A return to Camelot?
Current economic expansion could exceed the magical 1960s in duration unless a slowdown in 1999 halts growth
By Daryl Delano -- Industrial Distribution, 1/1/1998
As the new year begins, it's natural to start thinking more intently about what's in store for our businesses throughout the course of 1998. Will the currency and financial market crises in Asia have any significant impact on economic policy and/or U.S. economic growth prospects? That remains a topic of hot debate, although it appears the situation could slow U.S. growth by maybe a half percent or so.Will the Fed raise interest rates from the levels that have prevailed since March 1997, whether or not there are clear signs of accelerating inflation? Do we have to worry about a recession in 1998, or can we look forward to another year of solid, uninterrupted growth? And what does this all mean for distributors, anyway?
Macroeconomic overview
We see a continuation of generally favorable economic conditions for the distribution industry during 1998. As 1997 came to a close, we enjoyed the benefits of the third longest period of economic expansion in the past half-century. The last full-scale U.S. recession -- and a relatively mild downturn, at that -- ended in March 1991. There's nothing on the horizon to suggest that this expansion can't continue -- at a moderate pace -- through 1998.
Recession concerns become more real as we enter the final year of this millennium, but we'd still place the odds of an absolute downturn in the economy -- as contrasted with simply a slowdown in the rate of growth in real GDP -- at just slightly greater than 50 percent.
Following growth in GDP during 1994 that reached 3.5 percent, real economic growth slowed to a two percent pace in 1995. Although it appeared to most forecasters that 1994 would ultimately be recorded as the best year of this economic expansion, preliminary indications are that GDP grew by an even stronger 3.7 percent during 1997 -- a pleasant surprise to say the least, especially since it came with no appreciable run-up in either wage or price inflation.
We're looking for a pronounced slowdown in economic growth in 1998. We see GDP rising by an inflation-adjusted 2.3 percent from the heady 1997 level, as measured on an annual average basis. Interest rates should average somewhat higher in 1998 as the Federal Reserve Board pursues a tighter monetary policy.
Three major trends bear watching during 1998, and all will have some moderating influence on the growth potential for the distribution business:
* A pronounced slowdown in the growth rate of business investment spending
* High levels of consumer debt, particularly installment (credit card) debt
* And, an uptick in inflation brought about by increased average wage demands resulting from historically low levels of unemployment.
None of these factors is significant enough by itself to cause the U.S. economy to stall out this year. The relatively stable nature of our exclusive indicator of business sentiment -- the Reed Elsevier Business Confidence Index -- suggests continued cautious optimism on the part of the business community. The momentum built up during the past five years -- fueled in large part by productivity-improving business investments -- will keep the economy rolling, albeit with a bit more friction, during 1998.
Construction overview
Coming off an exceptionally strong 1996, the housing sector recorded mixed results during 1997. Through the first nine months of 1997, total housing starts had declined by 2.2 percent from the year-earlier pace. The weakness was concentrated in the single-family home sector of the market, with starts declining by 3.6 percent over the first three quarters of the year, compared to the first nine months of 1996. Multi-family housing (apartments and condominiums) continued to grow during 1997, adding 3 percent more units through September 1997 than over the same period in 1996.
We expect total starts to decline 3.6 percent in 1998 to a still-healthy 1.385 million units. Both the single-family and multi-family sectors are expected to lose some ground next year. Single-family starts will fall 2.6 percent to 1.085 million units, while multi-family starts will decline 6.8 percent.
Nonresidential construction spending grew by 9.1 percent through the first nine months of 1997. The surprisingly positive trends for that sector were expected to continue through the remainder of 1997, with spending rising 8.5 percent for the year as a whole to $223.5 billion. Next year, the spending pace for nonresidential construction will lose some momentum, but still manage to grow 3.3 percent to $230.9 billion.
Nine-month trends suggest that commercial construction will finish 1997 about 7.8 percent ahead of the 1996 spending total. During 1994-1996, commercial construction spending grew at an average annual rate of 14.4 percent, so as solid as the sector's 1997 performance looks, it still marks a slowdown. We're forecasting a small decline in spending for the sector during 1998, with a drop of just under one percent.
After increasing by about 14 percent in 1997, both office and hotel/motel construction spending will ease to growth rates of 4.2 percent in 1998. Retail construction -- which had grown by double-digit rates from 1993 to 1996 -- expanded by only 2.7 percent during 1997. With increasing evidence that this sector is severely overbuilt in some parts of the country, we expect to see total spending fall by about five percent during 1998.
Industrial construction spending has been on something of a roller-coaster ride in recent years. Following strong growth in 1994 and 1995 (an average 11 percent annual rate), spending for new manufacturing plants and warehouses dipped to 1.3 percent in 1996 and eked out a gain of just under one-half percent during 1997. We're forecasting a modest 3.8 percent increase in industrial construction spending in 1998, although an increasing share of the $33.4 billion total will likely go towards the renovation and expansion of existing facilities rather than the construction of brand new buildings.
