TrendTracker Update - August 2019
By Art Raymond
Into the Unknown…
History Lesson: Fifty Years in the U.S. Wood Furniture Industry
In the 1970s, the U.S. economy was prospering from the Greatest Generation’s return from winning World War 2. Their progeny, the Baby Boomers, were fast becoming the Luckiest Generation. Many industries were benefiting from a little-known fact: the number of homes built in the 1970s would surpass any other decade before or after. And those houses needed furniture.
The First 30 Years
The golden age of furniture making in the U.S. ran from the early 1970s through the mid-1990s. Annual manufacturers’ shipments of wood and upholstered products grew from $4.5 billion in 1970 to $16.3 billion 24 years later. Home to company names like Broyhill, Thomasville, and Henredon, North Carolina became the center of the furniture universe. While 19 companies had annual sales greater than $100 million in 1985, thousands of smaller single-plant companies battled for the consumers’ wallets. That competition left the Industry’s average net profit after taxes at only 4 percent and falling.
Producing the wide range of wood furniture designs demanded by U.S. consumers has always been labor intensive. Much of that labor is difficult, if not impossible, to replace with capital investment. Factory labor, including benefits, ranges between 25 and 30 percent of manufacturer’s selling price.
The typical furniture factory of the 80s and 90s featured numerous manual machining, assembly, and finishing operations with a few islands of automation. Computerized information systems for managing production were virtually non-existent. Compliance with tighter safety and environmental regulations consumed an increasing share of capital available for capacity expansion and productivity improvement. As a result, many plants were obsolescent. By the mid-1990s, furniture making was fast becoming a no-profit zone.
The Rise of Importing
By the mid-1980s, many U.S. furniture makers were experimenting with sourcing parts and products produced in foreign factories with low-cost labor. That strategy offered a critical benefit: the expansion of sales without the capital investment required to maintain efficient factories. That trend began with shipments from Canada and Yugoslavia in the early 1970s. By 1978, Taiwan had become the largest import source and remained so through 1994.
In the early 1990s, Taiwan’s economy shifted to the manufacture of higher-value products than furniture. The average Taiwanese worker soon cost seven times that paid to a furniture factory employee in China. That finding, plus four other advantages, proved to be the critical impetus that drove the relocation of Taiwanese factories to China:
- Productive Labor: Combining China’s strong work ethic with its low wage rates yields a labor content of about 5 percent of selling price versus 25 percent in U.S.-made furniture.
- Low Cost of Entry: The cost of building furniture making capacity was about two-thirds lower than in the U.S.
- Efficient Transport to Market: Containerized shipments are inexpensive and fast.
- Government Incentives: Factory owners benefit from incentives for job creation and rebates of value-added taxes on export sales.
The tidal wave of price competitive, design-rich imported furniture was building in Asia. In 1995, China exploded as a furniture source. Shipments to the U.S. totaled $682 million and ranked third among supplier countries with a 13 percent share of total furniture imports. By 2004, China supplied US$8.68 billion of furniture products, garnering a 48 percent share of imports. The capacity and capabilities of Chinese suppliers had surpassed critical mass and mortally wounded U.S. producers.
In the 10 years following 2000, more than 300 U.S. wood furniture plants were shuttered in the U.S. Only a few U.S. companies now operate a single domestic wood plant. Even fewer run multiple factories. An estimated 40,000 furniture production jobs were lost, not including those in the furniture supply chain. The center of the furniture universe had shifted to China.
In 2017, Chinese furniture makers shipped $16.6 billion of their products to the U.S., a 58 percent share of that category. Economic growth is no longer dependent on industries like apparel and furniture that require low- and medium-skilled labor. Its companies now compete in high-tech product sectors like electronics, that require true innovation and engineering.
Like in Taiwan, China’s transition to such advanced manufacturing has brought higher costs. According to the Boston Consulting Group (BCG), factory labor costs have risen by 15 percent annually since 2000. No doubt Chinese furniture companies are finding tougher sledding in some export markets as customers shift to suppliers in Vietnam and other countries with lower wage rates.
