 2000, most industrial stocks surged in strong double digits through the first half of 2001, despite a down stock market. He said that after the traditional third-quarter jitters and the 9/11 reaction, most industrial stocks performed well in the latter part of 2001 and through the first half of 2002, as investors looked beyond the economic valley.
He said a recent ISM manufacturing report on business conditions showed that economic activity in the manufacturing sector grew for the seventh straight month in July after 18 consecutive months of decline. Of the 20 industries in the manufacturing sector, only eight reported growth.
Lustgarten said stock market volatility and weak economic data have combined to spook investors and businesses. The University of Michigan Consumer Sentiment Index fell to a seven-month low, and the Conference Board Index showed the steepest decline in July since 9/11, then plunged further to 93.5 in August — the third straight monthly decline. New job creation was just 6,000 in July.
He said positive signs for economic growth are still visible: July and August motor vehicle sales were the best since October 2001, aided by new zero-interest rate incentives.
The fear today, he said, is broader unevenness of recovery and expansion: personal savings rose to 4% in Q2 from 3.5% in Q1, suggesting reliquification of consumer financial position; inventories were still negative in Q2, but lower liquidation added 1.15 percentage points to real GDP growth; business equipment spending turned up in Q2 by 2.9%, the first increase since the third quarter of 2000; personal consumption expenditures rose 0.5% in June, giving a good launch point for Q3; Q3 real GDP was on track for at least a 2.5% pace, depending on trade data.
Higher capital spending likely
Lustgarten said there is a profile for higher capital spending following normal economic underpinnings: internally generated funds now cover more than 90% of reduced outlays for capital expenditures and inventories, up dramatically from last year; operating profits are beginning to improve sequentially, even year over year for the S&P 500 as profit margins widen; improving profits are reflecting exceptional productivity and wage restraint; and Q2's 2.9% upturn in real equipment and software spending surprised many investors.
He said capital spending will “be on the mend, but slowly.”
Companies will continue to position themselves for a potentially dramatic improvement in earnings in a better industrial economic environment that hopefully will begin sometime late this year or in 2003, he said.
He said further cost cutting, overhead reduction, and consolidation efforts are under way as companies recognize that they cannot control the economy, but they can control how they run their business. He stressed that while investors are trying to sense when the worst may be over, it is important to remember that any improvement, when it starts, will not necessarily continue in a linear manner. The weakness of the dollar will help, but companies recognize they can't “cut their way to prosperity.”
In the farm equipment sector, Lustgarten said large crops and depressed price problems are beginning to wane. Both global and US grain supplies are back to normal or to above normal. Farm income has remained near current record levels for the past several years, buoyed by government farm payments. He said farmers have rebuilt their balance sheets and cash flow will remain strong, but recent dependency on government payments, which have risen from $7 billion to a peak of $23 billion, may reverse.
In the lawn and garden sector, he said surveys indicate that lawn care and landscapers are good vehicle customers because: 25% buy new exclusively and 23% lease; they are not necessarily seasonal purchases, as 43% buy throughout the year; they replace vehicles between four and eight years; and most have trailers, led by the open style with real gates (81%), enclosed (16%), and enclosed truck (3%). The best trailers are 6'×10', 7'×16', and 8'×20'.
He said 21.9% customize 90% of their vehicles: 52.8% the bed size, 52.7% add a ramp, 51% storage compartments, 42.7% hand-held equipment rack, 7.3% add spray capability, and 3.1% eliminate bed walls.
Trucks are a small part of the market. The total of 334,560 breaks down like this: compact pickups (34,675), full-size pickups (168,934), minivans (10,546), full-size vans (8,505), one-ton cab and chassis (69,300), and medium-duty trucks (42,600).
Forty-five percent of lawn and landscape contractors plan to buy trucks, 34% walk-behind mowers, 30% riding mowers, and 17% skid-steer loaders.
Lustgarten said that in the construction equipment sector, the positives are unlikely to balance the negatives. The primary problems: a credit crunch; rental companies are undergoing major contraction of fleets; there is little recovery in global commodity-related spending; federal and state governments are feeling the pressure of the recession and budget deficits; and mining equipment and power markets have softened.
He said the medium-duty Class 5-7 market will be hurt by weak demand. The estimate is for 165,000 units in 2003 — up from the 155,500 estimate for 2002, but well below the peak of 240,500 in 1999.
In the Class 8 diesel truck market, he said the current thinking is that slightly more than 160,000 units will be sold which would be the same as the estimate for 2002. The optimistic thinking is 180,000, while the pessimistic view is 130,000.
There will be sustained moderate growth in all construction sectors — except for weakness in utility construction and sluggish growth in highway construction.
That's the conclusion of Jack Shaner, corporate economist for Caterpillar Inc's Power Systems Marketing Division, the distribution channel for engines, in his Construction Market Forecast for North America.
He said truck customers are reacting to the EPA regulations on diesel emissions by buying used trucks, buying out of inventory, or postponing buying.
His Canadian summary: the US recovery supports moderate growth; accommodative Bank of Canada will hold interest rates; business capital spending will remain weak until mid year; electric utilities have sufficient capacity; and rising oil and gas prices will lead to increased drilling activity.
The stock market isn't good at predicting recessions, but it is good at predicting recoveries, said Bob Costello, chief economist and vice-president for the American Trucking Associations, in his Freight Tonnage Forecast.
He said wages are rising faster than inflation, which is more important than what is going on in the stock market. He said there are a lot of positives for the economy — low inflation, interest rates and unemployment rates, strong banking system, rebounding manufacturing, robust housing market — and the recent overall increase in freight traffic was due to excessive cutting of inventories.
However, “the consumer never really stopped spending, so we won't get much of a surge in the economy. Business must do it.”
Truck tonnage currently is 52% by private carriers (companies that have a fleet of trucks only to support their primary business) and 48% by for-hire carriers (which haul products only for other companies). He said 1,000 carriers go out of business with every 10-cent hike in diesel prices.
|State||Class 1||Class 2||Class 3||Class 4||Class 5||Class 6||Class 7||Class 8|
|Source: Joe O'Neill, National Conference of State Fleet Administrators|
Truck Equipment market: truck shipments up
Commercial truck shipments are expected to increase 2.5% in 2002 (from $56.8 billion to $58.3 billion) while truck equipment shipments fall 7.1% (from $27.8 billion to $25.9 billion), according to Stephen Latin-Kasper.
Latin-Kasper, the NTEA's director of market data and research, gave the Truck Equipment Market Outlook.
The biggest increase so far has been seen in Class 2 (5.8%), while the biggest drop has been in Class 4 (31.6%).
Private construction spending was down, while federal, state, and local construction spending was up.
Latin-Kasper's forecast pros: the glut is cleaned up (by the first quarter of 2003, there will be a 25% increase in used truck prices); low interest rates; low misery index; and trade is improving (our exports are up in 2002).
His forecast cons: terrorism has shaken our confidence; there are questions about capital expenditures, productivity, and employment.
“The significant pros outweigh the cons,” he said. “We will see growth — not as we would like, but we are moving forward.”