The stomach-churning ride heavy equipment manufacturers have been on the past couple of years would prompt even the most ardent thrill seeker to slam on the breaks. Construction equipment firms saw their sales and profitability skyrocket during the housing and commodity booms as customers purchased new construction and mining equipment with a seemingly insatiable appetite. Those sales figures then came crashing down after construction activity halted and commodity prices were slashed. Similarly, agriculture equipment manufactures witnessed unprecedented demand for new tractors and combines as crop prices soared and farmers' wallets became laden with cash. Yet these firms too now find themselves in the midst of a global demand drought. So with the recent signs of improvement in the economy's leading economic indicators, are we likely to see a swift snapback in heavy machinery sales? In our view this appears unlikely, at least over the near term.

A catalyst for new construction equipment sales will take time to play out.  U.S. residential housing starts continue to hover around their paltry historic lows despite reaching an apparent bottom in early 2009. We expect modest recovery in residential building activity from here, but it could take at least a couple of years before we get back to more normalized build rates. Meanwhile, non-residential construction activity in the U.S. continues to contract and the international construction boom has been derailed due to substantial credit constraints. This is weighing heavily on new equipment demand. Non-residential construction could remain depressed for several more quarters as this sector tends to lag economic recoveries. As the economy slowly nurses itself back to health, construction activity in both the residential and non-residential sectors will eventually improve and demand for heavy machinery will pick back up. However, with the feverish pace manufactures like Caterpillar (CAT) and Terex (TEX) were churning out equipment before the recession, the pick up in machinery sales may be muted initially as the industry works through what we believe could be an oversupply of new and used equipment already in the market (a sizable portion of which is likely idle at the moment). But like the housing market, we expect the construction equipment industry to slowly work through its inventory overhang before resuming its upward growth trajectory by late 2010 or early 2011.

The hit to farm incomes in 2009 will trigger a pause in agriculture equipment demand. The farming sector was able to stave off the full brunt of the current recession longer than most.