As its workers earn higher wages, China is fast replacing its export economy with one driven by consumers. Many export-based companies are now re-focusing their resources on the burgeoning domestic market as the economy consumes more of what it produces.
Consultants like McKinsey and BCG, plus publications such as The Economist, claim that the advantages of globalization are fading. That phenomenon – the cross border integration of companies to utilize each country’s comparative advantages – created today’s China. These experts assert that the differential between the fully-loaded costs of an imported and domestically-produced good is shrinking, and the economics of offshore production is no longer as compelling.
Does that opinion put to question the continuing viability of China as a furniture supplier? Many factors say no:
- Ample Labor Resources: Factories are moving to the under-utilized interior, away from the higher-cost coastal region.
- Well-Developed Supply Chains: Vertically-integrated value chains enable efficient production of unique products.
- World-Class Logistics: Efficient transport and port facilities ensure quick, inexpensive delivery to customers.
- Productivity Improvement Opportunities: Costs can be lowered through capital investments that streamline manufacturing.
As important is China’s proven installed capacity. U.S. shipments by the next nine largest source countries are only 60 percent of China’s. Shifting 10 percent of China’s shipments elsewhere would require an export furniture industry as large as Canada’s.
Bottom Line: The economic nature of things virtually ensures that tomorrow will be different than yesterday. On that basis, China will eventually lose its competitive advantages. But until jobs are created for the millions there who remain under-employed, that event will be later, rather than sooner.
… by Art Raymond and reprinted from the April 2019 edition of FDM+C magazine
More on China
Owing to its large population and scale of development, China should remain a significant manufacturer of wood furniture well into the future (see 2019 February Update). However, the target market for Chinese producers is fast becoming domestic in lieu of its historic focus on exporting.
While China remains the largest wood furniture supplier to the U.S., remember that the Vietnamese wood furniture industry developed as a reaction to the imposition of anti-dumping duties on Chinese producers in 2005. Currently, Vietnam is now the second largest source of wood furniture for U.S. buyers and the third largest foreign buyer of U.S. hardwoods.
Malaysia, Indonesia, and India have witnessed the growth of Vietnam’s furniture industry and are belatedly developing as viable sources. Also Mexico, with its inherent transportation advantages, is getting a second chance at being known as a creditable producer of furniture for the U.S. market.
While recognizing that replacing lost market share requires a substantial investment of time and money, TrendTracker believes the world remains a significant customer for our hardwood producers.
Key Indicators of Our Hardwood Economy
In July, the current U.S. recovery from the so-called Great Recession entered its 11th year, the longest period of growth since the end of WW2. Looking at the key indicators for our hardwood economy:
U.S. Gross Domestic Product
2Q 2019 GDP grew by 2.1 percent, down from 3.1 percent in Q1. That performance was driven by the healthy 4.3 percent in consumer spending, which in turn reflected the strong job market (see below). That sector bounced back from a relatively weak 1.1 percent in Q1.
Also contributing to growth was government spending, up 5.0 percent from the prior quarter.
Subtracting from these two positives were reductions in inventory investment, exports, business investment, and housing investment. The latter fell for the sixth consecutive quarter. More on the housing sector later in this report.
No doubt weakness in these elements of the economy contributed to the Federal Reserve’s decision to cut interest rates on July 31.
The Personal Consumption Expenditure Index, the rate used by the Federal Reserve in setting the Federal Funds rate, hovered at an annual rate of 1.5 percent during Q2. As a result, the Fed voted on July 31 to preemptively lower its benchmark interest rate 0.25 percent from its previous range of 2.0 percent and 2.25 percent.
Two members of the Federal Open Market Committee voted in the negative, arguing the reduction leaves insufficient room for further cuts in the event of a continuing downturn. Also, the Committee expressed worry that the stubbornly low inflation rate would remain below its target of 2.0 percent.
