By Peter Toja President, Economic Planning Associates Inc Smithtown, New York (Digest of a presentation at the TTMA convention in Carlsbad CA)
I HAVE SOME good news, not only for the next couple of years, but beyond the turn of the century. But it behooves this industry to take a long look at the conventional ways it does business in order to become as efficient and effective as possible.
Do not be as concerned about the "what" of this forecast as the "why" of the forecast. What is occurring in the industry that will drive your markets? How can you best position yourself to take advantage of these markets?
We need to see beyond what is happening in the United States, but the U S economy certainly is the place to start an economic outlook. And when we look at the U S economy, we see a good foundation for continued growth.
The consumer sector is the driving force. Retail sales have been expanding for six years, almost an unprecedented performance. Last year, retail sales increased 5.5%. Already this year, we have had strong months in January and February. The consumer continues to remain on a spending pattern. It looks like the first quarter of 1997 will be the best since 1994.
With the consumer starting 1997 on such a strong note, what will the rest of the year look like? It depends a lot on income, employment, confidence, inflation, and consumer debt. Let's look at each of these factors individually.
Employment. We have grown tired of hearing about how major corporations have downsized their employment and announced layoffs. Last year 2.6 million net new jobs were created in the U S economy. Our unemployment rate now is hovering around 5.8%, a level we have not seen in many years. The employment picture is such now that companies that had been laying people off are now offering their employees incentives to bring in friends and associates.
The job market is heating up well. As a result, income levels also are rising. The consumer is extremely optimistic.
Prices are moderate. Inflation continues to hover around 3%, despite continued economic growth. It is difficult for wholesalers and retailers to pass through price increases because the consumer today is extremely sophisticated. Whether it is the purchase of an automobile, furniture, or appliances, he knows how to drive a bargain. This is not the kind of environment for passing through major price increases. Prices have been extremely moderate. In spite of recent activity on the part of the Federal Reserve, we do not believe that any escalation in inflation is on the horizon.
Income growth. Consumer income increased more last year than in any year since 1988. And based on preliminary data, the first quarter of this year shows a stronger increase than all of last year.
With income growing and with prices moderate, we are seeing consumers take on more and more debt. Consumer debt is one of the biggest items that Wall Street analysts consider when forecasting future spending. The consumer cannot take on increasingly higher levels of debt.
But the flip side of consumer debt is assets. From 1994 to the end of 1996, consumer assets just in equity holdings grew $2.3 trillion. This is extreme wealth. In addition, home prices have revived over the past three years. The consumer perceives that his wealth is increasing. This makes him feel that he can spend additional income and take on additional debt.
The biggest driving force in U S consumer spending over the past 20 years has been the Baby Boomers. Because their retirement is approaching, they are taking liquid assets and converting them into financial assets.
This is fantastic. But I have three 20-year-olds still at home who are determined to take my liquid assets and convert them into their consumer durables. I don't spend a lot more than I did 10 years ago, but they do. This scenario probably is fairly common.
Our forecast does not call for a stoppage in consumer spending, but we do believe it will slow down. Where consumers spent between 4% and 4.5% more in the first quarter than in the previous quarter, we think that will slow to between 2% and 3%.
The one uncertainty is interest rates. The Federal Reserve wants to make sure inflation does not increase. I don't know how Chairman Alan Greenspan will react. The labor market is strong, and he follows the labor market. The unemployment rate probably will come down even lower. So in a preemptive mode, he has begun to raise interest rates. Rising interest rates could dampen the housing market, automotive commercial paper, and credit card purchases. All of this points to some slowing as we go through the next two or three quarters. We don't see this as a major problem, and we believe that what Greenspan has done is a preemptive move. We don't believe that much more aggressive rate increases will be required from this point on.
Looking at Segments
Automobile sales were decent last year, with 15.1 million units. The fourth quarter of last year was extremely weak, but January and February have rebounded well. We think that retail sales in 1997 will be about the same or maybe a little lower than last year-14.9 million to 15 million units. Sales will ease a little more in 1998-to 14.8 or 14.9 million units. We see long-term demand for light-duty vehicles moving into the range of 14.6 to 15 million units.
