The end of February starts the home stretch of the first quarter with key end-user markets headed in a southerly direction. The fourth quarter of last year saw 2.2% growth in the GDP versus the 3.5% initial estimates. With lemming-like precision, investors around the world followed the Shanghai stock market yielding one-day losses not seen since the fall of the World Trade Center.

This MarketEye article will take a close look at the numbers measuring general manufacturing, automotive, and housing markets, along with, interest and inflation rates, and leading indicators to see what they tell about where the relay and switch market is headed for the balance of 2007.

General Manufacturing

The U.S. Commerce Department just announced that orders for durable goods fell by 8% in January. This follows two months of growth in November and December. The decline was led by an 18% slide in the transportation sector. In this sector, commercial aircraft orders were down 60% and motor vehicles fell 5%. Durable goods ex-transportation dropped 3%. Durable goods shipments showed a 0.2% increase while inventories rose faster at 0.3%.

The graph below shows the Institute for Supply Managements PMI index from January of 2000 through February of 2007. The black line plots monthly readings and the red trend line was developed using polynomial regression analysis. The sinusoidal trend line indicates a current level just above 50 and flattening. The last reading was just above trend while the three prior marks fell below it.

Automotive and Truck Manufacturing

The automotive industry began to show signs of serious turmoil in the fall of 2005 when Delphi announced its bankruptcy and it continues to operate under its protection. The chart below shows the U.S. Federal Reserve Banks production indexes for automobiles, light trucks, and heavy duty trucks. Delphi’s troubles began about 18 months after the production index for automobiles and light trucks hit their seven-year peak in the first quarter of 2004. Since then automobile and light truck production has trended down, but this trend may be leveling out.

During this time General Motors has bought out approximately 30,000 union employees and closed plants. This is beginning to help their bottom line. Now they need to produce cars and trucks that consumers want to buy. Ford and Chrysler’s fortunes have deteriorated in this period. Daimler Chrysler recently announced the layoff of 13,000 jobs at its Dodge/Chrysler plants and said they are considering all options to restructure the business sparking talk of selling the business.

On the bright side foreign manufacturers such as Toyota have been opening and announcing the construction of new plants. Since 2005 foreign makers and their suppliers have created 30,000 to 40,000 factory jobs in the United States. That number should rise to 50,000 to 60,000 by 2009 according to the Center for Automotive Research in Ann Arbor, Mich.

 
Another bright spot in the automotive industry has been heavy truck sales. This has been driven by new federal requirements for cleaner burning diesel engines that went into effect at the start of this year. These new engines are more expensive to produce and users of these trucks were faced with a significant price increase. This pulled demand forward and as the graph above shows January saw a significant drop in production.

Hopefully, automobile and light truck production will stabilize at levels last seen in the first half of 2002 for the balance of 2007. Heavy duty truck sales will fall, how far is hard to foresee.

Housing Market And Supplying Sectors

In January of this year new home sales dropped to a seasonally adjusted 937,000 units per year. This is almost 17% less than the annual rate of 1,123,000 sold in December and 20% less than January of last year. At current sales rates there is about a six-month supply of new homes.

The following chart shows permits issued and new starts of single units and multi unit homes as tracked by the U.S. Commerce Department. Permits for new construction dropped off sharply during all of 2006. New starts lagged permits and fell less dramatically. This is undoubtedly in response to existing inventories and lower sales rates. Starts will likely continue to decline until inventory levels fall.

So, why discuss housing to gauge the future switch relay market? There are two reasons. Suppliers to housing industry consume switches and relays, and, the negative effects that a down housing market has on consumer spending and confidence.

Below is graph of industrial production indexes for the appliances and ventilation, heating, air conditioning, and for refrigeration as calculated by the U.S. Federal Reserve Bank. Both measures saw growth during the housing surge in 2004 and 2005 then fell, as housing did, in 2006. Both of these industries are major consumers of relays and switches.

The wealth factor associated with home prices has an impact on consumer confidence and ability to obtain credit. In an over supplied market, prices usually fall or incentives rise to stimulate sales. As this happens with new construction, the same must occur for existing homes. Homeowners have been accustomed to significant price appreciation over the past four years. Some cash out this increase to spend it on improvements, vehicles, vacations, and other things by refinancing. They may not be able to do this as prices slip and interest rates increase. Some may even find themselves upside down and would need to write a check in order to sell their home.

Interest Rates, Prices, and Leading Indicators

Raising interest rates has achieved the Fed’s goal of slowing down the economy to GDP growth in the third and fourth quarters a bit more than 2%. Major components of this slowdown have been the auto and home building industries.

On the next chart federal funds interest rates are overlaid with the Institute For Supply Management’s PMI and commodity price index. It is clear to see that as interest rates fell during 2001 manufacturing activity picked up in 2002. In 2003 manufacturing dipped again and further cuts in interest rates were implemented. Then, the PMI reached a peak during the first half of 2004, as the housing market was taking off. In the summer of 2004 the Fed initiated the climb of rates to today’s levels. As rates rose over the next two years the PMI declined. This decline seems to have leveled off, after interest rates did.

It is interesting to note that commodity prices show a similar trend to the PMI with greater amplitude, confirming that price increases with demand. It also validates the concept that higher interest rates can keep inflation, or rising prices, in check.

The last graph, shows the Conference Boards Leading Indicator Index (the method of calculation for this index changed in June of 2005 and data prior to that has been adjusted to be inline with the new index) compared to the PMI. The leading indicator index seems to be at best a short term, months, leader and often coincides or lags the PMI. The largest divergence of the two has occurred recently as the leading indicator has risen and PMI has fallen. Perhaps there is good news ahead.

Conclusion

The best news for the relay and switch market, as well as the general economy, would be a stabilization of the auto and home building industry. And this seems possible at this point. If this firming occurs the run rate for switches and relays will likely be equal to the third and fourth quarters of 2006. This means in total 2007 will come in lower than 2006 since the first half of 2006 was the best part of the year. A better scenario would be for these industries to improve. This will likely require the Fed to reduce interest rates. If the Fed does the opposite, perhaps raising rates to control inflation, the downward trends in the PMI, auto, and housing markets will probably worsen. Looks like Fed watching will continue with even greater interest this year.