2007 Forecast: The Goldilocks Economy
The economy is ambling along in what a recent Wall Street Journal article called the “Goldilocks Economy”-–not too hot and not to cold. As I write this on Oct. 1, the Dow Jones industrial average is pushing a record, and the 30 component stocks are trading at 19 times their combined earnings per share of the past 12 months. This is well below the 26 price-earning ratio of the last record level in 2000. If interest rates drop, or investors are willing to tolerate more expensive stocks, the gain could continue, according to the Wall Street Journal report. In the short-term, that might be “just right.”
While the gross domestic product is expected to finish the year at 3.4 percent, we have experienced continued constriction. The fourth quarter is projected to be a much slower 2.6 percent. Moody’s Economy.Com is forecasting that we will regain some momentum to 2.9 percent in the first quarter of 2007 and steady, if not exciting gains, to 3.2 percent in the fourth quarter of next year. Blue Chip is a less enthusiastic 2007 consensus of 2.7 percent. National Association of Home Builders is at 2.9 percent average, ending the fourth quarter with 3.1 percent. You pick.
Both finished goods, Producer Price Index, and consumer spending, Consumer Price Index, are forecast to increase by 2.7 percent. Mortgage interest rates, 30-year fixed, are forecast at 6.5 percent. Unemployment is forecast by NAHB to increase from 4.7 percent to 5 percent in 2007, while Blue Chip is at 4.9 percent for next year.
GDP for our friends north of the border is forecast by Blue Chip to drop from 3 percent in 2006 to 2.8 percent, even though the commercial construction market is strong across Canada and absolutely busting at the seams in Alberta. Inflation is a modest 2 percent, and the exchange rate per U.S. dollars is $1.14.
For our friends south of the border, GDP also is expected to decline from 4 percent this year to 3.4 percent in 2007. Inflation is a more aggressive 3.3 percent this year and is forecast to increase to 3.5 percent in 2007.
One of the bright spots is the reduction of energy costs for two key reasons: the price reduction in gasoline, fuel oil and natural gas will put money in the hands of consumers and will stimulate the market and take some of the edge off the negative effects of a slowing housing market; and it reduces the inflationary pressure on the Federal Reserve to increase interest rates. Some forecasters are even predicting that Fed rates could decline in the first half of next year, and that could have a positive effect on housing and automotive sales. That may be a stretch.
Since residential construction accounts for more than 40 percent of the glass produced in North America, and more than 6 percent of total GDP, we might as well look at this conundrum first. Builder confidence, as measured by NAHB’s Housing Market Index, is at its lowest point, 30, since the last housing recession in 1991. Any level below 50 is unfavorable. While this is alarming, the pace of decline is nowhere near the 30 percent drop experienced in the 1990s. A key problem is the 6.6 months of new homes for sale inventory. So the decline in starts will continue. Moody’s is forecasting starts of 1.7 million in the first half of 2007 with an adjustment down to 1.6 million for the second half. This is down from the robust 2.1 million in 2005. Blue Chip is forecasting 1.7 million, and NAHB is at 1.655 million, which is a drop of 10.6 percent from the anticipated 1.852 million for 2006. NAHB also is forecasting a 4.6 percent increase to 1.731 million starts in 2008.
Existing home sales also is forecast to decline from 5.604 million in 2006 to 5 million units in 2007, but increase 7 percent to 5.35 million units in 2008. Manufactured home shipments, not included in the totals above, also are on the decline from 127,000 estimated for this year to 118,000 for 2007. Shipments are expected to remain flat for 2008.
The best forecasting data we have on residential windows might be a little optimistic based upon the housing-starts forecast. But, for example, if the largest decline in housing is in the starter segment, which is smaller homes with fewer windows, the overall forecast for windows might be close. Total windows are forecast to drop from 70 million units to 69 million units. The decline is all in new construction as the repair and remodeling segment is forecast to gain in both share and total to 39 million units.
The automotive and light truck market is forecast by Blue Chip to decline slightly from 16.6 million units in 2006 to 16.4 million for the new year. You don’t need me to understand this is bad news for the big three domestic manufacturers, who are losing sales and share while reducing capacity and laying-off workers. Meanwhile, foreign nameplates are building capacity, sales and share. It will be interesting to see if declining gasoline prices at the pumps will stimulate the sales of SUVs and vans, which average almost 50 square feet of glass per unit.
The bright spot in the glass industry remains the growth in the commercial-architectural construction market. Nonresidential construction, not including nonbuilding structure construction, is projected to grow 8 percent, compound annual growth rate, between 2006 and 2010 from $378 billion to $517 billion. Grubb & Ellis said it best so I will quote analysis from its Web site: “The office market will benefit from 2 million net new jobs expected in 2006, about one-quarter to one-third of which will be located in office buildings. New supply totaling 25 million square feet will fall far short of net absorption totaling 80 million square feet, which will reduce the vacancy rate to 12.8 percent by year-end 2006, down from 14.5 percent at year-end 2005. An increasing number of markets will move from the recovery cycle to the expansion cycle, the stage where rental rates are high enough to justify new construction.”
Furthermore, state and local governments are expected to increase their spending by 5 percent CAGR by 2009. Our employed population also is growing and will approach 150 million by 2010, an increase from 141 million in 2005. Two particular growth areas are healthcare facilities driven by baby boomers and educational building construction with a 9.7 percent CAGR between 2005 and 2010.
Overall glass demand should increase 1 percent to 2 percent in 2007 and should absorb the new capacity in the Northwest. The West Coast might experience some imbalance until the market adjusts itself. The East Coast might even show some tightening, but overall the market will be similar to 2006. Low-emissivity, tints, tempered and laminated, especially the hurricane laminates, will continue to be the major gainers especially as codes, federal energy policy and energy costs tighten our focus on efficient glasses, coatings and installation systems.
For the near term, this might be the Goldilocks economy, “not too hot and not too cold,” but in the long term it will not be “just right.” In a recent section on emerging economies in The Economist, the editors forecast that the economy of China will have passed the United States on the basis of consumer purchasing power in 2040, which will be the 97th anniversary of my birth, and I have no expectation of knowing whether this will be true. China currently has a GDP growth rate of 11.3 percent, industrial production of 15.7 percent and an inflation rate of 1.3 percent. It also holds foreign reserves of $941.1 billion. India, which is not far behind has a GDP of 9.3 percent and industrial production growth rate of 12.4 percent. The Economist believes that these growth changes in the emerging economies are due to capitalism, and the dynamics of a free market—something we may have forgotten.
In his book, “The World Is Flat,” Thomas Friedman evaluates our economy along with the global market. You should read this book, and then send a copy to your Congressman. We could hide our heads and refuse to acknowledge that we are part of the world’s economy. Or, we could face the issues, unchain our private sector, improve our education system, especially in the areas of science, and aggressively seek change, improvement and our new place in the global community. This is a bipartisan task at which both sides of the aisle need to work for our overall success. While I do not agree with Friedman’s social solutions, he is asking the right questions. We have to figure out ways to compete on a global basis, or we will become a second-rate country.
This is an issue of national security because with-out a strong, growing and profitable economy, we are at risk.