Nothing much is happening regarding automotive demand in the U S. But plant haul-aways of finished vehicles will be up significantly in 1997 and will hold that pattern in 1998. Even though sales will be flat, production will be up for several reasons:
* The consumer continues with his love affair for light trucks, a product produced in North America.
* Inventories will be built up as we get into the 1998 model year season.
* Transplants. Increasingly foreign manufacturers will be supplying demand with vehicles built in U S facilities.
* Demand in Canada and Mexico will increase.
Housing started strong last year, but were dampened later by increases in interest rates. Even though they ended on a weak note, housing starts rose 9% in 1996. Most economists look at the three strong years in the housing market and would expect a softening in 1997 and 1998-except for one factor. While housing starts were 1.4 million units, home sales in 1996 hit a record four million units. For people wanting to get into the housing market and didn't, there might be significantly fewer homes available. Not surprisingly, February showed a significant pick-up in housing starts. Given demographic and income levels, we believe housing starts will hold up in 1997 and 1998. If we have a strong housing market, think of what that will do for demand for furniture, appliances, carpeting, and consumer electronics. These should increase in 1997 and 1998.
We think that total consumer spending will increase approximately 2.5% to 3% in both 1997 and 1998. Compare that with the pattern for 1995 and 1996. Relate that to what happened to trailer demand during that period. We expect a steady increase in consumer demand.
Our economy will be marching to other tunes beside that played by the consumer. Demand for capital goods continues unabated. We have companies that continue to invest to improve quality of product, to streamline costs, and to capitalize on foreign opportunities.
Industrial production is a key area for trailer manufacturers. If goods are produced, they have to be moved. The momentum in manufactured activity has been steady.
Most of the growth in industrial production has been in durable goods. The strongest growth in durable goods has been in those industries that are extremely export oriented-construction machinery, farm equipment, material handling equipment, and aircraft and parts. But even the nondurable goods industries are increasing nicely, including food and beverages, chemicals, and pulp and paper.
Inventory to sales ratios for manufacturers are important. Should sales increase, it benefits the trailer industry when the sales increase leads manufacturers to increase production. That means more goods have to be moved through the trucking system. We now have inventories at such low levels that increases in demand automatically trigger increases in production and the movement of goods. More importantly, manufacturers over the last six years have lowered their labor costs as well as inventory costs. The days of having massive amounts of sitting inventory are gone. Components and materials no longer sit at the unloading dock, nor do finished goods stay at the loading dock. Components come in, move through the factory, and are shipped to the customer.
This system of just-in-time manufacturing implies low volume, more frequent deliveries. This is something that is not easily accomplished by rail. This trend should benefit the truck and trailer industry.
We expect manufacturing activity, which was up between 3% and 4% last year, to increase another 3% to 3.5% this year in both 1997 and 1998.
To round out the economy, construction activity also should be positive. Construction picked up significantly in the second half of 1996. We see continued growth and momentum in areas such as industrial, commercial, and educational areas. After a 1.5% increase last year, construction activity will increase between 2% and 2.5% in 1997 and 1.5%-2% in 1998.
Where the Growth Will Be
The most dynamic area of growth in the U S economy is foreign trade. Yes, we hear on the nightly news where the monthly trade deficit moved up to 12.7 or down to 12.2. So what? Look at the volume of products that are moving through the system, or you will miss the entire picture.
We have moved extensively into the area of foreign trade. In 1985, 12% of our economy was import/export. In 1995, it was 19%. By the year 2001, it will be 25% of our economy.
During the next five years, the transportation system of the United States must gear up to deal with this increasing volume of traffic. This traffic will go beyond the traditional exports of crops, chemicals, and aircraft components.
U S manufacturers have made magnificent strides in penetrating foreign markets. We have lowered costs, improved quality, and are major sellers in several foreign markets. However, transportation costs are a significant component of the final product cost at the destination. Manufacturers will count heavily on the transportation system to keep their costs at a minimum and their prices competitive. This will be particularly true as the U S dollar gains strength in international markets.
Over the next five to ten years, the transportation system will need efficient, reliable, and flexible systems and equipment to accommodate the growth in merchandise trade. Logistics, distribution, warehousing, transportation equipment all will be dynamic sectors of our economy.
