Molders Economic Index: Will a 4.5% prime rate and 3.9% growth add up to no recession for now?

In weeks to come and well into March the most critical next steps to watch are how the U.S. economy—in concert with a battered global economic outlook—will fight the growing risk of a recession.

The U.S. economy grew a stunning 3.9% in the third quarter compared to a year ago, despite housing and credit concerns. But this is unlikely to last. The fourth quarter may show economic growth of less than 1.5% and the outlook for the first quarter of 2008 is similarly glum.

The Q3 growth was substantially better than anticipated and was sustained by economic growth in most sectors. The U.S. economy has, at least for now, shrugged off the alarming increase in oil prices—soon to hit around $100/bbl—and the worst housing market in two decades. The combination of concerns over housing coupled with steep prices at the pump may reduce the most critical engine of growth: consumer spending. In the third quarter such spending jumped 3% on an annualized basis.

But housing declined 20.1% in the same quarter while a boost to manufacturing came from an annualized 16.2% growth in exports.

The hope now is that the latest cut in the prime rate to 4.5%—and the Federal Reserve has hinted it will hold the rate at that level for some time—along with continued export growth will give the U.S. economy the resiliency needed to ward off a recession. Plastics processors complain—they say their new orders are down and steep energy prices are hurting profit margins and thus reducing their ability to invest in more productive processing machinery.

Warning signs in October

October delivered several warning signs of slower growth. The monthly index of the Tempe, AZ-based Institute for Supply Management (ISM) dropped to 50.9 (which is minor growth) from 52 in September. “It does appear that the impact of the slowdown in the financial, housing, and transportation segments has spilled over into manufacturing,” says Norbert Ore, head of the ISM survey committee.

The ISM index has now declined for four straight months. The ISM production index dropped to 49.6 in October from 54.6 in September, the first reading below 50 since January. And manufacturers are paying more for supplies: the ISM prices paid index rose to 63 from 59, with 33% of firms reporting paying higher prices, compared with 7% reporting lower prices. The export index rose to 57 from 54.5.

Car sales are also down again. Sales fell 12% for Chrysler in October while overall U.S. auto sales fell only about 3% for the month. Overall U.S. light vehicle sales were 1,231,575 in October, some 3% behind the same period last year. Asian companies raised their share of U.S. sales to 41.1%, up 2 percentage points from a year earlier and short of the record of 44.6% set in July. GM, up 3.4%, had its third straight monthly sales gain and lifted its market share to 25%.

Early November brought reports of more troubling construction data. The September housing construction report from the U.S. Commerce Dept. showed that housing starts plunged 10.2% to a 14-year low of 1.191 million. Permits fell 7.3% to 1.226 million. This spells lower sales for many molded products for housing—plumbing parts, window components, electrical devices for houses, small and large appliances, and lighting components—for the next nine months or more. Note that housing activity has been down now for seven consecutive quarters.

Equally troubling for the outlook on consumer spending are data suggesting that the downturn in housing values has reduced the ability of Americans to borrow against equity and keep on spending. Just how this will impact the economy will take many months to show. Consumer spending has been essential to sustaining domestic manufacturers and molders. In addition to reduced borrowing abilities by the consumer, steep prices for energy will further cut spending. Right now the outlook for holiday season spending is grim and will lead to sharply lower orders in January and February.

Keep in mind that a full 70% of all U.S. economic activity is driven by consumer spending. Any drop—even as little as 2%—will hurt all manufacturers. And the engine sustaining consumer spending has been household borrowing. According to the Federal Reserve, U.S. household debt as of August 2007 had jumped 24% over five years. Community-based nonprofit group NeighborWorks America in October released data from a study showing that 43% of U.S. households spend more than they earn each year.

Made in the USA Those who just returned from the K show in Düsseldorf will know that the greenback is worth very little. But the steadily declining value of the U.S. dollar has fueled the biggest export boom in a generation and probably will continue to do so.

Injection molders in most sectors report sustained long-term increases in orders for parts that will be assembled into exported items. This is excellent news and has, to some extent, helped boost overall output of molded parts.

U.S. Commerce Dept. data show that between 2000 and 2003, the U.S. lost some 3 million manufacturing jobs and some $69 billion in export sales. Now, as detailed data on new jobs as well as export sales show, this is being reversed. This is one area to concentrate on. “Fourteen million U.S. workers produce twice as much as 60 or 70 million Chinese workers,” Frank Vargo, VP for international economic affairs at the National Assn. of Manufacturers (NAM), said in October.

Note that the August 2007 trade deficit in manufactured goods was down 10% compared to August 2006. If this trend continues, by August 2008 the trade deficit in manufactured goods will narrow even more to less than $200 billion/year. India’s lure

North American molders searching for a solid offshore manufacturing location may want to start looking very hard at India. Keep in mind that some manufacturers (U.S., Japanese, and Canadian) are facing higher real estate costs and wage increases in China. A good number of Japanese and now German firms have started to locate manufacturing and molding in India.

A recent study from Capgemini (New York, NY; www.capgemini.com), a major outsourcing consulting firm, shows that China is rapidly losing some of its old advantages compared to India. The report was prepared in cooperation with ProLogis (Denver, CO; www.prologis .com) and the China and India Supply Chain Councils. (Download the full report.)

Key for molders is that, unlike China, India has a very solid legal system based on British common law, and intellectual property rights are well protected. Plus, average wages in India are about 55% of Chinese wages and on average the labor force is better educated. The Indian government helps with new companies but, admittedly, needs to do more on issues such as ports, shipping, and overall infrastructure. More than $500 billion will be invested in infrastructure in the next five years, according to Indian sources.

Agostino von Hassell ([email protected]) of The Repton Group (New York, NY) prepares this index.