September 14, 1977
Weakness in the steel industry and more cautious inventory policies by manufacturers and retailers have slowed the pace of economic activity in the Fourth District this quarter. Despite strong sales gains again in August, retailers remain cautious about prospects for the balance of 1977. Capital goods producers report continued strong demand for machinery and equipment, but heavy construction remains weak. Residential construction and mortgage loan demand continue strong.
An atmosphere of gloom seems to have marked the steel industry in recent weeks. Steel orders have not rebounded as much as was generally expected. Although several producers are operating at about 75-to-80% of effective capacity, they expect another quarter of little or no profits. A recent surge in steel imports and further mild runoff of inventories have led directors and steel economists to scale down forecasts for the balance of this year. Consumption has remained relatively strong except for structural steel. Still, one economist noted orders from the automotive industry have not been as strong as previously expected when production schedules for 1978 model cars were announced. The industry, therefore, is marked by discounting of prices, layoffs of salary and production workers, suspension of cost-of-living adjustments for white-collar workers, numerous closings of marginal facilities, and halting or stretching out of capital-spending plans. A producer, for example, cut the price of structural steel products $50 a ton below published price to keep its mill in operation. Another producer hopes to improve cash flow by selling its interest in iron ore properties in Labrador, valued at about $75 million. While steel economists anticipate that next quarter's production levels will increase to at least 80% of capacity, they acknowledge little sign of improvement in orders to support their expectations. Furthermore, the industry would not generate much profit even at a higher operating rate.
Retailers and producers generally feel inventories have been built sufficiently earlier this year and approach inventory policies with caution for the rest of 1977. Inventories are not judged to be excessive, although some adjustment is now occurring. Still it is not of the magnitude experienced late last year. A large automotive and truck parts supplier expresses the view typical of cautious inventory policies; keep inventories as low as possible regardless of past inventory-sales ratios. Similarly, a director associated with a retail chain commented that retail stocks are more balanced since the July-August pick-up in sales and that should sales soften later this year, orders would likely be cut back promptly to avoid another inventory buildup. Steel inventories at both consumer and producer levels are not judged to be high. One large producer, however, will trim stocks to reduce costs. Steel consumers have been cutting inventories but steel economists expect a reduction to be brief and mild in contrast to that of late last year. One economist estimates that steel inventories currently are only slightly above those during troughs in 1970-1971 and late 1976, in spite of the fact that consumption is considerably higher than in those periods. Copper and scrap inventories held by one firm are reported to be at an all-time high and will likely be cut. Crude oil and gasoline stocks continue at levels well above a year ago, although one refinery reported a rather sizable reduction in gasoline stocks during August. On the other hand, distillate and residual fuel stocks are only slightly above last year's levels and as sane producers will apparently aim to increase those stocks.
Directors and officials associated with consumer goods are mixed in their views about prospects for consumer spending. Even though sales gains in August were large relative to a year earlier, some retailers remain cautious. A director of a department store chain cautions that slower gains in income and an unsustainably high proportion of expenditures for automotive and luxury-type goods would likely hold down future consumer spending. An economist in retail trade expects slower growth in disposable income and increased personal saving rates will hold overall gains in real consumer expenditures to about a 3% annual rate of increase this half. He does not believe that the rapid rate of increase in retail sales last month can be sustained, nor is it consistent with forecasts of only 4-to-5% quarterly gains in real GNP during the second half of 1977. A director associated with a producer of household products, whose sales surged in August following two months of reduced order activity, took a more optimistic view. He reports his firm plans to step up its capacity expansion program.
Recovery in capital goods industries is still not broadly based. Although producers contacted expressed growing confidence that the 13% gain projected in the latest Commerce Department survey will be realized, they see few indications that suggest an accelerated pace over the next few quarters. One official with a large producer of parts and equipment for industrial and agricultural machinery suggests the atypical lag in the recovery can be attributed to concern over the next recession, lack of strength in export markets, and ample capacity. His firm experienced a substantial decline in sales of components for farm implements, a trend he expects will extend into 1978. Orders for medium trucks used for inner-city transit are slowly increasing. On the other hand, the firm's heavy-duty truck production has rebounded rather strongly, and 1977 output is expected to be 45-50% higher than last year. Similarly, orders for industrial lift trucks accelerated sharply since spring and shipments for the year are expected to be about 35% higher than in 1976, but well below 1973-1974 peak levels.
The contrast in capital goods industries is perhaps best illustrated by the rising demand for machinery and equipment—including machine tools, materials and handling equipment, forgings and communication equipment for which backlogs have been rising steadily—while construction of new plants and public works projects remains weak. Continued weakness in public construction has prevented recovery in production of off-highway equipment, structural frames for bridges and highways, and structural steel. Financial officers with two large international firms that design, engineer and construct plants report that interest in new construction projects has either been flat or weakened recently. One noted a tendency for shelving projects until an energy program and tax legislation are enacted. One of these officials also expects that it may be at least a year or more before construction of new plants begins to accelerate.
Residential construction remains strong and demand for mortgage loans is at or near record levels, according to officials of several large S&Ls. A major northeastern Ohio utility increased its forecast of 1977 housing starts by 10% because sales have kept pace with completions. Several S&Ls continue to report very strong demand for mortgage loans. None report disintermediation but an official with a $360 million deposit association reported a recent runoff in deposits because maturing 4-year certificates were not redeposited. In fact, some associations have had to step up borrowings from Federal Home Loan banks. While still above the 7% requirement, liquidity at S&Ls has generally been reduced.