As we wind up the first quarter, many vendors, reps and distributors are not yet seeing much of a downturn in sales, despite the ominous sounds from Wall Street or the Federal Reserve Board.
While DISC Corp., Orange, Conn., is projecting a down year for the electrical industry, in the aggregate the key economic indicators are not currently in the red, with the exception of the residential market, and this is not the most important influence on electrical industry sales. However, I believe that when we look back on 2008, we will fold it into the package of past recessions, along with the 2001-02 downturn and all the others in the post-war period. It takes a number of key events to occur for a weak economy to be officially designated as in a recession. The National Bureau of Economic Research, an independent research organization based in Cambridge, Mass., typically has the last word on defining the timing and length of recessions. The rule of thumb is that a recession occurs when there are two consecutive quarters of negative growth in gross domestic product (GDP). That's not the official definition, but it's a good place to start.
We haven't seen any negative GDP growth through the fourth quarter of 2007, the last data point available. To date, the final fourth quarter GDP numbers have not been released. What we do know is that the preliminary GDP numbers for the fourth quarter 2007 show growth to be an anemic 0.6 percent over the previous quarter — a considerable slowdown versus third-quarter growth of 4.9 percent.
I don't hear anyone denying that we are in the midst of a recession, but that doesn't mean anything one way or the other. The point is that while some industry observers believe we are in a recession, we don't have enough hard actual data to demonstrate it. The operational words are “hard actual data.” Nevertheless, the national employment picture is fairly convincing evidence that we are already there or soon to be there.
Although the national economy will soon be in a recession (using the word “soon” makes this a forecast, not an actual event), it does not follow that the electrical industry will experience a simultaneous downturn. Experience over previous business cycles demonstrates that our industry follows, not leads, into a downturn. We expect that to be true again in the current cycle.
Why am I sketching out this scenario? My job is to give you a heads-up on what my firm sees coming down the pike, so you can adjust your plans and operations according to important economic events and not be caught short. Here's one of the important messages: Stay focused on what is happening in the electrical industry — not on the overall economy — because the two do not operate in tandem. Here's another important message: I cannot find a period over the last 35 years when the overall economy slipped into a recession without the electrical industry following suit.
So, if you believe, as I do, that the U.S. economy is now or will soon be in a recession, you should behave as though the electrical industry will be in one very soon. If you still feel we will dodge a bullet, I want to emphasize that all the risks are on the downside.
Most commentators are picking the overall downturn to occur in the first half of 2008, with a recovery in the second half of the year (as we head into the presidential elections). I think the administration and the Federal Reserve are trying to minimize the impact of the downturn. They are less concerned about the inflationary effects of pumping cash into the economy than about the consequences of a downturn on social welfare — translate that as income and jobs.
The other very important point to make is that while economists are predicting a short and shallow downturn that will end this year, we do not see events turning out that way in our industry. In fact, we do not see the electrical industry's recession beginning to take hold until the second quarter of this year, at the earliest. While the overall economy may be pulling out of the downturn in the second half of this year, the electrical industry will be at the beginning of its downturn. Although the overall economy may be sailing along smoothly in 2009, the industry will still be in the throes of its recession.
The reason for this difference is that the overall economy is mostly driven by what consumers spend, (about two thirds of GDP). In contrast, the electrical industry is driven by what business spends. It's not only a matter of how much; it's a matter of when the spending occurs. The point is that the incidence of spending adds another dimension to the business cycle, which is why the timing of an overall economic recession differs from an industry recession.
I see continuing growth in nonresidential construction spending through the second quarter of this year. However, by the third quarter, nonresidential construction expenditures are going to be negative by about one percent from the same quarter a year ago, and there will be double-digit negative growth through the first half of next year.
DISC always looks for segments and sub-segments in the expectation that there may be opportunities masked by overall performance. But by the second half of this year, commercial construction — bread-and-butter business to many vendors, reps and distributors — is expected to decline at about twice the rate of decline in nonresidential construction spending.
This dip in nonresidential construction and commercial construction continues through all of 2009 as well, at a time when the overall economy is expected to be stronger. During this time period, I expect commercial construction to fall at about twice the rate of nonresidential construction. I am not painting a gloom-and-doom scenario, only what I think is reasonable in view of the havoc the residential market is causing in the financial sector of the economy and its impact on the nonresidential construction market.
Impact on sales in the electrical wholesaling industry
So how does this outlook impact the distributor-served markets? While my firm sees some negatives, I don't see double-digit negatives for total electrical industry sales throughout the industry's downturn. The only double-digit negative we see is in the distributor-served contractor market, which by definition includes both residential and nonresidential markets.
In the fourth quarter of this year and the first quarter of 2009, I think the distributor-served contractor market will fall by around 10 percent from the year-earlier periods. This drags total industry sales down by less than 6 percent in the same time frame.
Meanwhile, the distributor-served industrial, institutional and utility markets are expected to do better than the contractor market. While I expect negative growth in all four segments, I don't expect double-digit negatives in these other three segments.
Interestingly enough, I see negative growth in the contractor market only extending through the end of next year, the industrial and utility markets turning the corner into positive territory in the second quarter of 2009; and the institutional segment pushing into positive growth territory in the third quarter of 2009. This means if you can serve segments other than the contractor market, you may want to dedicate more resources to those segments.
One last point: The business cycle is a fact of life, and we have all seen it before. Now is the time to prepare your business to handle the weakness and look for niche opportunities. What goes up must come down, but as with all business cycles, what comes down always goes back up.
Herm Isenstein is president of DISC Corp., an economic forecasting consultant based in Orange, Conn., and specializing in the electrical industry. He can be reached at (203) 799-3673, or by e-mail at [email protected].