Industry OutlookMike Mcnamee
On medieval maps, the terra incognita around the borders was festooned with whirlpools, dragons, and dire warnings: "Here there be monsters!" In 1996, as the U.S. economy sails into uncharted waters, its map might well be decorated with cherubs and zephyrs. Refreshed after 1995's slowdown and wafted along by falling interest rates, American business should glide into 1996, leaving in its wake steady if not sparkling growth through the sixth year of expansion.
Favorable portents abound. Congress and the White House seem certain to deliver a plan to whack hundreds of billions out of federal deficits over the last half of the '90s. Even with the budget unresolved, the Federal Reserve cut short-term interest rates on Dec. 19 from 5.75% to 5.5%--the first of three 25-basis-point cuts that Fed-watchers expect by the end of 1996. That's welcome news: "We'll see growth in '96, but I think we'll see more of it if the Fed keeps lowering rates," says Ross J. Centanni, president of air-compressor maker Gardner Denver Machinery Inc.
Coupled with continued low inflation, the Fed's easing will ratify the remarkable rally in bond prices, keeping crucial long-term rates down. That will provide a lift to housing and commercial real estate. And America's top trading partners should struggle out of their 1995 doldrums and buy more from U.S. manufacturers.
SCROOGES GALORE. That's not to say that business will sail effortlessly through the year. The 23 industries profiled by BUSINESS WEEK in this year's Industry Outlook will need skillful navigation to steer through shifting currents. The sectors that will lead the way through 1996 will either enjoy continuing strong demand--such as semiconductor makers or Wall Street's securities houses--or, like defense manufacturers, will continue to squeeze more profits out of shrinking sales.
Laggards will find themselves on the wrong side of 1996's negative trends: slower growth in capital spending, pressure on pricing, and tight-fisted consumers. After a three-year modernization binge with 12%-plus growth rates in capital spending, investment in producers' durable equipment will rise only 6% in 1996, after adjustment for inflation. Even computer makers will lose some altitude, with inflation-adjusted sales rising 18% in 1996, vs. 27.1% growth in 1995, according to forecasts by DRI/McGraw-Hill.
The '90s efficiency boom will spell trouble for any producer trying to raise prices in 1996. In a BUSINESS WEEK/Harris Executive Poll in December, only 40% of the executives surveyed predict they will raise prices in 1996, down from the 63% who were confident of price hikes before 1995 began. "We're in a buyer's market," says Bradford W. Hildebrandt, a management consultant to law firms. And carmakers, restaurateurs, retailers, and other businesses catering to consumers will find they're dealing with wary customers, thanks to debt burdens that have hit a record 19% of disposable income. "Debt is putting a lot of pressure on households, particularly the under-$50,000 families" who are the core of the mass market, says economist Mark M. Zandi of forecasters Regional Financial Associates.
But even careful consumers will spend enough to keep the economy growing. Jobs and income will keep rising, and inflation will stay low, with consumer prices up about 2.9%. That will help keep long-term interest rates near their low 1995 levels, with yields on the 30-year Treasury bond averaging 6.3% for 1996. All told, BUSINESS WEEK expects the economy to turn in a better performance in 1996 than 1995: The gross domestic product will grow about 2.3%, after inflation, from the fourth quarter of 1995 to the end of 1996. That's up from the 2% expected when the books are closed on 1995 (charts, pages 74, 74A).
That 2.3% growth may not sound like much, but, remember, the scale for measuring the economy is changing. The Commerce Dept. is adjusting the way it calculates growth in GDP--in particular, how much of growth represents a real increase in output vs. how much results from inflation. The old system tended to overemphasize growth in surging industries with falling prices, primarily computers, thus ballooning the economy's overall growth rate.
The new "chain-weighted" measures will reflect price changes more quickly, resulting in less exaggeration of fast-growing sectors. So while the old scale measured GDP growing at a respectable 2.8% in 1995, the Commerce Dept. will probably report a 2% gain by the new measures--forcing business and economists to recalibrate notions of what constitutes a "weak" or "strong" economy. BUSINESS WEEK uses the chain-weighted system in this report.