In addition, the Fed is clearly concerned about weak growth overseas. GDP growth in the Eurozone in the three months ending in June fell to an annualized 0.8 percent, less than half the 1.8 percent in the prior period. Overall, the German economy fell 5.2 percent year-on-year in June. Leading the downturn are the important German and Italian manufacturing sectors. Similar weakness is the case in France. Also hanging over Europe’s head is the likelihood that Great Britain will leave the European Union later this year.
Interest rates in the Eurozone are already negative, thus leaving only a revival of now dormant quantitative easing as the only program in the European Central Bank’s toolkit.
During the period 1955 through 2010, the federal funds rate often ran above 5 percent and reached nearly 19 percent in the early 80s. With inflation running around 2 percent and unemployment at a near 50-year low, how then can the Fed consider 2.5 percent high enough to justify a cut? Just wondering…
The U.S. economy continues to generate new jobs. Payroll employment increased by a solid 164,000 in July, compared to an average of 223,000 in the first 6 months of the year. Last month became the 109th consecutive month of job market growth, the longest streak on record.
The headline Unemployment Rate for July remained at 3.7 percent, the lowest level since December 1969. The number of unemployed was steady at 6.1 million.
Professional and technical services added 31,000 jobs in July, followed by 30,000 in healthcare. Many of these jobs require special training/skills prior to entering the job market.
The share of Americans working or seeking a job as measured by the Labor Force Participation Rate was up 0.1 percent at 63.0. This statistic reports the percentage of the working age population either employed or actively seeking a job. It reached an all-time high of 67.3 percent in January 2000.
The Employment–Population Ratio has changed little in 2019 at 60.7 percent. It reached a peak of 63.4 in 2007, just prior to the onset of the Great Recession.
The Total Unemployment Rate came in at 7.0 percent, down 0.5 points from a year ago. This metric, known as U-6, is based on a broader definition of unemployment status that includes:
- persons ‘marginally attached to the labor force’ ie, who are currently not working nor looking for work, but have searched for a job during the past year and indicate that they are available for a job.
- ‘involuntary part-time workers’ who want full-time work but have settled for a part-time position.
Many economists consider U-6 the most accurate measure of the under-employed.
In July, 1.5 million persons were in the former group, which was essentially unchanged from a year earlier. The latter group declined by 363,000 to 4.0 million.
Among the marginally attached are 368,000 discouraged workers who are not looking for a job. That group is down by 144,000 from a year ago.
In July, the average work week for all non-farm employees fell by 0.1 hour to 34.3 hours. Average hourly earnings rose by 8 cents to $27.98. Over the last 12 months average earnings grew by 3.2 percent.
In June, the Job Openings & Labor Turnover Summary – better known simply as JOLTS – showed evidence of moderating labor demand. June job openings fell slightly to 7.348 million, down 0.5 percent. Hires dropped to 5.702 million, down 1.0 percent. Openings, while remaining above hires by 1.646 million, have fallen by 0.6 percent from a year ago.
America needs more workers. Having more jobs than people available to fill them can create two problems: (1) growth stalls from the lack of workers or (2) companies bid up wages causing inflation. Watch for the July JOLTS to be released on September 10 for signs that the gap between openings and hires is continuing to decline.
For the week of August 3, the four-week moving average of New Jobless Claims came in at 212,250. That metric hit a low of 201,500 the week of April 13. Since that low the average has ranged as high as 225,000.
Pay attention to this metric going forward. Some economists argue that a bottom in this metric marks the end of a recovery. Press releases from the Bureau of Labor Statistics are published every Thursday morning. As always, remember that one data point does not create a trend. As with many economic metrics, turning points that denote a top or bottom in the business cycle are not visible for some time.
