Last week the National Fluid Power Assn. hosted an economic update webinar for the fluid power community. Fitting for a post-Halloween event, Catherine Putney, an economist with ITR Economics, predicted a bit of a fright next year, with better prospects beyond. Here are some excerpts from her presentation.
In terms of a general economic outlook, the big barometer for the health of the fluid-power market on a macro level is U.S. industrial production. Data show that we’ve been in quite a long rising trend, recent tax reform has had a positive impact, and the economy is doing well right now.
However, 2019 will be a year of business cycle decline as some headwinds take hold. But keep in mind that while we will go through a downturn later next year, it will be brief. So as you head into this downturn, don’t compare it to recent slowdowns, it’s not going to be relatable. The recession in early 2000 was due to technology, in 2008 the housing market, and in 2005-16 was solely driven by oil and gas. The slowdown in 2019 and 2020 will be driven by more of a strained consumer that’s going to weigh on the overall economy.
We are starting to see signs that we’re heading into what is called the back side of the business cycle. We have been riding a really hot, positive wave in the U.S. economy, which has hit its crest.
What are the drivers propelling the U.S. economy into that downturn? Let’s look at some of the leading indicators. The U.S. Purchasing Managers’ Index is a great indicator that tracks macroeconomic activity. This has been declining for quite some time and actually entered into negative territory in the recent month. The Wilshire market cap recently rebounded but the stock market, especially towards the technology side of things, hasn’t been doing so hot. And the JP Morgan indicator also entered into negative territory—more evidence that we are in the latter stages of the business cycle.
Another catalyst to the downturn revolves around interest rates. We expect the Federal Reserve will continue to hike interest rates. And as that happens, it’s going to dis-incentivize and limit the ability for individual businesses to get loans and cost them more to purchase new capital equipment. So that’s going to be a deterrent on the economy, which goes hand-in-hand with our outlook for slowing growth next year.
And even through 2019 when we experience this hiccup, don’t expect interest rates to drop. They might stabilize a little, but then further interest rate increases will be in the offing.
Shifting gears, trade and tariffs are huge topics of conversation nowadays. What started as disagreements over intellectual property protection in China has since escalated quite significantly. It’s creating significant inflationary pressures, and causing a lot of losers in the game compared to winners.
If you look at the degree of impact of what these tariffs are causing, the U.S. has enacted about $300 billion in tariffs so far, with another $600 billion proposed, most of it related to auto imports. On the other hand are more than $100 billion tariffs on U.S. exports, to date. Look at the aggregate, these are big numbers. And when you limit that ability to allow free trade, that causes a lot of inorganic hindrance and obstacles in the economy that’s only going to create inflationary pressures.
And we’re already in an inflationary environment. Look at the steel industry, with three large players in the U.S.: Nucor, U.S. Steel and AK Steel. Even before these tariffs were put in place their revenue was doing well. And now workers are demanding their share, and we’re seeing steel workers going on strike for higher wages.
That ultimately leads to higher prices that will affect downstream industries such as construction, automotive, oil and gas. There’s a laundry list of companies that are planning to increase prices. They want to preserve their margins, and inflationary pressures are continuing to build.
There a lot of different areas in the economy and some are doing better than others. Based on U.S. retail sales growth the automotive market, for example, isn’t fairing too well right now despite the thriving the U.S. economy. Why not? We’re seeing a lot of risky lending in the automotive markets, delinquency rates have surpassed historical averages, and production is in decline. Thus, retail sales are stagnant and will only get worse next year for the auto industry when the overall economy is in decline. Think about kicking a dog when it’s down! This industry is already suffering, it’s going to hurt even more as we head into this downturn next year.
Vice versa, there are some good industries to be in. For one, online retailers are doing extremely well. In terms of particular industrial sectors, that buoys material handling equipment. New orders have been positive for quite some time, in part due to the Amazon effect. A lot of this type of equipment operates in warehouses, and we’ve seen a huge growth spurt in warehouse construction.
Likewise, U.S. food production is an industry that has recently transitioned to decline. However, we don’t expect a recession out of this market. Historically the downturns in this market aren’t necessarily severe. The population is constantly growing, people need to eat, so inelasticity is very high in this market for the demand, and that’s going to create a lot of opportunity out of this particular market as we head through the next year or two.
Most other industrial markets are approaching or have passed their peak and have transitioned to business cycle decline, due to obstacles that include an extremely tight labor market, supply dynamics, higher commodity prices and environmental regulations. This includes U.S. chemical production, mining and oil field machinery production, engine and power transmission equipment, farm machinery and heavy duty trucks.
In the end, NFPA total shipments are expected to trend in line with the macro economy through 2020. Forecast is for an 11.2% increase in shipments for 2018. Shipments will rise into early 2019 and then decline through the remainder of the year, down 1.3%. Shipments in 2020 are predicted to rebound by 7.5%.
Expect that 2019 is going to be a down year, with negative numbers for both hydraulics and pneumatics. And then in 2020, we’re getting back on our feet again. The decline in 2019 is pertinent, but the downturn where it hits the lowest will still be the mildest since the great recession. So don’t compare it to the last three recessions, be more optimistic.