Consumer Spending Bodes Well for Plastics in 2006

You can’t stop Americans from spending, but sometimes they do slow down. And since the vast majority of plastics products ultimately wind up in the hands of consumers, it is important for processors to monitor their spending trends. After adjusting for inflation, total U.S. personal consumption expenditures expanded a moderate 3% in the fourth quarter when compared with the same period from a year earlier. This was just below the long-term average growth rate, but the outlook calls for growth in consumer spending to accelerate gradually through the next few quarters. For 2005 as a whole, real consumer spending escalated 3.6% compared with 2004. Our latest forecast calls for a rise of another 3.5% to 4.0% in 2006.

This forecast is based on a continuation of the trends in the fundamentals that drive consumer spending growth. These include: a strong labor market; elevated consumer confidence levels; a rising stock market; and moderating energy costs. The Fed will raise interest rates at least once or twice more this year, and this will impede the momentum for many types of consumer spending. But rates will remain relatively low by historical standards, and according to the Fed’s survey of loan officers, banks remain eager to lend.

One area of concern in the recent data was the substantial decline in consumer expenditures on motor vehicles that occurred in the fourth quarter. The latest data indicate that spending in this category fell by nearly 18% when compared with the previous quarter. One of the reasons for this drop is that many of the incentive programs auto manufacturers offered earlier in the year were not available to car buyers in the fourth quarter. So much of the growth in spending on autos that occurred in the second and third quarters came at the expense of growth in the fourth quarter.

Another factor was that many of the cars purchased in the fourth quarter were less expensive and more fuel-efficient models. For the first time in several years, the number of autos assembled in the U.S. increased at the end of last year while the number of light trucks (the category that includes SUVs and mini-vans) assembled actually declined.

Early estimates put the overall inflation-adjusted GDP growth at an anemic annual rate of 1.1% in the fourth quarter. This will likely be revised upward in the coming months, but it will still remain well below the 4.1% rate posted in the third quarter. Along with the sharp downturn in consumer spending on durable goods, the deceleration in real GDP growth in the fourth quarter also reflected a one-time downturn in federal government spending and a rise in imports of goods (imports are a subtraction in the calculation of GDP). But the good news is that the rate of real economic growth will rebound early in 2006, and for the year as a whole the U.S. economy will grow at nearly the same rate as total consumer spending, another 3.5% to 4.0%.

The biggest risk to this forecast continues to be high energy prices. As 2006 started, there was a well-established downtrend in the price of natural gas, but crude oil prices remained volatile and subject to ongoing geopolitical problems. The supply and demand fundamentals for these markets indicate a gradual decline in the price of all petroleum prices in the coming months, but the markets are wary of persistent political issues in some of the Middle Eastern, African, and South American oil and gas producing countries. And there is still a substantial amount of domestic production that remains stubbornly shut down as the result of last year’s hurricane damage.

Surprisingly, inventories of natural gas are 25% higher right now than they were at this same time a year ago, and they are also nearly 40% above the five-year average for this time of year. With much of the heating season behind us, it is doubtful there will be enough cold weather to pressure the natural gas markets for a sustained period of time. So natural gas prices should decline as 2006 progresses.

Other important economic indicators portend continued improvement in the U.S. economy and the plastics industry through 2006. A major indicator of consumer demand for plastics goods, especially packaging products, is the trend in retail sales. Total retail sales (minus autos) were up a vigorous 9% in 2005. This growth rate will decelerate gradually as 2006 progresses, but not by much. Total retail sales are forecast to advance another 7% in 2006.

And finally, the foreign exchange markets remained favorable to domestic manufacturers as 2005 came to an end. The record-high U.S. trade deficit in the fourth quarter indicates that the dollar should start to decline again in 2006. The monthly average for the U.S. Dollar Index was almost exactly the same in 2005 as it was in 2004, but the huge gap that currently exists between exports and imports will keep downward pressure on the dollar. The gradual decrease that is expected to prevail this year will make imports more expensive, and it will make U.S.-made goods less expensive overseas. The average value of the dollar in 2006 will be 5% lower than it was in 2005.