NEW YORK (EconoPlay) Sept. 20 – Machine tool orders, a barometer of capital spending, slowed modestly this summer on seasonal factory shutdowns and the slumps in housing and Detroit autos – with no hint that the credit market debacle was cascading more widely into the manufacturing economy, industry sources say.

There was offsetting strength in aerospace, oil, power-generation, medical technology, defense, transplant automotive and among exporters of big-ticket capital goods – none of which needed an extra boost from the Fed’s 50 basis point rate cut on Tuesday.

The rate cut is expected to have a marginally positive impact on machine tool orders going forward, although much of the industry seemed opposed to the move as a threat to global inflation.

Job shops catering to industries outside of housing and Detroit were “busy” before the rate cut and were expected to remain so for the balance of 2007 – although with no clarity beyond.

Machine tool executives describe Detroit as a “wasteland.” Even so, they harbor hopes for an eventual turnaround premised on UAW givebacks and good early soundings from the Cerberus takeover of Chrysler.

Some envision a permanent atomization of the business cycle, whereby specific sectors weave about in a complex tapestry rather than in a uniform boom and bust march – where, in two or three years, housing and autos may reemerge only to see today’s leading lights begin to dim.

U.S. machine tool consumption in July fell by 22% from June and was down 9.5% from July 2006, according to data last week from the AMTDA (American Machine Tool Distributors’ Association) and AMT - The Association for Manufacturing Technology. Year-to-date consumption was up 5.3% from a robust year-ago period.

The soft July number reflects seasonal factory shutdowns and is thought to be unrelated to the global credit crisis.

“Business is pretty solid. We don’t see any manufacturing recession in sight. Job shops are still happy and healthy, and when they’re happy and healthy we feel good about things,” said Joe Romanowski, CEO of Machinery Systems, a machine tool distributor in Schaumburg, Illinois.

“Home building and automotive isn’t very pretty, but I don’t see it cascading through the manufacturing sector. All you have to do is look at all the activity in medical technology, aerospace and power generation,” Romanowski added.

Suppliers to Caterpillar remain busy, despite the company’s exposure to the residential construction slowdown. “Overall, Caterpillar remains a huge driver of the economy in our market. It continues to do well overseas. I don’t consider that a negative situation yet,” he said.

He sees no connection between manufacturing strength and the loss of manufacturing jobs. “I wouldn’t think employment in manufacturing is ever going to come back. Stripping labor content is the only way to compete with low-cost labor countries,” he said. “Looking at manufacturing employment is a losing battle. You’re better off tracking production numbers.”

A Mild Lift Seen from Fed Rate Cut

Romanowski expects a mild lift in business from the Fed rate cut, as lower interest rates do make it easier to finance a machine that can run $100,000 and more. But lead times are long in his industry, and any boost in the short term would be “psychological,” he said.

His business is down about 10% from last year. “But 2006 was probably our best year in eight or nine years, so this year still feels pretty good. In the world of capital spending where investments are huge, 10 percent up or down is not meaningful,” he noted.

Romanowski sees manufacturing moving forward in a disorderly motion with recessions “rolling through” on a sector by sector basis. “Right now, it’s housing that’s down and it will probably go down further,” he said. “But other sectors are way up. Aerospace is sky high. Maybe in two or three years, aerospace will be down and housing will be sky high.”

He feels “a little more confident” about the manufacturing economy as a whole than he did at the beginning of summer, when he anticipated more fallout from mortgage lending. “I think the manufacturing economy will hold steady – strong and steady, but nothing spectacular,” he said.

He expects presidential elections to hold things together – with a “rush to spend” on defense before the political tide changes next year. “There’s a lot of defense money filtering through the economy right now,” he said.

The plunging dollar should also continue to fuel exports of U.S. manufactured goods – a trend likely to deepen with the Fed’s rate cut. “All the projections I’ve seen suggest U.S. exports should be even greater next year,” he said.

“Outside of housing and American automotive manufacturing, I am not experiencing a slowdown,” said Bruce Tillinghast, president of Walker Machinery Co., a machine tool distributor in Cincinnati.

“It looks pretty darn good through January. Order prospects are out there, especially for the larger equipment manufacturers,” he added. “By and large, they’re busy and it appears as if they’re going to stay that way.”

Aerospace, energy, power generation, Japanese transplant automakers “are all very strong right now,” he said.

Detroit automotive strikes him as a “wasteland” right now – but he is optimistic about a turnaround from Chrysler, and is mindful of opportunities at some indeterminate future point.

Tillinghast reports no interference from the credit market fallout this spring and summer. But he is keeping an eye on the strong euro, which has made U.S. machines more competitive. The problem is that he also represents European brands that have become 40% more unaffordable – a hard pill for his customers to swallow. “I don’t think the interest rate cut will spur that much new business,” he said.

Business “Never Been Better”

“For us business has never been better – and it’s been very, very good recently,” said Roger Hayes, president of Huffman Corp. in Clover, South Carolina, a manufacturer of tools used in aerospace, power-generation, medical technology and more.

His markets in OEM and repair are turning “their cycle ramp to high” – most notably, the industrial gas-turbine market is on a strong cyclical upswing.

Gas turbines used for aircraft engines are looking especially robust with huge order backlogs for commercial aircraft about to enter a delivery phase. Factories “have been preparing for the new engines by building more factory space, hiring, and just now getting around to adding more capital equipment,” Hayes said. On the military side, the Joint Strike Fighter “is just now entering ramp up.”

The surgical instrument and medical implant market also continues to outperform. “People schedule elective surgeries, like hip or knee implants, after vacations so things will pick up later in the year,” Hayes said.

He also sees demand growing for power-generation equipment to feed the hunger for electricity worldwide.

