Through the first half of this year the major consumers of relays and switches have seen their business decline. This, of course, has a negative effect on relay and switch consumption. This article will examine these trends and the drivers behind them.

With the euro at an all-time high many European companies are shopping for acquisitions. The ZF Group of Germany has entered into an agreement to purchase the Cherry Corporation and some of the details will be reviewed.

General Manufacturing

The graph below shows the Institute for Supply Managements PMI index from January of 2000 through June of 2008. The black line plots monthly readings, and the red trend line was developed using polynomial regression analysis. Since December of 2007 the index has been in contraction territory except for a blip up in January and this past June. The index peaked in the first half of 2004 and has trended lower since then.

Automotive and Truck Manufacturing

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 2007 then fell 25% to 30% from July of last year to May of this year.

A bright spot in the automotive industry has been heavy truck sales. New federal requirements for cleaner burning diesel engines went into effect at the start of 2007. These new engines are more expensive to produce and users of these trucks were faced with a significant price increase. This pulled demand forward in 2005 and 2006 and, as the graph above shows, January through September of 2007 saw production drop sharply nearly reaching the lows of 2001. Since then production has improved about 25%.

Housing Market and Supplying Sectors

The housing market continues to see the worst conditions since the Great Depression. Prices for existing homes have fallen as much as 10% to 20% or more depending on price range and location. This has left many homeowners holding mortgages with a balance greater than the market value of the property. If their mortgage has an adjustable rate and the payment increases beyond a make-able level, they can’t refinance to pay-off they old note nor can they sell to do the same. This has led to record levels of foreclosures and banks trying to unload foreclosed property at prices well below what a homeowner would expect to see. Declining prices have kept those able to buy on the side lines waiting for the best deal and the growing number of existing available homes restricts the sale of newly constructed ones.

Below is a 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, in 2007, and the slide continues into 2008. It took until the end of 2006 for construction equipment to rollover, and it realized a much sharper drop in 2007 than the others and this trends keeps on going into this year. 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. Property owners have been accustomed to price appreciation for decades. Some have chosen to cash out this increase to spend it on home improvements, vehicles, vacations, and other things by refinancing. Many may no longer be able to do this as prices slip, interest rates increase, and underwriting standards tighten.

Interest Rates, Prices, Employment, PMI and the Future

Raising interest rates from June of 2004 through July of 2006 achieved the Fed’s goal of slowing down the economy causing GDP growth to slow in the third and fourth quarters of 2006 to a bit more than 2%. When the GDP continued to slow to less than or equal to1% in Q4 of last year and Q1 of this year the Fed quickly lowered it rates to levels seen during the last recession.

On the next chart federal funds interest rates are overlaid with the Institute for Supply Management’s PMI, commodity price, and employment indexes. 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 ascent of rates. As rates rose over two years the PMI declined. The decline in the PMI entered contraction territory in the last quarter of 2007 and the Fed began to aggressively cut rates.

It is interesting to note that commodity prices show a similar trend to the PMI with greater amplitude until the beginning of 2007. As growth overheated in Asia, so did demand for commodities such as oil, steel, cooper, and aluminum. This has sent the price index to its highest point in over eight years despite a slowing U.S. economy. Recently, commodity prices have eased as demand for American gasoline dropped significantly once prices exceeded $4.00 per gallon. This led speculators to sell contractors before they would actually be required to buy oil at higher price than they could sell it for. The flight of speculators carried over into other commodity markets as well. Hopefully commodity prices will ease enough to prevent large-scale price increases that would cause the Fed to increase rates to cut-off inflation and snuff out hopes for a faster growing economy.

Unemployment, or employment, is another economic concern. So far this year the economy has lost jobs each month. The ISM’s employment index went below 50 in November of last year and is at its lowest level since May of 2003 with a trend that is worse than the PMI.

Conclusion

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

The first quarter of 2007 was the best quarter of the year for the relay and switch markets. For switches, the first quarter of this year was about equal to last year and perhaps the market will not loose ground in 2008 despite the dour outlook for markets that consume them. Relays show a different trend. The first quarter of 2008 was down over 15% from the same quarter last year. This deficit will be hard to over come and this year will likely be down compared to 2007.

ZF Group To Purchase Cherry Corporation

On July 29th it was announced that ZF Friedrichshafen AG has reached an agreement to purchase Cherry Corporation. Cherry is a manufacturer of switches, sensors, controls, and keyboards sold to the commercial, industrial, and automotive markets. In 2007, Cherry had sales of approximately $400 million with 3,100 employees worldwide. Upon government approval, ZF will acquire the Cherry Corporation, headquartered in Pleasant Prairie, Wisconsin, with production locations in Germany, the Czech Republic, Mexico, Hong Kong, China, and India (India is a joint venture with TVS Group).

ZF is worldwide corporation head quartered in Friedrichshafen, Germany. In 2007 their sales were €12.6 billion ($19.9 billion). They have 57,500 employees worldwide, which includes 34,500 in Germany, 10,300 in North America, and 3,300 in Asia. They produce mechanical systems that are used in many areas of the drive train and chassis on all types of automotive and non-automotive vehicles. ZF is owned by private foundations and is not a publicly-traded company.

Following the closing, the company will do business under the name ZF Electronics and continue to use the Cherry brand name in non-automotive markets.

"With the new ZF Electronics, we are reinforcing our competence profile in the fields of mechatronics and electronics," underlined Hans-Georg Härter, ZF's CEO and President. "In particular for our future tasks in driveline and chassis technology, we can swiftly apply Cherry’s know-how."

Peter Cherry, Chairman and President of Cherry said: "This transaction has great strategic value; as it will allow Cherry to expand its current customer base and ZF will bring substantial additional resources for future growth in all of Cherry’s product segments. There are many opportunities for incorporating Cherry’s technologies into the broad range of ZF applications."