Industry strong, but economy slowing

DO YOU WANT the good news or the bad news first?

Let's go with the good news. That's what the Industry Practices Group's Ken Kremar did in his presentation to the Truck Trailer Manufacturers Association: “The US and World Economic Outlook: Implications for the US Trailer Industry.”

Kremar said most of the major trailer-buying markets did “quite well” during 2004, when truck trailer production jumped 27%, according to government data he cited.

“Pent-up replacement demand provided most of the support,” he said, “but fleet capacity expansion emerged as more of a factor as the year wore on. Trailer builders entered 2005 with a lot of wind at their backs and a lot of business on their books.”

Now for the bad news. And it's really not all that bad.

Kremar said the economy already has downshifted: 2005 will not be as good as 2004, and 2006 will not be as good as 2005. Beyond 2006, economic growth is not expected to accelerate.

“This sets the tone for activity in key trailer-buying markets,” he said. “Profit growth will slow over the next few years and interest rates will be heading higher. There will be enough of a favorable tilt to the economy to keep trailer demand at very lofty levels — but not enough to keep demand and production heading higher ad infinitum.”

There. That wasn't so bad, was it?

Kremar said the truck trailer production index has closely followed truck trailer traffic. Both bottomed out in 2002, grew rapidly in '04, and will decline slightly through '09.

“There are a lot of guesstimates about what the numbers really are, because not everybody is reporting the numbers on a regular basis,” he said. “The critical point is that in each sector, traffic will continue to grow, but at slower rates. The economy has gone from 4.4% growth to 3.5% to 3%. I don't care what you do — motor carrier traffic is not going to head in the opposite direction in terms of momentum. Growth will not accelerate. It will decelerate. And that has implications for you where your industry is heading.”

Traffic to decline

He said truck trailer traffic for vans increased 6% in '04 — its highest since '97 — but will decline steadily through '09. Flatbed traffic grew by less than 4% in '04 and will see less drastic declines.

“In our view, there was a snapback in traffic last year, and along with that came a snapback in demand for equipment,” he said. “There will be continued growth in trailer volume, but it'll be slower.

“There will be a little bit of a pullback next year in the truck trailer production index, reflecting the slowdown we are seeing in a number of the key sectors of the economy. Also, we think that with the EPA engine regulations in '07, there is going to be pre-buy on the power-unit side and you might see some diversion of resources for that, which may take the wind out of the sails for trailers. We're talking about a 5% drop in '06 and '07.”

He said complete trailer shipments were up 28% last year, to 229,000. He expects that number to increase to 275,000 this year, then fall back to 250,000-260,000 in '06, and 250,000 in '07. Detachable equipment shipments will remain steady at around 50,000 through '09. Shipments of complete trailers and detachable equipment will follow GDP growth very closely through '09.

Kremar said he is “quite optimistic” about the future of large trucking companies, but believes the growth will slow along with the rest of the economy because “trucking companies don't generate traffic — they reflect what's going on in various sectors of the economy.”

He said he is optimistic about large trucking companies because “they're going to be gaining ground at the expense of smaller players in the business. There's a trend away from private carriers — small to mid-size — so that someone else handles their transport function. So there will be a bit more traffic flowing through the major companies.”

He said the 5.7% in tonnage last year was the high point, and he expects a 4-4.5% increase this year that will decline even further next year.

Kremar said automakers are “hitting heavy” on incentives and when they start to back off, consumers will, too. He said fourth-quarter sales were down from a year ago.

He said light vehicle sales will be flat this year, with a big shift away from SUVs and light trucks to crossover vehicles and passenger cars, and much of the growth in import brands.

Business investment improving

In summarizing the economic climate, Kremar said leadership of the expansion is switching away from consumption and housing; business investment is improving, but exports are struggling; the Federal Reserve is in a rate-raising mode; and high oil prices are taking a toll.

“If oil prices were $30 a barrel, we suspect that spending would be stronger and the overall economy would perform much better,” he said. “It's very definitely having a significant impact on the economy, but not as much as it used to because we've become more fuel-efficient over the last 10 or 20 years. Things are not as bad as they might be, but it has taken its toll on economy activity.”

Kremar said the overall inflation rate is edging higher, not just because of the oil situation but also because there have been significant increases in prices of steel and lumber. There also has been a very strong demand for those commodities outside the United States, particularly in China, and prices have been bid up.

“Scrap steel prices have come down a bit, but the demand from China remains strong,” he said. “By the time the Chinese in-house supply starts to pick up, other countries such as India will increase the demand. We don't think scrap prices will give back a lot. We think there will be some downward drift as far as iron, steel, and aluminum prices. Prices will remain very high. They won't go back to where they were in 2001, 2002, and 2003, but they will do better than they have recently.”

