The economy and the component switch market grew nicely in the first half of this year. The economy is slowing and the question is will it recede. The geopolitical situation is a mess and the coming elections will likely bring changes. Will these changes have a positive or negative effect? A question only time can answer.

Let's take a look at where the switch market stands at this point of 2006, which market segments are hot and those that are not, and the author's outlook for the balance of this year and 2007.

Switch Market Starts 2006 with Sales Dollars Up 6% and Bookings 3% Better Than the First Half of 2005

The following graph shows indexed quarterly sales and bookings in dollars and units for electro-mechanical component switches. Sales in first the first half of 2006 were 6% better and bookings 3% than 2005. Over the last two years sales have hit a low point in Q3 and recovered some in Q4. Early indications are this will not happen this year and Q3 sales may come in near Q1 levels. Q2 bookings dropped to a level below sales and this gap will likely widen in Q3.

Switch selling prices dropped sharply in Q4 of last year coming off two-year highs. For the first half of this year selling prices remained fairly constant. Booking prices also were nearly unchanged this year. However, they did not experience the same dramatic decrease selling prices had last Q4 and are not at two-year highs.

Survey results on new orders and business conditions offer some insight. The new orders index in January of this year. The resulting sales and bookings can be observed in the first graph. After this two-year high was reached the index trended down and is now near two year lows.
 

The index of current business conditions shows a trend very similar to new orders. Optimism about market condition in six months is also at the bottom of its two-year range.

Where did the Switches Go?

A survey of where switch manufacturers sell their products was just completed. In 2006, the top six switch end-user markets account for about 70% of the switch shipments —

• Industrial Machinery, Automation, & Process Controls
• Non-Automotive Vehicles
• Telecomm, Cable, & Broadcast Equipment
• Commercial Equipment
• Computers, Peripherals, & Office Equipment
• Consumer Electronics

The following graph shows all 10 market switch market segments and the percentage of the total switch market they consume.

The Outlook for the End of 2005 and 2006

The switch market ended 2005 up 5% in sales and 10% in booking dollars over 2004. The strong booking performance pushed sales in the first half of this year to be 6% ahead of last year while bookings came in only 3% better. The third quarter of this year looks like it will be similar to the first quarter and much better than Q3 of 2005. However, Q3 bookings seem to be the worst of the year and this may dampen sales in Q4 and on into 2007. Based on the strength of the first three quarters, the switch market will probably end the year showing a 5% to 7% improvement over last year. This is better than the 2% to 5% increase forecasted last year.

The economy is slowing. The GDP grew by 5.6% in Q1 of this year, a revised 2.9% in Q2, and information just released measures Q3 at a 1.6% rate of growth. The housing market is becalmed and sellers are dropping prices to induce a breeze. The North American automobile makers are all bleeding severely and the bankruptcy of major tier one suppliers threatens the future. A reversal of fortune for these two key industries may be needed to avoid a slide into recession.

Consumer spending has held up despite higher energy prices. Some say this is due to strengthening wages or perhaps it shows up as rising consumer debt. Energy costs have costs have come down and this will act as a tax rebate. Consumer confidence has reversed its summer slip and is headed up. Perhaps this will lead to a good holiday shopping season ahead.

Consumer spending has been pushing the economy along and many economists have expected this to wane and corporate spending, fueled by profitability, to increase. Eighteen consecutive quarters of double digit profitability improvement for S&P 500 companies is an impressive run and has generated unprecedented amounts of cash. This profitability run has endured attack by rising costs for energy, freight, and many raw materials. These higher costs have seemingly reversed course over the past few months. But will they stay lower, particularly energy, as OPEC implements production cuts to help support the price of oil.

So what do companies do with this cash? This year increases in capital spending appear to be good in the tech, chemical, and machine tool industries. But there are doubts that capital spending increases will be as large and wide spread as expected, at least in the United States, as manufactures continue to invest in low cost manufacturing regions. Also many corporations have decided to use their cash surpluses to buy back their stock versus reinvest in physical assets. Buy backs also improves earnings per share data that helps preserve the streak of improved profitability. Using the cash to grow through acquisition also seems to be favored over investment in organic growth.

Another issue wearing on the economy vis-à-vis the value of the dollar is government spending and the trade deficit, although a weaker dollar should help our ability to export. The coming mid-term election will not change the executive branch of government, but significant changes in the legislature may occur next January. The effects of this are impossible to predict but change, in some form, does seem to be coming.

In light of the above and to develop a better view of next year a quick prognosis for each of the top end-user segments will be supportive.

• Industrial Machinery, Automation, & Process Controls - Capital spending is key to this segment and a growing economy is needed for that. Corporate profits in the third and fourth quarters of this year should point the direction for next year. Conventional thinking would conclude lower second half profits will lead to less capital spending next year and higher profits the same or slightly more spending next year. But how corporations decide to invest their profits seems to be less conventional than 10 years ago.
• Telecomm, Cable, & Broadcast Equipment - The telecomm segment continues its slow recovery. Delivery of broadband services will again be important to telecomm and cable providers. Voice over Internet protocol (VOIP) continues to be a market driving technology.
• Non-Automotive Vehicles – The construction and material handling equipment portions of this segment have taken a hit as the housing market and mined commodities decline. An economic down turn is first felt in the sales of boats and RVs. New diesel fuel requirements enacted this year has stimulated the sale of trucks and busses.  This probably pulled some demand forward causing sales here to decline for the short term.
• Computers, Peripherals, & Office Equipment –Corporate spending on IT has been fairly good and should continue. The lack of “must-have” innovations for home computing continues to limit consumers to replacement of aging equipment.
• Commercial Equipment – As in the computer and industrial segments, this sector is heavily dependent on capital spending by businesses.
• Consumer Electronics – Of the top segments this one ranks sixth. The outlook here may be brighter than once thought since the resilience of consumer spending continues.

Deciphering and defusing economic uncertainty is again the key to forecasting the switch business. Is the economy going to dip into recession or will consumers push the fourth quarter GDP higher as they spend money they once poured into their fuel tanks? This forecaster will offer a 2% to 5% dollar increase for the switch market in 2007.