A US Recession Will Not Slow the FPD Progression

The day after Labor Day, the three-day weekend marking the end of summer in the USA, the Standard & Poor’s 500 Index closed up 1.1% and the NASDAQ Composite Index closed up 1.3% on its steepest four-day rally in four years. Apparently, investors shrugged-off news that residential construction spending fell 1.4% in July and may fall as much or more in August because the Federal Reserve Bank hinted it might reduce interest rates. On the following day, August 5, investors headed for the exits, roiling the markets yet again. The plain fact is that the historical record shows that the consumer-driven cycle of home construction and sales leads the US economy into recessions. Edward Leamer, Professor of Management, Economics and Statistics at UCLA, explained this dynamic in his paper “Housing and the Business Cycle” presented at a symposium sponsored by the Federal Reserve Bank of Kansas City last week. If history is any guide, the US is headed for a recession and there is little anyone, even the Fed, can do about it.

The question pertinent to DisplaySearch subscribers is how a US recession may affect the FPD industry. I believe any negative effect of a US recession on the flat panel display industry would be mild over the mid-term for four reasons:

The US recession is national, while the FPD industry is global. As shown in the DisplaySearch Quarterly Global TV Shipment Report, two-thirds of LCD and PDP TV set sales occur outside North America. The share of units sold in the US is less than one-third. Consumer demand outside the US is growing faster than domestic demand is.

Financial markets will roil for a while longer, but the global consumer market will be more sensitive to monetary policy. My interpretation of events is that the US Fed held interest rates too low for too long after the dot-com bubble burst. Tax cuts added additional stimulus to the demand for home loans (and construction). As a result, demand that would otherwise appear in 2006–2008 appeared in 2003–2005. Rising supply and demand created a tsunami that has finally crested. The surge in home loan defaults is the foam and froth we see as the wave breaks. The size of the wave was determined by decisions made earlier in the decade and the wave action will follow its natural cycle. The good news is that it is a cycle and that there will be a recovery; residential housing usually leads the recovery several quarters after a recession begins. Monetary policy is the bigger worry. The way emerging powers like China or India invest their foreign currency reserves, develop their bond markets and manage inflation will have long-term effects on US consumers. For example, if the Euro became the currency of choice and oil contracts were no longer settled in US dollars, US consumer purchasing power would be weaker and more uncertain over the long term. There are many possible monetary futures unaffected by a cyclic recession in the USA.

Discount retailers are increasing US consumer purchasing power. Recent analysis by DisplaySearch shows the market share of flat panel TV sets sold through discount channels such as Costco or Wal-Mart has been increasing. In addition, we see FPD supply chains becoming leaner and shorter; LCD TV assemblers increasingly use PC market strategies and methods to reduce cost and time to market. This implies that consumer prices can continue falling even if panel prices stay flat. In reality, panel price per square inch of display area will continue declining, albeit more slowly than in the past. US consumers will see increasingly attractive price propositions. More important, buying a new notebook PC or flat-panel TV is not the same as buying a new house or a new car. Consumer durables may be hit hard by a recession. August sales figures already show the trend. However, there is a 100X difference between the price of a portable PC and a pick-up truck. A flat-panel TV is more of a “must-have” product for most consumers. New cars or homes replace old cars or homes, but new LCD TVs displace old CRT TVs.

Large panel makers are becoming more prudent. After capacity expansions in the 50-60% range during 2005 and 2006, we see TFT LCD capacity expanding in the 20-30% range this year and for several years to come. Most of this new capacity will serve TV demand. The PC market is maturing but the portion of notebooks is gaining on desktops. Notebook displays are smaller than monitor panels are, so the average PC panel size is growing only 2% a year. Larger glass fabs are not required; producers can meet PC panel demand by reallocating capacity in existing plants. Moreover, demand elasticity relative to price for PC panels is about one, meaning that any decline in price stimulates only enough demand to keep revenue constant. Producers have little incentive to over-produce and their recent behavior indicates they realize this. Supplier shipment targets for 2H’07 obtained by DisplaySearch show a planned slow-down going into Q1’08, which further indicates that panel makers and their customers are learning how to manage prices and inventories. In addition, much of the mid-term expansion we forecast will come from investments made by vertically integrated companies like Samsung or Sharp, who rely less on merchant panel sales. I therefore believe the FPD industry faces less risk of “irrational exuberance,” as Alan Greenspan might say, than it did in the past.

In closing, 2007 is going to be a good year for the FPD industry and 2008 may be even better. As President Roosevelt said, “…the only thing we have to fear is fear itself.”