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Experts say there is a recovery on the horizon, but will it come soon enough?

TRYING TO PREDICT WHERE THE economy will be in six months is never an easy task. The terrorist attacks of September 11 had far-reaching effects on our economy, but the depth and breadth of these events remain unclear. It is also impossible to predict what effects the nation's war on terrorism will produce.

Forecasting the economy is especially difficult this year, but it is perhaps all the more critical. We can't predict disasters and even though the economy, as a whole, didn't truly slip into recession until September, the manufacturing sector was already in recession for much of 2001.

Scott Parrish, president of the Industrial Distribution Assn., says the economy was poised for recovery in the fourth quarter of 2001. There was an increase in orders and capital spending and many indicators showed improvement.

"Then September 11 came and dragged us back down into recession," says Parrish. "It threatens the entire economy, but has really stalled the manufacturing economy. Recovery will depend in part on our country's security."

Barring further disruptions, Parrish sees a solid recovery in 2002. The consensus of experts indicates the country will see a recovery in the second half of the coming year.

"We are looking at recession through the end of the year," says Economy.com economist Gus Faucher. "We will start to see recovery in the general economy at the beginning of 2002. It will be weak in the first half and will pick up in the second half."

Faucher points out that the manufacturing sector was weaker than the rest of the economy and was hit hard by the September 11 attacks. This will lead to an overall decline of 1.3 percent in 2001, which will be below 2000 levels, he says.

"The recovery will be ushered in by strong steps to boost the economy by the government and the Federal Reserve. The economic stimuli of the interest rate and tax cuts should boost demand" says Faucher.

Faucher predicts that pent-up demand will accelerate the economy and manufacturing will benefit. But before these incentives kick in, the picture does not look good.

"Business has been awful for metalworking and plastics," says Gardner Research executive vice president Steve Kline. "Business is off 30 to 50 percent."

He says machine tool spending will be $4.6 billion in 2001, which is the lowest in 12 years. Adjusting for economic factors, spending may be the lowest in 30 years, he speculates.

"We are forecasting a 10 percent increase in capital spending for 2002," says Kline. "Starting from such a low point, that is only a moderate increase."

Unused capacity

Kline says the number to watch is industrial capacity utilization. A number above 80 percent spurs capital spending.

Don't look for good news from this front at the moment, however, the numbers released in November show capacity utilization at 74.8 percent, the lowest since 1983.

CIBC World Markets senior equity analyst Holden Lewis agrees that capacity utilization data is a critical indicator of the health in the manufacturing sector.

"It has plunged into lows not seen since the recession in the early '80s," says Lewis. "We also focus on orders data, which usually gives a prediction. Through October, there is no sign of a recovery coming soon."

Manufacturing and distribution have been in the slowdown for 16 months, so they have probably seen the bottom of the decline, he speculates.

"It is reaching critical levels even for healthy distributors," adds Lewis. "There is a lot of economic stress on smaller players and many privately held firms are on the rocks."

The industry is at a critical level, he says. If the economy does not recover by mid-2002 as anticipated, Lewis says he expects some firms to go out of business.

Of course, even though manufacturing is currently weaker than the general economy, when the upturn arrives it will be stronger, says National Assn. of Business Economists president Harvey Rosenblum.

"The economy will reach its bottom by the end of the year and begin a slow recovery," says Rosenblum. "The manufacturing sector will remain low for the first half and then will snap back more."

He expects manufacturing to give a lift to the general economy in the second half of 2002 and anticipates renewed investment spending.

Rosenblum says energy and residential construction have both been strong, hut there will be a decline in housing demand and there is great uncertainty in the energy industry.

National Assn. of Manufacturers chief economist David Hyether also expects to see manufacturing recover faster.
"In 2001, industrial equipment, electronics and transportation have been hardest hit," says Hyether. "Other sectors have not done well, but each of these dropped more than 10 percent."

These were driving forces before the slowdown, he adds. Depending on what fiscal stimulus the government provides, Hyether expects upwards of three percent growth in the second half of 2002.

Telecom was also a driving force in previous years. Hyether says he doesn't expect it to rebound as well.

"There may be overcapacity since there is currently a vast amount of fibreoptic cable laid, while only a small percentage is actually in use," he says. "At the same time, there is a small surge in electronics investment, not in expanded capacity, but in backup and recovery systems."

"IT spending had been dropping off through 2001," says Exact Macola president Bruce Hollinger. "It didn't decrease significantly after September 11, which indicates that it is not likely to get any worse."

He says many companies are still operating on legacy systems, which should he upgraded to increase efficiency. He says the post dot.com focus is on bringing the efficiency of back-end systems to the front-end functions.

"Companies are looking for greater cost control and increased efficiency," adds Hollinger. "For many firms, the cost-saving benefits are there. Companies will spend to update their infrastructure if it provides added value."

Nonetheless, Hyether says most companies are still delaying major computer systems purchases. He points out another factor that may contribute to a slower overall recovery: much of the manufacturing economy depends on the export market.

"In the last recession, international trade was strong and manufacturers could focus on overseas markets. The forecast for overseas growth is not very strong -- perhaps five to eight percent by the second half of 2002."

Aerospace was another sector that was strong before the terrorist attacks. There is little doubt that the commercial side of the aerospace sector has been hard hit, but Parrish and others point out that the defense aerospace business is doing well.

"Anything to do with security and defense is seeing some positive impact," says Kline. "This is different than other wars, but missles, helicopters and satellites are in production as well as the recent approval of the joint strike fighter."

Industrial Supply Manufacturers Assn. president David R. Thompson says a force that is sure to contribute to future growth is that there is limited inventory in the channel. Nearly anything required will have to be purchased from a manufacturer since there is so little inventory in the supply chain.

"We started to see this in August. Customers' orders were on the rise," says Thompson, president of Kennedy Mfg. "It has dropped back to levels on par with this summer, though. Right now, it is a very dramatic reduction."

Driving factors

Thompson says one of the positive factors is that the automotive industry is pushing new car sales, although he questions how long this will continue.

"Any recovery will be led by the automotive sector:' says Kline. "For a real recovery, the automotive industry needs to start spending, and there is reason to believe this will occur."

Kline says aside from incentives by domestic car manufacturers, which have kept the plants operating, the imports are coming out with new models and hybrid technology.

"Domestic manufacturers will be forced to produce cars with new designs and different engines'" Kline adds. "This will benefit automotive industry suppliers."

There also has been strong consumer spending through the slowdown. If this trend continues, it will help the recovery of the manufacturing sector, says Parrish.

The jobless rate is predicted at 5.9 percent, according to a recent survey conducted by the NABE. Many of these layoffs are from the manufacturing sector. Thompson suggests some manufacturing jobs may return to the U.S. as companies may not want the difficulties of importing in light of the recent tragedies and may not want to risk political instability abroad.

Even though many of the indicators still look bleak, the U.S. Index of Leading Indicators for October increased .3 percent, up from -.5 percent in September. This indicates that any recession will be brief. For those who weather 2002, Faucher predicts smooth sailing with 5.8 percent growth in 2003.

COPYRIGHT 2002 Cahners Business Information in association with The Gale Group and LookSmart.