Better, not great

Better, not great 2011, like 2010, will likely be a story of two halves; low growth to start but accelerating as the year progresses.

Commentary by Walter Kemmsies

   In a nutshell, relative to 2010, the outlook for 2011 is a lot better, but still not great.
   By the end of the 2011 decision-makers are likely to feel that the risk of falling behind their competitors exceeds the risk of committing to an expansion or strategic development plan. Evidence that volumes in many, but not all, industries have regained or surpassed their previous peaks will prompt the decisions to shift from cost-cutting to investment.
   Investment increases productivity and therefore, growth. U.S. trading partners' economies are growing, which supports export growth and reinforces the recovery trend in place.
   While the economy will sail more smoothly than in 2010, some of the headwinds will manifest themselves from time to time:
   ' The real estate markets and the banking system are not fully recovered, and stability may still elude these sectors for some time after the rest of the economy has healed and moved on.
   ' China's unsustainable currency policy may be the greatest threat to full recovery of the United States and global economies.
   The longer the pegging to the U.S. dollar policy is allowed to continue, the fewer the options available to resolve matters with the least amount of volatility because we are between the proverbial rock and a hard place.
   China is too dependent on export growth to allow the yuan to appreciate to a more market-based value very quickly. On the other hand, if China continues to de-industrialize other economies at the rate that it has over the last decade (the United States isn't the only country to see manufacturing relocate to China), it will drain purchasing power from the markets it depends on in order to keep developing.
   Until this is resolved the threat of another Smoot-Hawley scenario remains on the table. Meanwhile many emerging market economies will suffer as the Federal Reserve takes actions that indirectly will lower the exchange value of the dollar and worsen the effects of the yuan's peg.

Four Lost Years. Table 1 shows retail sales and inventories not adjusted for inflation since 1992. Retail sales peaked in November 2007 and troughed from December 2008 to April 2009. Since then retail sales have been recovering and at the pace of the last 12 months, will regain the November 2007 peak in May 2011. This could happen sooner if the recent improvements in the labor market pick up some momentum.

Related News •   'Moderation' the word for 2011

   However, it is important not to count too much on improving employment to boost retail sales. Credit card delinquencies have peaked, but remain close to historically high levels. Mortgage delinquencies remain close to 10 percent, which is the historical peak. It will take some time for consumer finances to stabilize, even if employment were to rise very quickly.
   Inventories have reacted to retail sales with a lag. They reached a peak three months after sales peaked in November 2007 and troughed seven months later. Since November 2009 inventories have increased, but far more slowly than sales. The inventory-to-sales ratio, shown on the right-hand axis, is past its trough but still below trend. It seems there is further inventory rebuilding to come as consumer spending continues to hold up.
   The poor consumer spending trends seen in Table 1 are evident in the industrial production and capacity utilization indexes published by the Federal Reserve. Both troughed in the second quarter of 2009 and have been recovering steadily. However, they remain well below average or trend levels. Given the current pace of recovery the previous peaks of 2007 would not be reached until mid-2012.
   Between industrial production (Table 2), retail sales and inventory building trends, it seems clear that the economy is climbing out of the deep hole it fell into during the 2008-2009 period. This is pretty remarkable considering that consumers took a severe blow in the form of the decline of house values.
   Home ownership has been the core of household wealth for decades. It is also remarkable given that the banking system has been devastated by excess exposure to the housing sector.
   Since the financial crisis began in 2008 banks have been reducing their loan portfolios, leaving little support for companies needing to finance inventories or to make capacity investments.
   It seems that by the time the previous peaks in economic activity are attained again, it will be as if four years have been lost.

Freight Movement Trends. For the freight movement sector, the recovery has been stronger (Table 3). Port container volumes are running about 15 percent higher than in 2009 and above 2008 levels. It seems that by the end of 2010, volumes will be about 7 percent below the peak level of 2007. Given the underlying macroeconomic trends, it seems that the 2007 levels will have been surpassed by the end of 2011.
   Rail containers and trailers have shown a similar trend, but have not performed nearly as well as port volumes.
   The truck sector has recovered but the tonnage index shown below has been a lot flatter than either port or rail volume indexes. The sector is impacted by high fuel costs and debt burdens.
   It may take some time before the trucking industry gains traction. In the meantime it is likely that railroads will continue to gain share.

2011 Markers. For 2011 a 2.4 percent growth rate looks likely. This would be less than the 2.7 percent growth rate that 2010 is likely to finish with, but the lower annual growth rate masks a pattern whereby growth in the first half of the year is lower than in the second half.
   In short it looks like 2011 will be another story of two halves; low growth to start but accelerating as the year progresses.
   U.S. trading partners, Europe, Asia and Latin America, are also likely to see a deceleration of growth that may have the opposite pattern of the United States. However, this deceleration is not likely to keep the U.S. economy from accelerating during 2011. This outlook bodes well for the freight movement industry, though it seems that trucking companies will not benefit to the extent that ports and railroads will.
   If these projections are wrong, China currency issues aside, it would more likely be that growth turned out to be stronger than expected. Interest rates and inflation are low, so there is no reason for policymakers to engage in policies designed to slow growth.
   As companies and public sector authorities gain confidence in the recovery, investment could increase more than anticipated. It seems that investment spending growth is likely to be higher than consumer spending growth in 2011.
   Walter Kemmsies is chief economist of Moffatt & Nichol, a marine instructure engineering firm, and is a regular contributor to American Shipper's monthly Strategic View column. He can be reached at (212) 768-7454 or e-mail, wkemmsies@moffattnichol.com.