“We see three to five years of sustained growth barring any weird events. We still see foreign corporations moving production to low-cost U.S. soil because of the exchange rate,” Hayes said.

Hayes takes little stock in the Fed rate cut, noting that “cycle-driven capacity requirements” eclipse any action that the Fed might take on interest rates. In his view, the true driver of capital investment these days arises from the replacement of conventional technology by new processes, designs and materials that enhance quality and productivity. “We see the U.S. economy doing better, and we in turn as well,” he said.

Donald Lane, president of Makino, a global supplier of manufacturing production equipment with a U.S. base in Cincinnati, has a more cautious outlook. “Interest rates cuts take months to get into the economy. There will be no immediate effects,” Lane said. “We think there’ll be a slowdown that extends into next year, bottoming in mid 2008 – a relatively short period compared to last time.”

Prior to that, he sees a “creep up” in industrial production in the second half, with “some industries doing well, some not.”

But he also sees an offset from currency weakness favoring U.S. manufacturers – not to mention the manufacturing strains in China from manpower shortages and quality issues, which have slowed China’s inroads into U.S. markets. “We are seeing good inquires in Mexico, which we believe are due to people rethinking China,” Lane said.

Lane spotted a credit crunch long before it became the fodder of newspaper headlines. “For our end-users it actually started months and months ago, when most lenders got very nervous around anyone doing business with the Big Three automotive companies. The bankruptcies of Delphi and others created a credit crunch in these manufacturing markets long ago,” he said.

Meanwhile, the subprime issues “have caused the housing industry to stop and commercial paper markets to seize, but our customers aren't being significantly or directly impacted,” Lane said. “To the extent the credit crunch slows the economy, and we think it will over the next six months, it will have an indirect impact on demand (for machine tools).”

To Lane, the possibility of an economic slowdown seems more tangible now than it did at the start of summer, “especially with the housing market correction going deeper and longer” than he thought back then.

He is also “a tad worried” that the next election could bring about “counterproductive governmental policies” that would include higher taxes, protectionist measures and more regulation.

Another area of concern is oil prices. “This will also have a dampening effect on the consumer and indirectly on machine tool demand,” Lane said, adding that he would expect some offset in the longer term because high oil prices would drive investment in oil-production equipment, alternative energy projects and new auto engines.

Lane did not support Tuesday’s rate cut. “We think that in the longer term, interest rates need to be higher as cost pressures are building in the world,” he said.

Jim Addy, president of Addy Machinery Company in Clinton Township outside Detroit, thinks Tuesday’s rate 50 basis point cut probably will do nothing for him, if the discount rate cut in August was any indication.

In fact, he worries that “flooding the Federal Reserve System with cash” to minimize the effects of the subprime mortgage blowout will only fuel inflation. “Remember Jimmy Carter?” he asks.

With oil at $82 a barrel, he would expect the energy segment of the economy to remain robust, if only the EPA chooses not to over-regulate on new refineries, auto emissions standards and global warming, he added.

Addy is exposed to the travails of Detroit automotive and is very invested in the outcome of the UAW talks and the Cerberus takeover of Chrysler. “I think (UAW President Ron) Gettelfinger and his team realize how critical it is to make the Detroit Three as competitive as their Asian transplant competitors,” he said.

Addy is especially enthused by Cerberus’s takeover of Chrysler and believes that hiring James Press (formerly of Toyota) as vice-chairman was a stroke of genius. “These guys are serious and are putting their money up front,” he said.

Weighing New Orders vs. Inflation

“It is safe to say that the Fed rate cut is a good sign for capital investment as it at least removes uncertainty,” said Bob Gardner, spokesman for the AMT. “The fewer questions there are about the course of the economy, the more likely manufacturers are to invest in modern equipment and added capacity.”

But he was careful to point out that there would be no quick reaction as his is an industry famous for long lags from the initial query to a final delivery.

Pat McGibbon, vice president of strategic information and research at AMT notes the rate cut had the predictable effect of further weakening the dollar, “which makes our exports more attractive.”

The downside is an inflationary effect. “Machine tool makers in this country have increasingly bought their components overseas in the past 10 years,” he said. “It will affect the price of castings and other labor intensive components. So machine prices could take a hit.”

But even if some components get expensive, the U.S. retains a global advantage when it comes to pricing for servicing, for engineering and for the quality, technology-rich components made in the U.S., he added.

McGibbon is not particularly worried by July’s weak machine tool consumption data. “Historically July and August are the weakest months of the year. So many customers and some of our own members close their plants,” he said. “Because it’s a pretty weak month to begin with, it’s hard to tell what the impact was, if any, from the credit crunch. We’ll have to wait until the end of September or the middle of October to see if there was any impact.”

The strong euro has not been an overwhelming problem for European exporters of machine tools.

McGibbon, who attended EMO Hanover (a metalworking trade show) in Germany this week, said European and Japanese presenters spoke glowingly about their export markets. “One thing to take into account is that the orders backlog in the U.S. has doubled in the last 18 months,” engendering a spillover into Europe. “Our guys are getting more orders than they can handle.”

For McGibbon, that’s a sign that business is strong. But it’s also a function of a major contraction that lasted more than five years through 2003. “We’re now at a fraction of the capacity we had in 1998,” he said.

In a related matter, commercial aircraft orders should be a negative weight on durable goods data for August with Boeing reporting 75 new orders, about half of July’s total of 149.

The U.S. Commerce Department is scheduled to release durable goods orders data for August on Wednesday, Sept. 26 at 8:30 a.m. ET.

For real-time subscription information to EconoPlay, please contact: info@econoplay.com or email our chief of sales at patricia@econoplay.com.  Newsroom: gary@econoplay.com, 212-780-0532. 

Source: EconoPlay, Inc.