Comment

01 January 2003

Fork in the road

Middle East hostility and pervasive uncertainty hamper business thinking

By Daryl Delano

The outlook for the instrumentation, systems, and automation (ISA)-related industries during 2003 depends, as always, to a large extent on the timing and strength of the overall economic recovery, which in turn depends on business and consumer confidence levels closely tied to our success or failure next year in reducing geopolitical tensions.

It's certainly an oversimplification to expect a solid and consistent correlation between the sales of control instruments and services and the growth in gross domestic product (GDP).

Any fool, even your garden-variety economist and market analyst, realizes the world is more complex than that and that there's an indecipherable relationship among all of these factors.

But the overall health of the U.S. and, to a lesser extent, world economies matters-and arguably matters more than the sum of all other structural changes going on in the control instruments industry and financial markets.

So what does all of this mean for ISA manufacturers, product/parts distributors, service entities, and users of same? Well, probably the best advice one can offer for the year ahead is to prepare for the worst but hope for-and expect-something better and to make new capital investment and marketing decisions accordingly, with a cautious confidence that will help stimulate and sustain economic recovery.

In the end, the economy is not a boring set of numbers, statistics, and trends interpreted by a boring cadre of self-important government policy makers, economists, and Wall Street analysts. It's a living, dynamic, and evolving entity whose future is highly dependent upon the hopes, fears, and expectations of consumers and businesses. There are plenty of imponderables and plausible alternative scenarios about how 2003 will unfold.

So we all have to make decisions about whether we should be dismal and depressed or defiant and determined about the anxieties and uncertainties we face in our professional and personal lives. Do we mope or hope?

Unlike a large number of other manufacturing businesses (semiconductors, telecommunications, commercial aircraft, to name just a few) that can today only fervently hope that their darkest hours (2000-2002) are just before the dawn, the measurement and control industry enjoyed reasonably good hours and days right through the past recession.

Could have been better . . . maybe should have been worse.

So most ISA firms enter 2003 still in pretty good shape. They can't expect to have much control over what happens to business investment trends and geopolitical tensions during the year ahead-war, biological warfare, and terrorism aren't in their realm of professional expertise-but they can make a difference "on the margin," at least, by taking positive and progressive actions to invest in the future success of their business.

These would be actions that at the same time show their confidence in the long-term growth prospects of the U.S. economy.

RED SOX IN THE WORLD SERIES

The U.S. and global economies face continued challenges in the year ahead. Consumer and business uncertainty was almost palpable during the closing days of 2002, and 2003's outlook for control instrument manufacturers depends in large part on these changeable attitudes and perspectives.

But on balance, it's reasonable to conclude that if at least some things go "right" over the course of this next year, overall economic growth rates during 2003 will be at least a little bit stronger than during either 2001 or 2002.

The sad truth, though, is that nobody, no matter how well informed or how well armed with the latest data and the latest predictive tools offered by today's advanced technologies, can predict the future.

The only things certain in life, whether looking one year, one month, or one hour ahead, are death, taxes, and the fact that the Red Sox and Cubs will never meet each other (or, it's beginning to seem, any other team) in the World Series.

And with the growth prospects for the measurement and control industry in the immediate future very much dependent upon trends in business investment, it's important to try and get a handle on where the U.S. economy, the world's largest, is headed.

The nation's total output of goods and services increased at an annual rate of 3.1% during the third quarter of last year-a rate much healthier than the 1.3% gain recorded during April-June 2002. This provided reassuring and much-needed evidence that the economic recovery wasn't "dead in the water," despite the rough patch many market sectors had to work through in the late summer and fall of last year.

BUSINESS CAPITAL SPENDING UP

It was very encouraging that economic expansion during the third quarter of 2002 could be attributed entirely to actual growth in final demand for goods and services, not just to the fact that businesses were anticipating a pickup in end market demand and therefore were building inventories from their severely depleted levels.

In addition, the specific GDP component that captures the trend in capital spending by U.S. companies increased for the first time in the past two years during the third quarter of last year. This is significant because of its positive long-term implications for a more broadly based (i.e., not consumer exclusive) economic recovery.

Although the annualized increase in total business investment spending (equipment and buildings combined) was a paltry 0.6%, the July-September 2002 gain, small as it was, represented the first time since the third quarter of 2000 that we've seen any increase at all in this critical measure of capital spending commitment.

Without question, the single most significant piece of news to come out of the third-quarter 2002 report was the fact that business spending for new equipment and software increased at a 6.5% annualized rate, following a 3.3% gain over the April-June quarter.