Finally, we're expecting that the least cyclical and least volatile category of nonresidential building types -- the institutional building sector -- will see growth of about seven percent in 1998 after increasing about 12 percent in 1997. Annual construction spending in this sector hasn't recorded a decline in over 20 years. During 1998, the reliable institutional sector will be led by a 14.3 percent increase in spending for education buildings (spurred by the recent baby boomlet), following gains that have averaged 12.8 percent annually over the past three years. Hospital construction will grow a more moderate 5.6 percent, and other institutional construction will gain just 1.9 percent, constrained by a slowdown in public funding.
Manufacturing Overview
Largely on the strength of the dramatic surge in capital investment since 1992, American manufacturing has enjoyed a full renaissance this decade. Long-term investments in productivity-enhancing, efficiency-improving equipment and buildings has led to a sharp improvement in global competitiveness. And, for most sectors, the business investments that have been made the past five years should allow productivity and production gains to continue unabated through the balance of this century.
Industrial production in the manufacturing sector has grown solidly since the last recession ended in the spring of 1991. Annual growth for this cycle peaked in 1994 with an overall manufacturing output gain of 5.5 percent. Following more subdued growth in 1995 and 1996, preliminary estimates show that overall industrial production increased by about 5.1 percent in 1997.
The dollar value of manufacturing shipments by U.S. companies reached $3.7 trillion in 1996, up 4.1 percent from the year before. Through the first nine months of 1997, total manufacturing shipments grew by 5.8 percent over the same period of 1996.
The strength in the manufacturing sector during 1997 was also evident in the trend in capacity utilization. After utilizing an average of only 82.1 percent of available productive capacity during 1996, preliminary numbers show the utilization rate rising to 82.9 percent in 1997. And capital spending growth, which has been such an important driving force in this long economic expansion, continued to surprise most forecasters with its vigor during 1997. Following three years when business investment spending increased at an average rate of 8.7 percent annually, preliminary numbers show 1997 capital spending growing at a 10.3 percent rate.
However, production gains are expected to slow in 1998. The economy will be into its eighth year of uninterrupted expansion, and output gains will be harder to realize at a time when consumers and businesses alike are stopping to catch their breath. We're looking for a gain in overall industrial production on the order of 3.4 percent, with capacity utilization declining modestly to 82.7 percent. And capital spending growth should slow in 1998 to about 6.4 percent.
A few specific industry sectors should continue to grow at rates in excess of the overall manufacturing average. Most of these are "high-tech'' in nature -- computers, electronic components, communication equipment, and the like. However, we also expect another strong year for the construction and farm machinery sectors, and for paper and paper product manufacturers.
Summary
The year ahead should be another good one for distributors. The current U.S. economy can be characterized as an environment in which demand is strong, but pricing power is weak. During 1998, demand should flag a bit -- most clearly illustrated by a slowdown in GDP growth from 1997's 3.7 percent to something closer to 2.3 percent. Wage and price pressures will become more of a concern.
Interest rates will likely rise only moderately during the year, however, as danger of a disruptive wage/price inflation spiral remains remote. Global competition and the strong industrial capacity growth of recent years will hold industrial materials and equipment prices generally in check (subject to the usual spikes in prices for commodity inputs like oil and metals). Wage inflation merits greater concern, with the unemployment rate for most of 1998 remaining in the 4.5 to 5.5 percent range. At this level, there can't help but be spot shortages (skill-wise and by geography) of labor that will put upward pressure on wages and benefits. Companies will be limited in their ability to pass these increased costs along, however, and continued productivity gains should help them absorb most of the increase without seriously impacting overall profitability.
Although both manufacturing and construction markets will slow in 1998, production and spending will remain near the best levels recorded during the past decade. And slower growth is just what the economy needs in order to increase the odds that the current expansion can continue until at least the end of this millennium.
If we can make it through next year without a recession, this expansion will be as long as the boom period of the 1980s. If we can make it through the rest of the century, this expansion will exceed even the 1960s Camelot period in duration.
HOUSING MARKET
(Annual % Change)
1994 1995 1996 1997 1998*
Single-Family Housing Starts 6.5 -10.2 7.9 -4.0 -2.6
Multi-Family Housing Starts 6.0 7.3 13.9 1.9 -6.8
New Home Sales -1.1 0.3 13.0 3.9 -4.7
Sales of Existing Homes 3.8 -3.6 7.6 -0.3 -7 .2
Source: U.S. Department of Commerce and National Association of Realtors
*Forecasts: Reed Elsevier Business Economics
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