We will not even need to go far to find increases in traffic. Just look north and south of our border. Canada has been sending product to us-primarily automobiles and natural resources-for years. Over the last 10 years, product coming to the United States from Canada has grown an average of 9% per year. Our products going to Canada have grown an average of 12% per year. The Canadian economy was slow in 1996, but it is poised for growth in 1997 and 1998.
If you think Canada is a great story, try Mexico. In 1995, Mexico had a major recession, and our exports flattened out. But once the Mexican economy turned around, U S exports to Mexico increased quickly.
Sure, the Mexican economy sends us product, about 10%-11% more per year over the last 10 years. However, U S exports to Mexico have grown an average of 18% per year, for a very simple reason. We are the lifestyle that the Mexicans want to emulate. Seventy cents of every dollar that Mexicans spend on imported products go to buy U S goods.
If you think Mexico is some sort of backward country, think again. It is the 11th largest economy in the world. Mexico spends more per capita on U S products than any of our major trading partners, including Canada. Think about the potential for strong growth in the Mexican economy and what that means for U S-made goods. Then think about the increase in traffic and how it gets accommodated.
The average age in Mexico is much younger than that in the United States. Think about the long-term growth as the standard of living in Mexico increases. Think about the appetite for U S goods, for consumer goods and for growth in the Mexican infrastructure: hospitals, schools, and other areas. Most of this will be accomplished with U S-built machines.
Both the Canadian and Mexican economies will be growing faster than the U S economy during the next few years. We should be sending more product north and south than we will see coming into the U S.
The transportation system has been responding. Railroads have brought on large-capacity cars, lighter-weight cars (including a greater use of aluminum for increased payload), double-stacked wells, and electronic tagging to better utilize existing equipment.
Trailer manufacturers also are responding. Production capacity has increased significantly. While this caused some problems when demand decreased in 1996, it bodes well in the long term. To have effective, flexible, productive capacity will help the industry respond to increases in demand for equipment. Manufacturers have improved technology, developed safer and more reliable equipment, longer-lasting components, and made trailers more productive.
We also see changes in containers being built by the industry. These not only are dry-freight containers, but also refrigerated, bulk, and liquid containers, all of which are flexible enough to fit in an intermodal system that will become increasingly important during the next 10 years.
Growth in Intermodalism
Intermodal shipments should grow. Over the years, railroads have improved services, made investments in rolling stock, and have seen an improved acceptance of containers on the part of shippers. We anticipate good growth in intermodal haulings in 1997 and 1998.
The bulk of that growth should come from containers. Railroads may talk about the investments they have made in equipment for handling trailers, and they may talk about plans they have for cooperating with truck fleets. But every major investment they are making from this point on is directed at containers. Some railroads have even told us that if it were up to them, they would not have any TOFC equipment on their lines. Eastern railroads are stuck with it because of tunnel clearances. But the average railroader wants double-stacked containers. Even so, there will be some modest growth in the trailer-on-flatcar (TOFC) segment.
Some people have told me that they see both the trailer and truck business picking up. That is true, but the increases are coming from negative territory. Over the last six to eight months, the decline in demand for trailers has moderated. We are starting to see some improvement, but keep in mind that the industry still trails year-over-year. The good news is that the momentum definitely is upward.
Trailer Demand to Increase
Based on that momentum and the economy, we think that in the second half of this year, we will see some improvement in year-over-year comparisons in trailer demand. But for the year as a whole, we still see trailer activity being off about 5.9% for vans and about 9% for all other types of trailers.
This is nothing more than a cyclical digestive phase after the strong years of 1994, 1995, and 1996. We look for some improvement in 1998 both for vans and other types of trailers.
For vans, we expect good long-term growth in dry-freight vans, open tops, dropframes, and refrigerated vans-especially given our demographics and our preferences for convenience foods and fast foods. This promotes a lot of reefer traffic. For non-vans, almost every type of trailer will begin to grow in 1998 and will continue to grow to the year 2002.
The basic message is that the trailer market will either be good or extremely good, depending on the point of reference. If you compare the next five years with what happened in 1994 and 1995, the market will be pretty good. But how good was 1994-1995?
