Through the first half of this year the switch market was down 3% in dollars and 8% units while relays were 3% lower in dollars and off 4% for units compared to the first half of last year.

This MarketEye article will take a close look at the numbers measuring the general manufacturing, automotive, and housing markets, along with, interest and inflation rates to see what they tell about where the relay and switch market is headed for the balance of 2007 and on into 2008.

General Manufacturing

The graph below shows the Institute for Supply Managements PMI index from January of 2000 through August of 2007. The black line plots monthly readings and the red trend line was developed using polynomial regression analysis. At the beginning of the year the sinusoidal trend line indicated flattening with readings around 50. The index improved to peak in May and recede through August with an upward trend.

Durable goods orders in September were down 1.7% compared to August and August was 5.3% lower than July according to the U.S. Census Bureau. This data is consistent with the PMI information graphed above.

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. Since this time, General Motors has bought out approximately 30,000 union employees, closed plants, and recently settled a new multiyear UAW contract allowing them to shed healthcare for retirees. This is all great news for GM’s bottom line and they recently regained the number one position for auto production in North America from Toyota. Daimler sold Chrysler off to a private equity firm. Chrysler is now renegotiating with UAW to allow it to make moves similar to the ones completed by GM. Ford continues to lag behind.

The chart below shows the U.S. Federal Reserve Banks production indexes for automobiles, light trucks, and heavy duty trucks. It shows that automobiles and light trucks have strengthened in the first half of this year, but the period is not of adequate length or strength to reverse the downward trend.

A bright spot in the automotive industry has been heavy truck sales. This was 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 through September production dropped sharply nearly reaching the lows of 2001.

Hopefully automobile and light truck production will continue to grow into 2008 and how lower can heavy duty truck sales will fall since they sit near a seven year low.

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 and things just get worse from there. In September new home sales came in at 770,000 units about 5% better than the 735,000 sold in August.

In July the “sub-prime mortgage” crisis brought home lending to a near stand still. Speculators could not refinance or sell their properties with many handing them over to foreclosure to cut their losses. Homeowners with bad credit or allowed to borrow beyond their means also could not refinance, sell, or make payments when rates adjusted on their loans. This has led to an over supply of new and existing homes that may take more than a year to return to normal levels.

The following chart shows permits issued and new starts of single units and multi-unit homes as tracked by the US Commerce Department. New starts peaked in 2005 and fallen since. This is undoubtedly in response to existing inventories and lower sales rates. Starts will likely continue to decline until inventory levels stop growing and fall.

So why discuss housing to gauge the future switch relay market? There 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 construction machinery, major appliances, and ventilation, heating, air-conditioning, and refrigeration as calculated by the U.S. Federal Reserve Bank. All measures saw growth during the housing surge in 2004 and 2005. Major appliances and HVAC then fell, as housing did, in 2006 and on into 2007. Whirlpool stated in its third quarter financial report that it expects units in the 2007 U.S. market to run 4% less than 2006. It took till the end of 2006 for construction equipment to rollover, and it realized a much sharper drop than the others. All 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. The “sub prime mortgage” crisis tightened lending standards and foreclosures have driven up inventory of existing homes that puts downward pressure on home prices. 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, PMI, and the Future

Raising interest rates has achieved the Fed’s goal of slowing down the economy with GDP growth in the third and fourth quarters of last year to a bit more than 2% and less than 1% in Q1 of this year. 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. Then in the summer of 2004 the Fed initiated the ascent of rates to today’s levels. As rates rose over two years the PMI declined. The decline in the PMI trend leveled off after interest rates did, then moved upwards in the first half of this year.

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.

In response to the “sub prime mortgage” crisis and the seizure it caused in the overall credit market the Federal Reserve cut interest rates by a half percent this September and many believe there will be another cut soon. This may push the PMI up as it did at the end of 2002. But the real boost came in 2003 as housing took off and this is not likely to happen until the overhanging supply of homes is worked off. Lower interest rates may help stimulate activity but much tighter lending standards may more than offset this.

Conclusion

The best news for the relay and switch market, as well as the general economy, would be continued improvement in the auto and stabilization in the home building industry, which is hopeful for next year but unlikely to affect this year’s results.

The second half of 2006 was far worse than the first for relay and switches. Perhaps this year the second can hold steady with the first. If so, switches may end the year down 2% for dollars and 6% lower in units with relays about equal in dollars and off 2% in units compared to 2006 year end totals.

For next year, if the housing market can end its slide so inventories begin to recede and prices stabilize along with slow continued improvement in the auto industry, the switch market may regain the expected losses of 2007 so 2008 will resemble 2006. Under the same scenario, relays may finish a few percent higher in dollars than 2007 and equal in units.