GROWING SEASON. However you measure it, the 1996 economy will feature some familiar trends, such as downsizing. Outplacement specialists Challenger Gray & Christmas Inc. predict that corporate layoffs will total 420,000 in 1996, matching 1995's level. Payroll-shedding will be most common in industries where the government's role, either as a purchaser or a regulator, is shrinking: defense, aerospace, telecommunications, banking, and utilities.
Slash-and-burn alone, however, will no longer dominate strategy sessions. "Very few companies have created sustainable advantages through shrinking," says Thomas J. Tierney, managing director of consultants Bain & Co. More companies say they're focusing on growth strategies designed to increase sales, boost market share, and expand overseas. In a September survey of senior planning executives at 100 large U.S. corporations, 73% said that boosting revenues would be more important than cutting costs over the next three years, according to the Futures Group Inc., strategic planning consultants. Only 18% of the executives surveyed emphasized belt-tightening.
One of the fastest routes to growth is acquisition. The 1995 merger boom will keep rolling--whether it's telephone and media giants scrambling for stronger positions in explosive communications markets or doctors banding together for clout to deal with insurers. Defense contractors, electric utilities, drugmakers, and banks are all feeling the heat. "People realize they need scale to compete--and it's easier to buy than to build," says mergers and acquisitions expert Kim Fennebresque, managing director of Union Bank of Switzerland. "If you have scale, you can reduce costs."
Take Union Pacific Corp., awaiting government approval for its $3.9 billion purchase of Southern Pacific Rail Corp. Ronald J. Burns, CEO of Union Pacific Railroad Co., figures the combined lines will reap nearly $700 million a year in cost savings and increased revenues when the deal is digested. With economies like that within reach, Securities Data Co. expects 1996's M&A activity to top the record $442 billion in 1995 deals reported as of Dec. 18.
Internal investment will remain heavy, too. For some industries, even a three-year boom in capital spending hasn't satisfied the need for more production capacity: Semiconductor makers are scrambling to build enough clean rooms to keep up with 20%-plus growth in chip demand. Even sectors with plenty of new facilities must upgrade for global competition. "When you're in a harsh, competitive environment, you can't stop modernizing," says Roger E. Brinner, DRI chief economist. Pharmaceutical firms, which boosted research spending by a relatively low 8% in 1995, plan to beef up budgets in search of blockbuster drugs.
Steel is an example of the modernization drive. Despite 1995's collapse in prices, steelmakers are rushing to build minimills. While each new minimill wreaks havoc on existing producers, cheaper production gives steel an edge over other materials: Builders, for example, are using more steel and less concrete. "People say steel demand is inelastic," says Nucor Corp. Chairman F. Kenneth Iverson. "But when you drop the price, you expand the market."
Many industries will be looking abroad to expand their markets in 1996. "We're not planning on the U.S. economy to carry us in 1996," says Daniel J. Meyer, CEO of Cincinnati Milacron Inc. Outfits such as Milacron looking to expand sales abroad can count two strong pluses in 1996: American industry is now ranked the world's most competitive, according to the Swiss-based World Economic Forum. And America's top trading partners, after a poor-to-disastrous 1995, see better economies ahead.
The biggest surprise may be Japan. After a 33% surge in the Nikkei stock index, coupled with the Bank of Japan's success at stabilizing the yen at around 100 to the dollar, Tokyo pundits are hopeful that economic stagnation will finally end after four flat years. Forecasters expect Japan's GDP to grow by 1.2% or more in 1996, after inflation.
That growth should open up possibilities for U.S. exporters. American brands are increasingly popular in Tokyo's Ginza, where Gap Inc. recently opened a store to push its low-key apparel. U.S. computer makers hold about 30% of Japan's $9 billion PC market, with Compaq Computer Corp. and IBM expecting to reap even more sales from the recent rollout of a Japanese version of Windows 95. Even American carmakers are pushing at the gates in hopes of capitalizing on last summer's U.S.-Japan trade deal: Ford Motor Co. and Chrysler Corp. unveiled right-hand-drive models of the Taurus and Neon at this fall's Tokyo auto show.