Starting in 1982 and looking at five-year periods, trailer shipments have grown steadily. Even though we have had a couple of recessions during that time period, demand for rolling stock has continued to increase.
Our forecast for the next five years is for a higher level than the last five years. Not better than 1994-1995, but better than the last five-year period.
While the domestic market will be good, it's important to appreciate the fact that we are globalizing. Your customers are globalizing, and they must have the products that will help them go after those markets.
After a slight drop-off this year, we expect to see long-term demand for trailers, containers, and chassis growing through the year 2002.
Question: Other than in Canada and Mexico, where do you see the growth occurring during the next three to five years?
Toja: Southeast Asia. The greatest potential is China. If you want to get involved in China, go ahead. You will be spending the next 5-10 years finding out how you play the game so that you will be able to play the game in the future. Southeast Asia is a fantastic market right now.
South America also looks good. The South Americans have formed a pact similar to our NAFTA. Chile will probably get into it before they get into NAFTA. Mexico will follow. And the U S may get in through our connections with Mexico. Five years from now, that will be a dynamic area of growth. The Brazilians have invested about $30 billion in automotive industry alone. They also have made fantastic investments in electronics.
Question: What are the prospects of inflation slowing the growth in Mexico?
Toja: Mexico had a serious bout with inflation, but the problems relate more to direct and indirect investment on the part of foreigners who began pulling out at the first signs of an uprising by the Indians in the southern part of the country. That political situation led directly to money moving out of the country, which in turn caused a run on the peso. Mexican inflation is a result of the devaluation of the peso. Inflation was 42% in 1995 and 24% last year. It is running about 18% now. I don't think you should watch inflation nearly as closely as investor confidence.
Question: As we look at a global economy unfolding and manufacturers penetrating various parts of the world, do you see fewer durable goods being produced in the United States?
Toja: Both sectors will grow. That's because we in America have some very efficient processes in place that cannot be duplicated quickly overseas. I don't see a sudden shift, but I do see steadily growing investments on the part of U S companies to build plants overseas. They will be doing this not just for labor savings but to be close to their markets.
Question: What effect will the continued strong U S dollar have on your forecast?
Toja: I have been a consultant to the machine tool industry for more than 20 years. During that time, U S manufacturers told me that as soon as the exchange rate between the dollar and the yen reached a certain level, the Japanese machine tool manufacturers would not have a chance. But no matter how much the yen appreciated, the Japanese competed with us.
Looking at consumer goods, the fact that an imported product will cost less than a domestic product is a fact that the Federal Reserve must consider when attacking inflation by raising interest rates. Cheaper imported goods reduce inflation two ways-by their actual price and by making it more difficult for domestic manufacturers to raise prices.
The textbooks tell us that if the dollar continues to rise, we can expect to lose some exports and gain a certain amount of imports. My opinion is that this negative effect can be overcome with continued increases in production efficiency in the United States.
Question: What do you see happening in Europe with its unified currency?
Toja: The European Union is a great concept. The problem will be the unified currency. Once the Europeans unify their economies, Europe will be one good market. It is a complex situation, and I don't see them really getting their act together until 2005 or 2010.
Question: What effect does the approaching ABS regulation have on your forecast?
Toja: Years ago, a regulation like ABS would have had a major impact. We didn't consider it to be sufficient enough this time to worry about it.
Question: Trailers are being designed to last longer. Won't this affect demand for new equipment?
Toja: An interesting point. Equipment is lasting longer, but you must remember that that equipment also is being utilized more heavily. If in 1985, the average Class 8 truck went 90,000 miles per year, there is a good chance that the average in 1995 was up to 130,000 miles per year. By the year 2000, it might reach 200,000. In the long term, we believe that the increased durability of equipment and the increased utilization rate will cancel one another. We are going to have a very efficient transportation system. If equipment is going to be utilized more, it had better be kept in good shape.
Question: What about congestion on the highways? Won't the utilization rate go down as we get more traffic?
Toja: It is possible. But the only place I see congestion being a major factor is in intermodal loadings. I don't see a problem on the highway, but when all these intermodal containers converge on a port, that is congestion.