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Be Optimistic, But Patient

There is a noticeable change in the disastrous economic conditions that have frozen the North American economy over the past nine months and greatly stressed motor carriers. And the outlook is becomin...

There is a noticeable change in the disastrous economic conditions that have frozen the North American economy over the past nine months and greatly stressed motor carriers. And the outlook is becoming “somewhat more positive” although the recovery will be far more gradual than hoped. That was the muted optimism for our economic fortunes posed by Carlos Gomez, senior economist with Scotiabank, at our recent Profitability Seminar.

Gomez outlined several economic indicators that point to a bottoming out of the sharp decline the North American economy has experienced and an eventual recovery.

To place into perspective just how badly the economy has faltered, consider that US GDP used to see about 2.5% growth on a year-over-year basis but the latest numbers show a -3% decline. Several sectors important to motor carriers experienced precipitous falloffs. Car manufacturing was basically frozen after inventories grew to dangerous levels. In a healthy market, cars sit on lots for about, on average, 65 days. Yet by late 2008, they were sitting on lots for up to 95 days. That caused car manufacturers to slash production from 13 to 14 million units to only about five to six million at an annual rate in the first quarter. The good news is that inventories have started to come down once again. They’re still a little big higher than normal, but they’re down to a 69-day supply, Gomez said.

Of course, it was the collapse of the US housing market that started the economy rolling the wrong way. By 2006, housing affordability had reached dangerous levels. But the combination of falling house prices with very low interest rates means the pendulum has swung the other way with affordability now at a record level in the United States.

“The problem that exists now is that there is still a very large supply of houses in the market in the United States. Normally in a stable housing market you have a five to six month supply. Right now you’re still at about a 10 to 11 month supply,” Gomez pointed out.

Another indicator showing improvement is the Baltic Dry Index, which measures the cost of shipping goods throughout the world. From the middle of 2008 onward, that Index plunged, but it’s now showing some stability.

Both the inventory-to-sales ratio for Manufacturing Index and the Purchasing Manager’s Index are also pointing towards improving conditions, as is Scotiabank’s own index measuring financial conditions overall.

“So most economic statistics that we would look at would suggest that after experiencing a sharp falloff from September through about February to March are now starting to see a little bit of stability, and that’s the key,” Gomez said, adding he expects the drop in GDP to have bottomed out in the second quarter, and then show a gradual improvement from there.

Gomez does not buy into concerns we’re headed for a “W” recession, meaning that as the economy starts to improve a little bit, it goes back down.

“As long as our Financial Conditions Index continues to improve, we don’t believe that is a likely outcome. But the point is that even at the end of 2009, you’ll still be negative. It won’t be until 2010 that you are posting positive year-over-year growth on average,” Gomez cautioned. “Our main outlook is that after this year’s decline in the order of about -2 to -2.5% on a global economy, we’re going to be recovering by about 2% next year. The point is though, while it is recovery, normally when you come from a downturn you tend to get gains in economic activity in the order of 3, 4, 5%. That’s the difference. This time it will be a muted increase, not the normal 4 to 5%, but more a 2 to 2.5%.”

Part of the reason the recovery won’t come till 2010 is because the largest segment of the stimulative packages that most major countries have put in place goes into effect in 2010. Also, although policy settings have been very accommodative, the financial system was essentially frozen and not able to transmit those policies into the market.

“The good news is that the latest indicators are indicative of a financial system that is starting to work again, and that is what will allow the overall economy then to improve,” Gomez said.

More good news for motor carriers: Interest rates should remain at a level that encourages investment. The central banks understand the significance of the crisis that is going on and have slashed rates as much as they can, Gomez said. “Our forecast is that rates will stay at this level through early 2010, and then as the economy gains some more traction, they will have to start to increase rates a little bit gradually, but it will be fairly low in comparison to where they were before this crisis hit,” he said.

Gomez expects the Canadian loonie to once again approach par with the American greenback, mainly because there is concern in the financial markets over the US running a deficit that is about 15 times GDP.

In terms of fuel pricing, Gomez acknowledged demand still hasn’t picked up, but he said what really drives oil prices is not what’s going on with demand, but what’s happening with the inventories. “One of the things that we can see is that from the middle of 2007 through 2008, we had inventories continuing to draw more and more on a year-over-year basis and it was that which fuelled the big price increase to around $150 per barrel,” he said.

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