The business cycle turns down.

The Business Cycle Turns Down

Last year in this report, ACMA predicted that 1990 would be about as good as 1989. It was also forecast that recession, if it did happen, would occur in 1991. As was pointed out then, the key would be inflation. By all accounts, 1990 was about as good as 1989 for most in the metalcasting industry.

That's the good news. The bad news is that the wider economy got such a heavy dose of inflation in the third quarter that it tipped the business cycle down even sooner than expected.

Economic Review

Throughout 1990, the economy was hanging on to growth by the slimmest of margins. Few believed it was going to be a prosperous year, but most hoped there wouldn't be a recession either. Looking back at 1990, we find that the combination of two years of sluggish performance and a series of economic and political disasters was too much for our fragile economy.

As evidence of this slugglishness, real GNP grew only about 1% in 1990 and consumer spending increased just slightly more than 1%. Among the most telling indicators of trouble last year was the dramatic downturn of the housing market.

On the political front, the crisis in the Middle East and the resulting rise in oil prices provided the dose of inflation we feared. Crisis number two occurred as a result of declining consumer confidence triggered by the epic federal budget battle and the widening savings and loan disaster.

This one-two punch was too much for the already weakening economy. So much so that a mild recession couldn't wait for 1991. In fact, all indicators point to August 1990 as the start of the current recession.

Economic Outlook

The outlook for 1991 is for a continuation of this mild recession, which began this past August, through perhaps midyear 1991. More accurately we refer to this as a technical recession because the economy's performance in 1991 will not substantially differ from its performance in 1990. The major difference will be this: instead of two or three quarters of zero growth (as in 1990), we will experience two or three quarters of minimal negative growth. This negative growth requires us to call our economy's performance recession rather than stagnation.

Given this general overview, ACMA's macroeconomic forecasts for 1991 are as follows. Overall economic growth (GNP) is forecast to grow a minuscule 0.5% compared with 0.9% in 1990. In addition, interest rates should fall in early 1991, as the Federal Reserve Board moves to avert a deepening of the recession, but should rise around midyear as the Fed moves again, this time to reduce inflation.

Overall, consumer price inflation should be higher in 1991 than in 1990, averaging about 7% for the year, mainly because of higher oil prices. Inflation, in the form of producer prices (PPI), should grow at about a 7.5% annual rate, in contrast to a 4% rise in 1990.

Industrial production, particularly in the nondefense capital goods sector, will see a long period of negative growth in 1991, despite a strong performance in some segments of the economy (the oil patch, for example). The forecast here is for an overall decline of about 0.5% in industrial production in 1991. This decline will be led, in large part, by the nonplus performance of the Big Three automakers.

Growth in consumer expenditures will be nearly unchanged in 1991. We predict an increase of about 1% over 1990, mirroring the 1989-90 rate of change. Housing starts could remain depressed through 1992, and will record only 1.1 million units started in '91, a drop from 1990's depressed 1.22 million level.

Specific numbers aside, it should be pointed out that future economic activity, and therefore this forecast, is tremendously uncertain. No factor is a more important component of this uncertainty than the current crisis in the Persian Gulf and its effect on oil prices.

If war breaks out and is quickly resolved, oil prices are expected to drop rapidly. The resulting lower inflation will boost consumer confidence, reduce interest rates and stimulate the economy. Increased defense expenditures would also help spur growth. Such a scenario would lead to a higher pattern of real growth in the U.S. economy. In addition, it could reduce the risk of a debt-induced recession.

This latter scenario is the second major factor of the uncertainty inherent in this forecast. Just as inflation devastated the economy in 1973 and again in 1981-82, our nation's overwhelming debt could push us into a severe recession in 1991. In fact, many economists believe that this must happen if our economy is to get out from under its heavy weight of debt. To make matters worse, the recent budget accord did little or nothing to attack this problem. Its only positive aspect may be to put off a severe recession.

The potential triggers for such a severe debt-induced recession are a worldwide shortage of capital or an acceleration of the capital flight now taking place. The latter refers to the movement of capital out of the U.S. as investors move their money to greener pastures, causing a shortage of cash needed to finance the national debt.

As the Fed reduces interest rates to soften the recession, it risks increasing the place of capital flight. However, responsible moves to tighten monetary policy later in '91 will likely counter this threat--at least in the short term.

On the other hand, a worldwide shortage of capital is a rapidly growing possibility for several reasons. First, the drop in the Japanese stock market, which has exceeded 45%, severely influences capital availability there. Second, U.S. banks are under pressure to meet higher capital requirements mandated by regulatory reform brought about by the S&L crisis.

Third, German banks will be under increasing pressure to invest in former East Germany because of the political fallout of high unemployment. At the same time, Germany has been a generous contributor to the ailing Soviet economy.

Significantly higher interest rates could result from a capital shortage caused by these events, which would in turn reinforce the current oil price shock's effect on economic growth and inflation. Such an event could also make the U.S. recession much deeper and longer than is predicted here.

