A hunch on the downturn: This time, it"s different

November 4, 2008
By: Eric Lundin

As I type this, the line at the polling place across the street has finally shown signs of movement. It"s the morning of Nov. 4, and by evening we"ll know who will have the world"s largest bully pulpit for the next four years.

Seeing how the numbers are adding up, I won"t envy the winner. The Institute for Supply Management yesterday released its October numbers on manufacturing, and they weren"t pretty. The organization"s manufacturing index, the PMI, plunged to 38.9 percent, its lowest level in 26 years.

"Manufacturing activity has been falling (in terms of the Federal Reserve"s industrial production) since October 2007, but in the last two months business activity fell off a cliff, said Daniel J. Meckstroth, Ph.D., chief economist for the Manufacturers Alliance/MAPI. Hurricane Ike and the Boeing strike contributed to the sharp downturn, but the breadth of production losses across industries shows that there is a more fundamental explanation; the U.S. economy is deleveraging.

A confluence of unfortunate events made October particularly depressing for manufacturers. Some events are by now just old news. Housing construction is in the doldrums, as is the auto sector. And banks continue to tighten lending requirements, putting the brakes on growth.

But a few newer developments made October particularly bleak. One is the rising value of the dollar. For months manufacturers making and exporting products have propped up the economy, offsetting the negative conditions in the automotive and housing markets. The rising dollar isn"t helping matters.

The export business conducted by the U.S. for the last two years has been almost single-handedly keeping the U.S. manufacturing sector from sliding, Chris Kuehl wrote in today"s Strategic Global Intelligence, a daily e-newsletter. Kuehl is managing director of Armada Corporate Intelligence, Lawrence, Kan., and an economist for the Fabricators & Manufacturers Association.

On top of this, commodity prices have tumbled, which spells trouble for sectors that until now have been considered economic bright spots: petrochemical, oil, gas, and agribusiness. Metal producers are also feeling pain. According to reports, steelmaker ArcelorMittal just idled its Cleveland plant, which employs 1,450.

And today Kuehl didn"t sugarcoat his analysis: There is little good news in this decline. Prices for a variety of inputs have been sharply down. This is not only taking place in the oil sector, but in the metals markets as well.

All this makes me think of the last recession earlier this decade, a time when the country"s manufacturing work force lost 3 million. For me the 2001-2003 time frame represented a turning point in the kinds of metal fabricators I"d visit. In the 1990s, I had to watch my step on many shop floors. More often than not, every machine was running, making parts, flooding WIP and finished-goods inventory, which just sat there for weeks, waiting to be shipped out the door.

After the recession and ensuing shakeout, the remaining shops took a long, hard look at their operations and, over the next few years, leaned them out significantly. I don"t see the WIP and finished-goods inventories I once did. During the past two years I"ve seen shops busy as ever, but shop floors look different. Every worker is busy, but not every machine is running, even though some company owners told me they booked record profits in 2007. Products flow through the floor in smaller batches. They are producing what is needed when the customer needs it, and not before.

For this reason, I"ve got a hunch this downturn will be different. The manufacturing sector already shed so many jobs a decade ago. Sure, we probably can expect plenty more job losses at companies connected to automotive and construction. Extremely small businessesthose with just a few employees serving one or two customersmay well shutter their doors.

But there are bright spots. Many predict spending in energy and infrastructure will skyrocket over the next few years. It"s these sectors, in fact, that may pull us out of our current economic funk. And small to medium-sized manufacturers who diversify and latch on to these economic growth engines may emerge from the current mess somewhat unscathed.

I don"t have piles of economic data to back up this argument. If the financial crisis puts the brakes on credit for too long, we may all be in for some painful times ahead. But I"ve seen a lot of small and medium-sized manufacturers that seem to run fundamentally sound businesses based on real, tangible assets, and they aren"t leveraged to high heaven.

Based on this, I hope my poorly researched hunch turns out to be right.

Eric Lundin

Eric Lundin

FMA Communications Inc.
2135 Point Blvd
Elgin, IL 60123
Phone: 815-227-8262