RECOVERING PESO. The other sick economy of 1995--Mexico--will also show signs of health. Following last winter's peso crisis, the Mexican economy has shrunk by at least 7%. U.S. exports to Mexico fell by 9% in 1995, while the cheap peso powered a sharp 30% rise in Mexican sales to El Norte. Now, Mexico seems set for a slow recovery, with 1.5% to 2% growth in 1996 followed by 4% or more in 1997. That won't ignite a boom in U.S. export sales, but pressure on the trade imbalance could ease if the peso gains strength against the dollar.
U.S. companies account for the bulk of the $6.3 billion in direct investments in Mexico pledged for 1996. AT&T, MCI Communications, and Bell Atlantic are spending heavily to prepare for the 1997 opening of telecommunications. Privatization will spread to petrochemical plants and railroads in 1996, and Mexico is encouraging foreigners to invest in natural-gas distribution and power plants. U.S. corporations increasingly see Mexico as an attractive production base for sales to the rest of Latin America. "We can tie together manufacturing in the U.S. and Mexico and go after markets in South America," says Kenneth C. Brown, president of GE de Mexico.
Forecasters don't expect much help with the trade balance from Canada's rebounding economy, which the Bank of Montreal predicts will grow 3.5% in 1996. With the weak Canadian dollar (trading at around U.S. 73 cents) and with shaky Canadian consumers holding on to their wallets, Canada's southbound exports may grow faster than the flow of goods northward. That could push Canada's merchandise trade surplus with the U.S. to a record $27 billion in 1996, says Sherry Cooper, chief economist at Toronto brokerage Nesbitt Burns.
Europe may not do much for the U.S. trade balance in 1996, either. While members of the European Union recently unveiled their proposed unified currency, the Euro, the recent French strikes to protest budget-cutting in Paris highlight the difficulty that EU members will have in meeting the stringent fiscal requirements for monetary union. French forecasters expect growth of only 1% in 1996. Germany is healthier, but business there is struggling to remain competitive in the face of high wages and taxes. "Europe still has the pain and agony of downsizing and restructuring ahead of it," says Nariman Behravesh, DRI's chief international economist, who predicts 2.3% growth for the EU in 1996.
For fast growth, U.S. exporters will once again have to turn to Asia. The economies of China, Hong Kong, Indonesia, Malaysia, Singapore, Taiwan, and Thailand will grow at rates between 5% and 9% in 1996, down just slightly from 1995. Texas Instruments Inc., for instance, has an Asian export winner in its high-end digital-signal processing chips, made in America and sold for use in interactive toys, telecom gear, and video devices. TI's Asian sales rose 50% in 1996, says Victor Koh, managing director for Hong Kong and China, in part because Asians are buying more electronics for their own use. "We're benefiting from the higher affluence in Asia," he says.
Global crosscurrents will make 1996 the third strong year for American exports, which should grow a further 9% after adjustment for inflation. At the same time, subdued U.S. consumers may cut down on their purchases of goods made abroad. So while the U.S. will still run a trade deficit, the improved trade balance should add some $18 billion to GDP in 1996, says Allen Sinai, chief economist at Lehman Brothers Inc., marking "the first time this decade that net exports have been a plus for U.S. growth rather than a drag."
BETTER THINGS TO DO. Export gains, continued capital spending, low inflation, and falling interest rates--what could go wrong with this picture? The biggest threat to the serene economy of 1996 may lie in Washington. In their struggle over balancing the budget, President Clinton and congressional Republicans have already shut down major portions of the federal government twice and spooked the markets.
Still, neither the White House nor Capitol Hill has much to gain from a budget stalemate. For both sides, the best course is to strike a deal and move on to matters closer to politicians' hearts--such as campaigning for November's elections. If Washington's dragons and sea serpents will just get out of the way, the U.S. economy could enjoy fair winds in 1996.