A Tougher Year Ahead - Electrical Wholesaling 07 Nov

Comparing today's economic picture with the previous downturn reveals more differences than similarities.

Our forecast for 2008 has been consistent at least for the past two years, and that outlook has always shown that electrical industry growth will be in the low single digits. I would be delighted to tell you that we now see more growth than anticipated. Unfortunately, I cannot be the bearer of such good tidings.

This is not a surprise to just about anyone in the electrical industry. The only questions are: How bad do we expect it to be? What are the root causes as we see them? And do we see any possibility that we could be too pessimistic?

Last year, the industry experienced its highest growth in six years, fractionally exceeding the 11 percent rate we saw in 2000. Is this ‘déjà vu all over again’? We remember that, six years ago, the electrical industry sales did a nose dive after the 2000 peak. In 2007, total sales are expected to grow about 4 percent after the 11.5 percent advance in 2006.

In that respect, there is not much of a parallel with the last industry recession, which hit home in 2001 and continued through 2003. In that period, we saw negative growth for three years running, and that is a huge shortfall.

We're not forecasting that kind of scenario this time around, but when we look at some of the economic fundamentals, it doesn't give me a nice warm feeling. One of the unknowns is just what is happening in the economy overall. Few, if any, economists are forecasting a general decline in the overall economy (what is commonly known as a recession). But then again, I can't remember when anyone called a recession before it happened. Typically, a recession is designated after it has begun or sometimes well after it is over.

When we talk about recessions, we generally focus on whether consumers or businesses will pull back on spending. But in general that is not the root cause of a recession. What triggers an economic downturn is a credit crunch or a liquidity crisis.

Sometimes it's caused by an inventory correction where businesses get too far ahead of demand and over-stock, and then pull back on production and wait until demand catches up. In the meantime layoffs happen, incomes fall and spending weakens. Before we know we are in the middle of a full-blown downturn.

I can't remember when, if ever, there was an overall downturn without the electrical industry also faltering. But we can certainly have very slow demand for electrical supplies and apparatus without an overall economic downturn. This time, the monetary authorities are doing everything they can to balance an anti-inflationary stance with an easy monetary stance. My bet is that the Federal Reserve will choose an easier money policy to avert a downturn and accept some modest inflation.

For 2008, it may be too late for an easier monetary stance to have an effect because it takes many months for a change in monetary policy to have an impact. Don't forget that the Fed didn't begin to lower interest rates until just a few months ago, and those changes are not going to be effective instantaneously.

All we can do at this point is to look at how the key drivers of the electrical industry are behaving and draw some conclusions from that. We are very confident that if we have a good forecast of the important economic drivers of the electrical industry, then we will have a very good forecast of the sales of the electrical industry.

I think it's important to briefly revisit what the setting or environment was for the last downturn in the electrical industry and see if we are anywhere near that situation.

The behavior of the critical economic indicators driving the electrical industry in 2001 through 2003 can be seen in Chart 1 (page 48), followed by the performance of industry sales in that same time frame in Chart 2.

The industry tanked for three years on the weakness of the equipment driver and the nonresidential driver. Spending for residential construction held its own during the industry downturn, indicating that while important, it's not a heavy hitter in determining the direction of overall industry sales.

For the current cycle in the electrical industry, we simply do not see anything remotely resembling the economic scenario of six years ago. See charts 3 and 4 on this page.

The point is that while the residential market continues to go negative, it doesn't drag total electrical industry sales negative.

Despite substantial strength in non-residential construction this year, neither total sales nor the distributor-served contractor or industrial markets thrived. What do we make of that? Residential construction took a nose dive and equipment investment was basically flat. The performance of these indicators took its toll on the distributor-served contractor market and consequently overall industry sales.

The final point to make regarding the comparison with the 2001-2003 period is that we believed then that the electrical industry would have a reasonably robust recovery in the following years, and that is what happened. We do not see that kind of robust rebound coming out of the anticipated weak 2008 industry performance.

Regardless of expected overall industry performance next year or in 2009, there continue to be niches that present interesting profitable opportunities to vendors and distributors. This year, we saw significant opportunities in components of nonresidential construction, particularly in commercial construction and health care. In growth years and in years where overall industry sales are flat, there are always such niches. It's a matter of finding them and serving them. But remember: it's a takeaway game, because everyone else is looking too.

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].

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