A One-Two Punch

Oct. 1, 2008
With the U.S. financial system under extreme duress, we are overlooking another issue of major concern to the electrical industry.

“The economic backdrop to the latest explosion in the U.S. financial system is troubling — industrial production is on track to decline sharply in the third quarter (for the second consecutive quarter), consumption spending is expected to contract, and the unemployment rate is ramping up sharply. Perhaps even more troubling, credit conditions continued to tighten during the summer months, and the growth of credit has slowed down to recessionary levels. Major downside risks to the economy, with diminishing inflation risks, are plain for anyone who has eyes to see.”
— Global Insight, Sept. 17, 2008.

With the U.S. financial system under extreme duress, we are overlooking another issue of major concern to the electrical industry. The above quote gets our focus back to the recurring business cycles every economy faces. We are faced with two issues, and they are related. One issue, of course, is the chaos in the financial markets. The second issue is the weakening economic situation, apart from the existing financial crisis.

The slowdown in the economy in itself is troubling. But the financial crisis adds another dimension that we had not completely factored into our last forecast. The key questions are:

  • How bad is the credit crunch now?
  • How bad will it get?
  • When will we see meaningful easing?

I am sorry to report that no one has any definitive answers. It's important to differentiate between an overall economic downturn — defined in its broadest terms to include a consumer pullback and resultant negative gross domestic product (GDP) — and a downturn in the electrical industry. Let's stay focused on the electrical industry.

Impact on the electrical market

The electrical industry has never escaped an overall economic downturn, and we won't escape this one either, mainly because the construction industry is so important in our economy and the electrical industry is construction-driven.

The usual questions are how far is down and how long will it last. But there is another question. We are talking as though the downturn in the electrical industry is already here. For some vendors and distributors that may be the case. But for the industry overall, I don't believe industry performance has turned negative as of late September. Our last analysis of how the critical economic indicators are behaving and in turn impacting electrical industry performance shows that industry sales overall are still growing through the second quarter of 2008. This goes back to DISC Corp.'s July analysis.

By the time you read this article sometime in October, we will have completed our final outlook in 2008 (scheduled for release in mid-October). The dynamics of the economy and the electrical industry, in the best of circumstances, guarantee that DISC's October outlook will not be the same as its July analysis. Even so, I still believe we will not see negative industry growth in 2008.

Nonresidential construction expenditures in deflated dollars, the most important driver of electrical industry sales, are expected to show positive growth through every quarter this year, although weakening significantly in the fourth quarter from a year earlier. Residential construction has of course been negative since the second quarter of 2006. The remaining key indicator, equipment spending, is expected to show negative growth in the third quarter of this year.

From this year's fourth quarter going forward, we do not expect any growth in the key economic indicators through all of 2009. This will drive total industry sales to tank in the second quarter of 2009 and continue its downward drift through the second quarter of 2010.

So beginning with the second quarter of 2009 through the second quarter of 2010 — five consecutive quarters — we are looking at a cumulative 16 percent decrease in overall industry sales. If you are serving a niche market, then your particular situation could be very different. At this point, however, we see the distributor-served contractor market taking the biggest hit next year because both the nonresidential and the residential construction drivers are expected to show negative growth for 2009.

The financial crisis

The second concern is the chaos in the financial system. The volatility of the stock market is not the issue as far as the economy or the electrical industry is concerned. The market is simply reacting to good news/bad news in the financial markets on a day-to-day basis.

The fact is that no one really knows what the outcome of this crisis will be nor do we understand the full consequences of whatever actions the federal government is taking. To be perfectly honest, I am not sure I can fully get my mind around the issues involved and the consequences of what the Federal Reserve and the Treasury are doing.

As we go through the coming quarters, we will have a clearer view of the magnitude of the crisis and the consequences of the government's actions. One thing is clear — this is a crisis of liquidity. It's all about putting enough money in the economic system so we don't have a collapse of the economy as we did in the 1929 depression. I am not suggesting that we are on the verge of that kind of disaster, because the government is acting decisively and taking the correct action. In 1929 the government did not have a clue.

At the highest levels, the discussions now are about costs weighed against benefits as to the correct course of action. Everyone understands that the issue is liquidity. What we don't understand is the best way to fix it. What I can say is that the important people making the important analytical decisions, like Ben Bernanke and Henry Paulson, are exactly the people I would want in the driver's seat. We are in a terrible situation but are in good hands.

I don't know of anyone who believes there is a quick fix to the financial system. But where we want to be is in a place where we are confident that we are in control of the situation. In other words, the big surprises should be behind us. We are not there yet.

What does all of this mean for the electrical industry? A credit crunch is a serious situation for any business, but particularly so in this business because of the requirements to finance inventories and the borrowing requirements of contractors. I already know of instances where construction projects are on hold because of a lack of funds to complete the work. This is not a good scenario.

Vendors, reps and distributors should have alternative operating plans based on best case/worst case scenarios, at least through 2009. The outlook we have at this time is a best-case scenario and I am not comfortable with it.

For DISC clients who receive the DISC Report in October, you should have a clearer in-depth picture of what 2009 (and 2010) could look like. Otherwise, look for a summary update in Electrical Wholesaling's November issue.

By the time you read this article sometime in October the financial crisis will not have been resolved. There will continue to be many unanswered issues, but we expect to have a better grasp of the magnitude, especially as it affects the electrical industry.

Here is one last thought for this article. A year ago, I don't think anyone could have even come close to predicting where we are now, let alone how it will all play out. The only difference is that now we all know we have a serious problem.

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].