Industrials Find Strength

 | Jan 13, 2012 | 3:30 PM EST
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What does 2012 hold for the economy and investors? While economic forecasts can be fraught with risk, given the large number of variables that interact in sometimes complicated ways, knowing the 'lay of the land' is often critical to having a forward-looking view toward investing.

Earlier this month, in my 2012 forecast, "New Year, Same Problems," I outlined my case for subpar economic growth, with GDP growth in the range of 1.5% to 2.25%, with risks to the downside.

The Chicago Fed, meanwhile, just published a paper on its Economic Growth Symposium, a composite of forecasts from a number of economists. While the GDP growth forecast of 2.0% for 2012 is right in line with my own views, the research goes into more granularity of some industries that might benefit during the coming year. With that in mind, let's take a look at where we might see some brighter spots in an economy that, according to their forecasts, will still end 2012 with an unemployment rate of 8.8%.

One key element in any economic forecast is that not all parts of the economy are likely to grow at the same pace. Even some elements within the same sector may fare differently. As an example, the Chicago Fed cites auto sales, both U.S. and international. During the Great Recession, Americans bought far fewer cars than they had prior to the downturn. As a result, the average age of cars on the road is now more than 10 years old -- a record high. This means a lot of pent up demand exists for new cars in the U.S.; as a result, the economists surveyed expect new car sales to reach 13.4 million units this year, up from a projected 12.7 million units in 2011. So, even though they have forecast overall consumer spending to grow at just 2.0%, auto sales might advance 5.5%.

Auto sales are not just a U.S. phenomenon. In China and India in 2009, there were only 58 and 25 vehicles, respectively, on the road for every 1000 drivers; in the U.S., however, there are 1005 vehicles per 1000 drivers. This means that there is ample room for growth, especially if China engineers a shift toward domestic consumption, with less reliance on exports. Other emerging markets may see similar trends. Many of these autos are built in the U.S. or made abroad by U.S. companies.

While auto sales may be a bit discretionary in emerging markets, food isn't. As the world population grows and adopts a more protein-intensive diet, as I discussed in my column, "Cooking Up Leads in Emerging Markets," demand for things such as farming equipment and fertilizer will increase. This is further supported by elevated food prices and record highs for farm real estate values, according to the Chicago Fed, which leaves farmers flush with cash. This supports the purchase of heavy machinery used in agriculture. In fact, according to Frank Manfredi of Manfredi and Associates, total sales of farm tractors are expected to be up 6.1% in 2012, following a year with around 10% growth.

Heavy machinery is not only used in agriculture, but mining, too, including extracting natural gas from shale deposits (despite the earthquakes attributed to fracking in the town where I grew up, Youngstown, OH). Construction is another sector that relies on heavy machinery, and while this area is still expected to be subdued in the U.S., other parts of the world could be more resilient. Research notes that China has overtaken the U.S. as the largest consumer of construction machines made in the world, consuming more than half of the equipment produced.

As a result, more steel is required to make these machines, and world steel consumption is expected to reach a record high of almost 1.5 billion metric tons in 2012, up from almost 1.4 billion metric tons in 2011. Emerging markets will spur much of this demand; China alone consumed 46% of all steel in 2011, as Robert DiCianni of ArcelorMittal USA notes. Steel consumption is expected to increase in the U.S. to 103.2 million tons in 2012, up from 65.1 million tons in 2009, but still below pre-recession levels.

Given this backdrop of demand for autos, heavy machinery and steel (and other basic materials used in manufacturing), industrial production has sharply rebounded in the U.S. from recessionary lows. The industrial sector, whose level of output fell by more than 17% during the Great Recession, has been increasing its production pace significantly since the end of the recession. From June 2009 through November 2011, industrial output grew at annualized rate of 5.4% during these two-plus years, recovering about two-thirds of the output lost during the recession.

Overall, I'm fairly constructive on the manufacturing sector in the U.S. However, one risk to U.S. manufacturers -- and, by extension, the U.S. economy -- is Europe. It's not just a matter of direct exports of goods to that region, which make up only about 2% of U.S. GDP, it's about trade that may shift toward European producers vs. American companies should the euro weaken considerably against the dollar. I discussed this risk in my column, "Trading One Risk for Another." As with any scenario, there are risks in either direction, so one must always consider the different paths that actual outcomes, not just forecasts, might follow.



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