The Foundry Industry

For most metalcasters, 1991 will be significantly slower than 1990 (Fig. 1). This will occur largely because of the wider economy's poor performance in late 1989 and early '90. The effect of a 1990-91 recession will probably not begin to influence the industry until late this year and early 1992.

Overall, demand for metal castings will be down 2.5-3% in 1991. The biggest falloffs will be felt by producers of iron pipe and copper-base plumbing related castings because of the depressed housing market (Fig. 2). The embargo on products bound for Iraq and Kuwait will also hurt pipe producers.

Overall, demand for iron castings will decline 3% in 1991. Construction-related castings, municipal castings and pipe especially will lead the downturn. Automotive-related castings will also experience a fairly large falloff this year, recording a 3.5% drop. Heavy truck and oil field castings are expected to be among the few bright spots.

The comeback of steel castings will be delayed in 1991, with overall demand falling about 1%. Leading this slight decline will be the railroad and construction equipment segments, which will fall 1% and 4%, respectively. Uncertain events such as labor problems may artificially buoy the construction equipment market for the first half of the year, but the second half will likely see a significantly poorer performance.

High-alloy steel castings will buck the trend in 1991, with demand remaining unchanged from 1990 levels. The corrosion-resistant steel castings business is very strong for a variety of reasons, which will enable it to hold the line in the face of our mild recession.

Similarly, no appreciable change in demand for aluminum castings is forecast in 1991. Although construction-related castings sales will suffer, growth in the aerospace and office equipment industries will largely offset these declines.

Overall demand for copper-base alloy castings will decline about 5% in the coming year. The leading cause of this drop is the industry's dependence on construction activity. Other segments of the market should hold up considerably better than those related to housing.

The Automotive Industry 

The near-term difficulties confronting the Big Three automakers appear to involve more than a dramatic slowdown in the North American consumer's appetite for new cars. Rather, and perhaps more importantly, lingering doubts about the Big Three's ability to compete effectively against direct imports and vehicles produced by the transplants will be the more important factor. Sales numbers tell only part of the story.

Since the near-term peak of 10.6 million cars sold (total North American sales) in 1988, sales have steadily but not drastically declined: 9.9 million units sold in 1989, 9.6 million in 1990 and a projected 9.5 million in 1991. The more dramatic shift has come in marketshare of the Big Three: from 65.5% in 1988, 64.4% in 1989, an estimated 61.3% in 1990 and a projected 60% in 1991 (Fig. 3).

What may be of more concern, though, is that the Big Three are seemingly still struggling to effectively compete with the Japanese. This is perhaps most apparent in the extent to which we lag in engineering, R&D and product development. These criticisms are not new, but ACMA's research this year finds that U.S.-based automakers are further behind than they were several years ago in these areas.

In 1990, the Japanese introduced entire new product lines like the Lexus. By comparison, 1990 was reportedly Ford's worst year since 1982, and GM's first Saturn automobile--a seven-year, $3 billion effort to compete with Honda and Toyota--rolled off the assembly line.

These 1990 events, among others, underscore the apparent edge the Japanese have on the Big Three in the marketplace. Similarly, the perceptible Japanese advantage in engineering and R&D can be seen in new engine technology and the use of aluminum.

In 1990, the need for engineering advances to increase fleet gas mileage re-emerged. In the past, this has meant designing traditional heavy materials like iron and steel out of a car and substituting lighter-weight materials such as aluminum. Recently, this trend was highlighted in Congress's failed bid to pass the CAFE (Corporate Average Fuel Economy) provision of the new Clean Air Act. This stipulation would require automakers to improve mileage standards 40% by the year 2001.

While U.S. automakers are only beginning to make the transition to lighter-weight materials, the Japanese are already there. Honda's engines, for example, are all aluminum, and the new Japanese luxury cars (Lexus, Acura and Infinity) contain aluminum suspension and aluminum engines. In addition, Honda's NS-X has aluminum body panels.

Although dead for the time being, CAFE points to a pressing need for expertise in design, engineering and aluminum engine technology. It also foreshadows the diminishing role of gray iron castings. More than anything else, it points to the ever-changing competitive automotive landscape, and to the perils of playing catch-up in engineering versus leadership in R&D, design and engineering.

1991 and Beyond

Despite a generally gloomy outlook, our industry's performance will be uneven in 1991. The recession's impact will depend to a large extent on each foundry's product and market focus. The downside extreme will be foundries heavily tied to the housing sector, especially pipe. On the upside will be foundries with ties to the energy sector.

Looking ahead, indicators point to fairly rough sledding for our industry in 1992, as the 1990-91 recession finally catches up with the metalcasting industry's economic lag. However, the extent and timing of the dropoffs depend heavily on the risk factors mentioned previously, most notably the Mideast crisis and the potential global capital shortage.

Through the merger of the American Foundrymen's Society and the American Cast Metals Assn that became effective on Dec 31, 1990, ACMA's management division is now a division of AFS.