It's taken a licking … how well the economy will keep on ticking depends on a range of volatile factors; "muddle through" scenario seems most likely

Diesel Progress North American Edition, Sept, 2008 by Jim Meil

An old wristwatch commercial used to close with the catchphrase "it takes a liOking and keeps on ticking." That is one way to characterize the U.S. economy's performance in the last year and it will likely continue to describe what the future holds for the next four to six quarters.

Volatile oil prices, the ups and downs of prices for industrial materials and natural gas, the housing bust, problems in financial markets and the banking system have applied a serious "licking." And while at times the "ticking" could barely be heard, we have had only one quarter of out-and-out GDP decline (in the fourth quarter of 2007).

Our best guess is that this "muddle-through" scenario will continue until midyear 2009. Not quite bad enough to be called a recession, but well below the growth rates that are typical of average economic performance. Also look for this: there will be greater than usual sectoral variance in key diesel end-markets in industrial, transportation and off-highway equipment.

Let's count up and comment on some of the factors that are likely to be constraints on growth this year and next.

* Financial turbulence--banking troubles and declining stock prices are likely to constrain credit availability and keep the "cost of capital" (hurdle rates) for investment relatively high.

* Profits and cash-flow generation--squeezed by weak sales and high materials costs, and potentially by rising labor costs if higher inflation expectations become embedded in the labor force.

* Volatility in commodity prices--even with recent declines in crude oil prices, diesel prices, copper, nickel, natural gas, etc., uncertainties act to constrain businesses and households in their spending and risk taking.

* Signs of overseas weakness--recent data paint a picture of decelerating economies overseas, Europe in particular.

* Political uncertainty--even when U.S. election results are finalized in November, there will be a sorting-out period for a new president and new Congress that will last through much of 2009.

That's the downside. It's not pretty. But not all is doom and gloom.

Since September 2007, the Federal Reserve dropped the Fed Funds rate by 3.25 percentage points, and has taken other actions in attempting to inject liquidity into financial markets and ease banking sector stress. The revalued U.S. dollar (notably versus key trading partner currencies like the Euro, U.K. sterling, Brazilian real and Canadian dollar) should keep on aiding manufactured exports, even in the face of slower demand in key trading partners. Inventories are generally in good control with little need of trimming back. Finally, the president and congress have shown willingness to put political differences aside to work together on fiscal stimulus and financial fixes. While the fall election season will likely put things on hold, the election may expedite needed corrective steps as we move into and through next year.

So how does one read what's ahead for 2009? Quite likely the year will start slow, with a first half that grows just enough to avoid a recession, but significantly below long-term average growth rates. Just like when a solid B-average student brings home a report card with Cs and Ds--the grade might not be failing (recession), but it's not enough to make anybody happy. As we work our way to year-end 2009, we think the Fed stimulus in particular will help push economic growth closer to long-term normal rates.

With that as our economic overview, here is what we think is likely to go on in a select number of key heavy equipment markets.

Construction Equipment: The two-and-a-half year decline in residential construction has made for weak U.S. domestic markets for construction equipment sales. Fortunately, that has been partly offset by nonresidential building that has been surprisingly resilient, highway and infrastructure repair at supportive levels and exceptionally strong export trends. So after a steep falloff in 2007, this year will show low to mid single-digit growth, as will next year, before recovery begins in earnest in 2010.

Farm Machinery: Strong agricultural commodity prices have contributed to gains in the value of crop production that the USDA estimates at 17% for 2008. This is fed by fundamentals such as government-subsidized biofuels programs, low levels of grain inventories and worldwide demand for corn, soy and wheat. This is a given as diet quality and protein intake rise with global incomes. So farm machinery should have another year of robust growth at 9% in 2009 after 2008's solid 8% gain.

Mining And Oilfield Machinery: Considering the stratospheric levels reached by prices of energy goods and other industrial commodities, it comes as no surprise that the oil patch and other mining sectors are targets of investment. We expect rates of growth for oilfield and mining equipment to be close to--or to exceed--the double-digit range in 2008 and 2009. Just as they have since midyear 2004.

Material Handling Equipment: 2008 year-to-date results point to slowing orders and flat backlogs, leading to our anticipation of a "flattish" market (about 1% growth) in 2009 after a trend, or average year of 4% growth as our 2008 outlook.