Surprise: Personal Income jumped 4.5 percent in 2017, 5.0 percent in 2018, and 3.4 percent in the first half of 2019. These increases far exceeded the data produced by the Bureau of Labor Statistics (and reported in the Update). In fact, the first six months of 2019 produced as much growth as all of 2016. So much for the ‘secular stagnation’ blamed for low growth by President Obama during his term in the White House. Seems Trump’s tax and regulatory is paying dividends to the American worker…
Since its high of 60.8 reached last August, the ISM Manufacturing Index has trended lower. July’s reading of 51.2 is a 0.5 percentage point decrease from June, and the lowest since August 2016’s 49.6 percent. An Index reading above 42.9 generally implies an economic expansion. On that basis, July’s performance is the 35th consecutive month of growth in the manufacturing sector, albeit weak. Remember that an Index is a composite based on 10 business indicators from 18 industries.
For July, only 3 indicators showed growth: New Orders, Production, and Employment. Supplier Deliveries slowed at a faster rate; Inventories, Order Backlog, New Export Orders and Imports contracted; Customers’ Inventories are too low; Prices decreased.
Of the 18 industry sectors, eight experienced higher production led by Wood Products and followed by Furniture & Related Products.
Looking at the employment situation in manufacturing, the sector created 16,000 new jobs. The average workweek decreased by 0.3 hours to 40.4 hours. Overtime fell by 0.2 hours to 3.2 hours. Average hourly earnings were $27.70, up 2.5 percent since July 2018.
Given this recent weakness, this important sector bears watching. The next ISM Manufacturing Index will be reported on September 3, with subsequent releases on the first business day of every month.
The housing sector continues to lag weakly behind other key economic metrics. Historically this component has led the economy out of past recessions. Three critical prerequisites enable a healthy housing market:
- a strong job market for young buyers
- reasonable borrowing costs
- an adequate inventory of affordable starter homes
The first two conditions are in place. The problem is the third: the average price of lower-priced starter homes has risen 64 percent in the six years from 2012 through 2018, versus 40 percent for higher-end houses. As a result, the homeownership rate in the U.S. for adults age 25 to 34 lingers at 40 percent, down from 48 percent in 2001. For all ages the combined rate is around 64 percent.
This situation creates a negative ripple effect through the market. Without a first-time buyer, owners of starter homes cannot trade up to a larger home. Demand is negatively impacted across the full spectrum of homes. Older owners of larger homes seeking to downsize may find a dearth of buyers too.
Buying a home late in life has negative consequences. Homeowners who bought their first home between the ages of 25 and 34 had housing-related wealth of $149,000 versus half that amount for first-time buyers aged 35 to 44.
Housing Starts in June came in at an annual rate of 1.22 million, the weakest in two years. The good news is that starts of single family homes was up 3.5 percent.
The level of new construction, of course, is foretold by the number of permits issued. Unfortunately permits are down 6.6 percent year on year, with multi-family off by 10.2 percent and single family down 4.7 percent.
New Home Sales in June increased 7 percent following two months of falling sales. A 6.3 month inventory of new houses is in place, versus six months last year. The median sales price of a new home sold in June was $310,400, nearly the same as a year ago. While a highly visible part of the residential market, new home sales represent only about 10 percent of the total sector.
After a strong start in early 2019, Existing Home Sales weakened in June to 5.27 million. Single family resales fell by 1.5 percent followed, by a 3.3 percent drop in condominium sales. Prices improved by 2.7 percent. Rising prices attracted more sellers with the supply of homes increasing by 10 percent to 1.93 million units.
All in all, in spite of the solid fundamentals noted above, housing continues to be a drag on the U.S. economy.
Bottom Line: Performance in the sectors considered critical to the hardwood industry remains uneven:
- GDP enters its 11th year of growth powered by strong consumer spending.
- Employment Situation continues to list more job opportunities than people to fill them.
- Personal Income surprised to the upside by growing faster than initially measured.
- Manufacturing continues to cool from its August 2018 high.
- Housing continues to underperform in spite of solid fundamentals.
But perhaps the greatest unknown is the impact of the trade war with China.
TrendTracker’s Opinion: The U.S. economy appears to be growing, albeit at a slower pace.