How much longer in the deep freeze?

10 February 2009

About a year ago, I said that
the negative economic rhetoric was overblown and that people were ignoring too many of the positive factors which would support recovery in housing – and therefore in North American panel markets.
The pessimistic view was generally accurate, but for the wrong reasons. Along with other ‘experts’, I failed to anticipate the implosion of the global financial system, frozen credit markets, bank failures and huge government interventions.
What started out as the ‘sub-prime crisis’, limited to housing, has since spread to the whole financial system, revealing large portions of it to be a huge pyramid scheme based on ‘smoke and mirrors’, rather than sound management.
The consequences of this financial meltdown have spread at an alarming rate through the ‘real’ economy, not only in the US, but through Europe, Asia and much of the global economy; almost all major countries are either in recession, or have seen a marked slowdown in growth since late 2007. Global economic data are likely to reveal economies rapidly contracting as 2008 ended.
The first quarter of 2009 is likely to reveal further large declines in GDP – the second quarter will remain in or close to negative territory. The best hope is for a global turnaround early in the second half in response to massive fiscal and monetary stimulus. Many believe it could be 2010 before we see significant recovery.
The speed at which the global economy has moved into recession has been alarming and forecasts for 2009-10 are lagging the rapid changes in the real world economy. The probability is high that the downturn will be steeper and deeper than anticipated; that recovery will largely be delayed until 2010-2012; and that few countries will be immune.
The breadth of the economic malaise is perhaps the most worrying feature. Unlike other economic cycles over the past half century, where large pockets of relative strength could at least partially compensate for weakness in another region, the current crisis is broad-based and those pockets are fewer.
As at end-2008, the expectations for annual GDP growth shown in Table 1 are the assumptions used for CFPA’s assessment of North American panel markets.
Housing is key
The credit crunch in October-November 2008 hit one of the most credit-sensitive sectors of the US economy, housing, already severely weakened by the sub-prime fall-out. The bad news is largely self-evident:
l  November housing starts in the US fell to a seasonally-adjusted annual rate (SAAR) of 0.625 million – the lowest in over 50 years. Single-family starts were just 0.441 million (SAAR) and multi-family starts 0.185 million. Multi-family starts held up well through most of 2007 and the first half of 2008, but the drying-up of credit has hurt multi-family projects even more than single-family in recent months
l  November new home sales dropped 35%, year-on-year, to 407,000 as inventories of unsold new homes climbed to the equivalent of 11.5 months of sales.
l  Existing home sales, after holding up through most of 2008 at around five million, dropped 9% (year-on-year) in November, largely due to the credit crunch. November inventories of unsold existing homes also exceeded 11 months’ supply.
These numbers are likely to be as weak, or worse, in December, January and February, but it’s not all bad news. Here are some more positive housing market facts:
l  US mortgage rates are at 50-year lows; qualified buyers will have no problems securing a mortgage
l  Home prices have tumbled and continue to fall. US government data show that in the first 11 months of 2008, average prices of new homes of US$291,500 were 7% below the 2007 average (the highest year ever). Prices for existing homes averaging US$243,600 in 2008 are 8.5% below 2007, and 9% below the 2006 peak of US$268,200. (these are national averages)
l  Lower interest rates and prices have made housing more affordable. This is already being reflected in higher existing home sales in the US West (up 18% year-on-year in November, as average prices here have dropped more than 20%).
l  Inventories of unsold new homes plunged to 374,000 in November, down 25% in one year. Any pick-up in sales will quickly reveal insufficient inventory, leading to a rebound in housing starts.
l  Underlying housing demand (driven by population growth and household formations) is well above current production. Even with lower immigration, and reduced vacation/second-home demand, the US needs to add 1.7 to 1.8 million units every year. The excess supply built in 2004-6 is being rapidly exhausted; US housing starts in 2008-9 will average only 0.87 million units per year. By 2010 there will be a rapidly mounting pent-up demand for housing, triggered as economic growth accelerates.
The chart above illustrates US quarterly housing data over the past four years and presents a forecast for the next three. The housing trough (at record low levels) is expected to run from the fourth quarter of 2008 through the second quarter of 2009.
By the second half of 2009, housing is expected to be in moderate recovery, but even in the fourth quarter, housing production (single- and multi-family and mobile homes combined) will remain well below one million (SAAR). However, this level will be reached early in 2010, and by that year-end, CFPA expects housing production to be close to 1.5 million.
But this will still lag underlying demand; only in 2011 will production match this demand. Production is unlikely to start releasing pent-up demand before 2012-13. Consequently, in those years, housing production will likely exceed two million units a year, approaching the pace set in 2005-6.
North American Panel Production
Housing, remodelling and related industries such as furniture are central to the prosperity of North American panel producers. With housing at historic lows, and furniture production tumbling, 2008-9 will see exceedingly low levels of panel consumption and, therefore, production.
The chart below and Table 2 summarise recent historical data; provide an estimate for 2008 production; and a forecast for 2009-11, based on the GDP and housing assumptions presented here.
Panel production is expected to hit bottom early in 2009; low inventories – and the early stages of economic recovery – will see it edging higher in the second half. Production at the end of 2009 should be well above a year ago (though fourth quarter 2008 was particularly miserable).
Nevertheless, this improvement will be a positive base for 2010 when production is expected to better 2008, though not to be as high as 2007.
By 2011, North American OSB and MDF/HDF production are expected to be setting new records (27 million m3 and 5.75 million m3, respectively), while softwood plywood and particleboard production will be up from their cyclical lows.
As with any forecast, there is risk – currently somewhat greater than normal!
We believe there is no question there will be an economic recovery but timing it is difficult. Our forecast could be too optimistic but, at this point, seems reasonable.
Housing’s recovery could be even slower and more painful than anticipated, but it could also be faster. For example, the recovery from the 1981-82 recession accelerated rapidly even before the wider economy demonstrated much strength. In the deep current gloom, it is easy to forget how resilient the housing sector can be, given low prices and mortgage rates.
For the panel production forecast, the largest risk, other than timing, relates to trade. Currency could easily change the forecast: A strong US dollar would allow for higher imports of plywood from Brazil and Chile; MDF/HDF from Europe, Latin America and Asia; and maybe particleboard from Latin America and Asia.
For MDF/HDF, a principal assumption is that significant new North American capacity will displace even more volumes of thin MDF/HDF imports, thus leading to record North American production, but a strong dollar could easily change this.
In addition, if recent weakness in the Canadian dollar persists, it could boost Canadian panel output more than in the US, once recovery gathers momentum.
In conclusion, this brief overview provides some insights into most likely trends and risks in North American panel markets. However, it is too narrow a forum in which to explore all the nuances, subtleties and ‘shades of grey’ which will define them over the next several years.