John Lynch Chief Investment Strategist, LPL Financial
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Increased business capital expenditures, or “capex,” remain one of the most important pieces for improving the long-term growth trajectory of the U.S. economy. Capital expenditures help increase productivity, and improved productivity is the foundation for sustainable higher growth for developed economies. Both survey and hard data continue to confirm that we might be seeing a rebound in capex, but how can we know it’s sustainable? The answer may be in our beach reading. Like the veteran detective in a favorite page-turner, we look for means, motive, and opportunity. For capex spending, means translates to additional sources of funding for projects, motive comes from increased business confidence and tight labor markets, and opportunity from fiscal incentives and global growth.
THE SETTING: HARD DATA, SOFT DATA
Clues that capex may be rebounding have been increasingly apparent in both surveybased “soft” data and in “hard” data that represent actual economic activity. One of our favorite soft data indicators is the new orders component of the Institute for Supply Management’s (ISM) Manufacturing Purchasing Managers’ Index [Figure 1], which tends to be a leading indicator both for capex and the overall economy. While off its recent peak in December 2017, it’s held above 60 for 13 consecutive months (above 50 indicates expansion), the longest sustained level of strength since 2004.
We are also starting to see the impact of that change in the hard data. Shipments of non-defense capital goods ex-aircraft flows, the best proxy we have for actual capex investment, have been accelerating since the end of 2016 [Figure 2]. While the acceleration has only taken the level of shipments to where it was from 2012–2014, we believe further gains are possible. But in order to get there, means, motive, and opportunity must all be in place.
MEANS, MOTIVE, AND OPPORTUNITY
Means for a business is about access to cash, which can be from cash on hand, cash flow from operations, or borrowing capacity. Right now, there’s potentially additional cash available across the board.
- Lower taxes – Lower corporate tax rates following the passage of the Tax Cuts and Jobs Act of 2017 have allowed companies to keep more of the profits they earn, which may then be put to use, potentially by investing in capex.
- Repatriated profits – The tax law also allows companies to bring home overseas profits (“repatriation”) at reduced tax rates, which may make added funds available for investment. We estimate that as much as $500 billion in profits held abroad could be brought back to the U.S. under this provision.
- Supportive financial conditions – While financial conditions have tightened somewhat, interest rates remain historically low and lending standards reasonable for growing companies.
While businesses may have more cash at their disposal, there are many potential uses for that cash outside of capex. Companies can use it to increase dividends, buy back their own stock, or reduce debt. They could increase salaries as competition for labor intensifies, or even just let it gather interest given the slow normalization of interest rates. More available cash will have businesses looking for potential opportunities, but having additional means won’t do the job. Motive and opportunity also matter.
Companies are motivated to invest by both the need to find ways to boost productivity and the confidence that it’s a good time to invest.