Work truck and trailer industry sales expected to decline in 2007

Diesel Progress North American Edition, Sept, 2006 by Stephen Latin-Kasper

As noted last year, the big picture has not changed much in he past year. U.S. GDP is still growing at about its long-run rate of 3%. The federal deficit remains quite high and that means there is still pressure on the Federal Reserve Board of Governors to continue raising interest rates. Oil and some other commodity prices--notably nickel and copper--remain high and others are volatile. However, the core rate of inflation, while higher than in 2005, is still manageable.

For the work truck and trailer industry though, there is one primary issue overriding all of the issues noted above and that is changes in the emissions regulations for diesel engines. In the first phase (2004), heavy-duty truck engine prices increased about $5000 and medium-duty engines increased about $1500. For 2007, the heavy-duty engine price increase is expected to be about $10,000. This has led to a heavy-duty prebuy throughout 2006, just as occurred in 2003. However, unlike 2003, the medium-duty sector of the market is also experiencing a prebuy.

In 2003, medium-duty prices didn't increase enough--especially for those who typically finance their truck purchases--to make potential truck buyers worry about the cost. The $1500 increase added just a few bucks a month to loan payments. For 2007 though, medium-duty engine price increases are expected to average about $5000--roughly the same increase that was experienced in the heavy-duty sector of the market in 2003.

Consequently, 2007 is expected to be a difficult year for the work truck and trailer industry, but there might be a couple of bright spots. One truck application market that should continue growing in 2007 is the utility industry. Both the gas and electric segments of the utility industry are in the midst of a building boom. As the industry responds to increasing demand for energy, the demand for service and other trucks is likely to increase as well.

The other truck application market that is expected to do well is government. Even if the economy slows down in 2007, individuals and companies are going to be paying taxes on what they earned in 2006. There was an unexpectedly large increase in tax revenues this year, and while it won't be unexpected in 2007, it will probably be ahead of the OMB/CBO forecasts. As a result, local, state and federal governments will be a good market for trucks in 2007.

Since I just alluded to the possibility that 2007 may not be such a good year for the U.S. economy, I'll spend some time here explaining why. First and foremost, interest rates have been increasing since July 2004. As a general rule, when interest rates increase for a long period of time, the economy slows down. And that is exactly what has been happening.

Consumer incomes have been relatively flat during the last two years, but thanks to historically low interest rates, refinancing and cheap home equity loans allowed consumers to keep spending. As of the third quarter 2006, that is changing. Interest rates have finally increased to a point where borrowing can no longer be considered cheap. As a result, lenders are finding it tougher to make loans and are finding fewer people/businesses that they want to make loans to. The result is a slowdown in the growth rate of the supply of money.

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At the same time, businesses are finding it more expensive to invest in plant and equipment. There has been a capital spending boom since the third quarter 2004, but that has clearly peaked and is now winding down. That begs the question: if consumers and businesses are likely to spend no more in 2007 than they did in 2006--or at least not much more--how can the economy grow in 2007? The only sector of the economy left that could increase spending in 2007 is government.

One thing we know for sure is that the federal government is going to spend as much money as it can between now and November 2006. But after November, the political pressure to continue increasing spending will dissipate. After that, the federal government will still have to worry about funding a war on at least two fronts. And given the nature of the bulk of federal spending, a huge chunk of which goes to Social Security and Medicare/Medicaid, it is highly unlikely that the federal government will spend less than it did in 2006.

Basic economic theory says that if the government spends more, the economy is likely to grow more. Good theory, but there is an addendum--only if the increase in spending doesn't have to be financed. In other words, deficit spending can lead to growth in the economy but it's not a sure thing. The reason it's not a sure thing leads us back to interest rates. The problem with deficit spending is that someone has to have the necessary liquidity to pay for the securities issued by the Treasury Dept. For the past two or three years, a large amount of the debt issued by the U.S. was purchased by China, Japan, Germany, Taiwan and South Korea despite the fact that the interest paid on those T-bills was historically low. What happens if the people in those countries decide that they would rather spend their money on consumer goods, than save it by continuing to buy U.S. T-bills? Or almost as bad--from the U.S. government's point of view--what happens if they demand higher interest rates?