He said he believes that the Fed's intent in boosting the federal fund rate to 3% is to continue to move interest rates up.

“It hasn't shown up in long-term rates yet, but certainly federal funds rates and shorter term rates are moving up, and that's also bringing in parts of the economy,” he said.

Employment growth has been very erratic from month to month, and that “lackluster” performance is “one of the reasons consumer confidence is limping along. Consumers just aren't feeling terribly healthy about the current state of affairs.” Both the Conference Board and University of Michigan consumer-confidence indexes reached a low in '03, increased last year but have been zig-zagging ever since.

Housing starts and existing home sales have increased steadily since '98. Kremar said housing starts in January and February were “rip-roaring”, then “came back down to earth” in March.

“We think housing starts will start to trend at reasonable levels and come back down from absurdly high levels — levels that were really unsustainable,” he said.

Kremar said imports are increasing at a much faster pace than exports. China is making its presence felt. In '98, it comprised just 6% of the United States' imports; this year, it will be 14%. That is especially evident in truck trailers. Starting in 2000, the totals have increased from $6 million to $7.3 million, $9.6 million, $16.5 million to $91.6 million in 2004. China will make up nearly 25% of America's trailer imports this year.

In the Purchasing Managers' Index of Manufacturing Activity, anything over 50 shows expansion and anything below 50 shows contraction. It peaked early in '04 at 62 and has been declining ever since — down to 55 in the first quarter of this year.

“The good news is that we're continuing to expand,” he said. “The bad news is that we're not expanding at the same pace. Manufacturing is critical to the extent that if you manufacture something here, you're getting multiplier effect of components, raw materials, intermediate goods, as well as final product. When manufacturing is doing well, the trucking industry tends to do well. When the trucking industry is doing well, you tend to do well.”

In wholesale and retail trade, Kremar said retail sales in March were “disappointing” and showed improvement in April, but “we think the very strong growth rates are probably behind us.”

He said the expansion will proceed at a slower pace because with interest rates rising and tax cuts finished, the consumer spending boom is over. Moderate gains in employment and income will keep consumer spending rising. Business equipment investment is surging in response to strong profits, growing markets, and technological advances. Nonresidential construction is beginning a slow recovery. State and local finances are improving, enabling more spending — but federal stimulus has ended. Exports will strengthen in response to the dollar's depreciation and growth in foreign markets.

He said worldwide demand for crude oil is slated to expand by almost 2% per year through 2010, with North America growing by 1.6% annually. Demand in China is slated to expand by 4.5% per year.

“The market is responding with increased exploration, but no one expects to stumble upon a big enough pool of oil to make oil cheap once again,” he said. “Refinery capacity remains extremely tight. Oil prices are expected to decline from current levels, but will not fall below $45 a barrel through 2007. We expect some relief on the commodity price front as demand moderates and supplies increase.”

Household net worth up

Kremar said household net worth is increasing, reflecting gains in real estate and financial assets, but a low saving rate is limiting asset accumulation.

“Federal tax cuts have boosted disposable income growth for three years — now tax burdens are likely to rise,” he said. “The household financial obligations ratio has diminished from late 2001 to spring 2004. But rising interest rates will cause some deterioration from 2005 to 2007. Credit-card delinquencies, which peaked in 2003, will gradually decrease as the job market improves. Rising employment and income will drive the next phase of the expansion in consumer spending.”

He said the outlook for foreign trade has become “gloomier,” given the rising oil prices and poor news on growth from the Eurozone and Japan.

“We still expect a rebound in export growth,” he said. “The primary driving force for exports is the cumulative gain in competitiveness since the dollar's 2002 peak. Worsening global trade imbalances mean that the dollar must fall farther, perhaps substantially so. An additional 5-10% decline in the currency by the end of 2006 should allow US export growth to overtake world trade growth next year — for the first time since 1997. But the outlook would be far healthier if the world economy were firing on all cylinders. The global expansion remains too dependent on US spending. As a result, imbalances such as the US trade deficit are continuing to widen.”

Kremar, talking about business investment, said the recovery in machinery and equipment will continue. Corporate America posted strong profits in 2004, which is having a positive impact on 2005 capital spending plans.

“Profit growth will slow over the near term, but continued growth in final demand — coupled with Corporate America's cost-control focus — bodes well for future financial performance,” he said. “Pent-up demand remains a major factor in the recovery, as domestic spending on many types of machinery and equipment declined dramatically from 2001 to 2003. Replacement and modernization programs will continue to drive domestic spending on machinery and equipment, but some industries are pursuing capacity expansion programs. After declining by roughly 25% during the recession, nonresidential construction has finally turned the corner.”

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