Prior to this, equipment spending had declined for six consecutive quarters and at a discouraging average annualized rate of 7.1%. With businesses now buying into (albeit cautiously) the recovery, the "double dip" recession scenario was no longer plausible as we entered the final quarter of last year-although GDP growth will slow until Iraqi tensions are defused.

The single most important question and uncertainty we face as we enter 2003 is: Will we be forced (or at least will the Bush administration feel compelled) to go to war with Iraq in the months immediately ahead?

The answer as we moved through the final few months of 2002 was "almost certainly"-barring an unexpected breakthrough on inspections that would effectively and credibly ease our concerns regarding Iraq's development/stockpiling of nuclear, chemical, and biological weapons of mass destruction.

And of course the nation's secondary, but more immediate in terms of economic im pact, concerns focus on the impact such a war would have on energy prices and inflation (and, by extension, interest rates) in general throughout the economy.

Add to this the always present concern and uneasiness related to further acts of terrorism by al Qaeda or its sympathizers, since nothing is any longer "unthinkable" in the 9/11 world, and you have quite a growth-dampening stew.

So economic forecasters and business planners are left in the unenviable position of Saddam Hussein's food taster: We're feeling OK at the moment, but given the dangers and uncertainties we face in our interdependent little world, how will we feel 10 minutes from now?

So here we sit with this not-at-all-tasty concoction that causes every person and every business to be more than prudently reluctant to make any sort of committed investment in the future and have a chokingly cautious mind-set that leads to employee layoffs, capital spending budget paring, and other morale-sapping, cost-cutting initiatives that reach broadly and deeply into the corporate soul.

MOST LIKELY SCENARIO: WAR

Most explicit forecasts for the year ahead, including ours, assume the following general scenario. War commences within the first six to 10 weeks of the new year. The quick conclusion and ultimate outcome of the conflict, favorable to the U.S. and its allies, is apparent by the early spring.

Confidence returns to consumer and business markets, prompting an immediate-if probably overly enthusiastic-"spike" in consumer spending, business investment, and the stock market. And then things settle down once again to a more sustainable but still elevated pace of activity as the realities of continued challenges (the vexing political and infrastructure rebuilding challenges of postwar Iraq, continued terrorist threats, global competitive pressures) are recognized and eventually addressed in a more sober and reasoned atmosphere.

This seems the "most likely" scenario for our economic and geopolitical world during 2003. Although there's almost no chance that it will unfold this neatly, these basic elements are likely to be evident and in place by the end of 2003, following some gut-wrenching twists and turns.

If they aren't, it means we'll either be enjoying GDP growth of 5%-plus because everything has gone "right," or the world is mired in the second phase of a "double dip" recession because some things have gone very "wrong."

Of course the "most likely" isn't a lock. Per vasive uncertainty still dominated business thinking-and consumer thinking-as we moved through the final weeks of 2002.

The clouds and drizzle of the late-2002 environment served only to further fuel our anxiety about the road ahead. And the foul mood that emanates from the actions of Iraq, North Korea, anthrax scares, and domestic snipers isn't likely to completely dissipate during 2003, even under the best of circumstances.

Most positively, we should gradually learn to better deal with these maddening, frustrating distractions. Then we'd develop enough confidence to move forward and make commitments toward investment in the future.

The level and pace of actual improvement in economic activity to date has varied considerably from region to region and among individual countries. Australia has generally outpaced other countries in terms of overall economic growth, largely because of strong gains in the nation's housing market.

Other important export-dependent countries, such as Mexico and South Korea, had also done well (compared with the rest of the world) in the first three quarters of 2002.

And The Conference Board's leading economic index for the "sick man" of Asia, Japan, turned up over the first nine months of 2002. But this was from a very low base and almost wholly export driven, even as employment growth and domestic demand remained extremely weak.

At the same time, the leading indexes for almost all of the European economies re mained depressed. The U.K. had fared relatively well into the fall of last year, but indexes for France, Spain, and Italy had all turned lower. And despite some initial signs of improvement this past spring, the German economy remained in recession during the late summer and early fall of 2002. IT

Behind the byline

Daryl Delano is an economic analyst/consultant and principal at Delano Data In sights (ddelano@adelphia.net). He worked in economics elated jobs with Cahners (now Reed) Business Information and the federal government for nearly 25 years. He writes and edits the Measurement Control and Automation Association quarterly newsletter, "Measuring Markets."

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