Get ready equity investors.
You’re about to see something you haven’t seen for years – the return of capital spending in the United States.
That’s right, investment in buildings, plants, machinery, and equipment. It’s been a long time coming, but there are a number of factors that are helping to make it possible. Despite strong corporate cash flows, low levels of leverage, and historically cheap capital, companies have maintained low levels of capital expenditure since the financial crisis. It’s not hard to understand why many corporations have been very conservative with capital expenditures over the last few years: political uncertainty, ambiguous consumer demand, global recession fears, and the repercussions of the 2008 financial crisis. That’s enough to make even the most profitable companies think twice about putting capital to work. Recent corporate behavior has been driven more by investors’ thirst for yield. Companies have been putting capital towards increasing dividends or buying back shares; this, at the expense of capital investment. We believe this is about to change, and there are a few catalysts that I’d point out.
First, consider the historical perspective. Fixed investment as a percent of GDP has historically ranged between 16% and 21%. Today, it’s around 12.8%. At that level, the United States ranks #143 in the world…very close to Greece on the list. If you assume reversion to the midpoint, that’s around US$600 billion in investment spending! You’ve got changes in fiscal policy. The “budget bomb that wasn’t,” also known as sequestration, wasn’t the economy killer that many feared, but it did shave nearly 2% off GDP in 2013. Those impacts will start to fade in 2014. Then there are the grinding gears of time. Things are getting old, falling apart, and needing to be replaced. Look at some average-age analysis from the Bureau of Economic Analysis:
- Equipment – Current-cost average age is 7.4 years; that’s the oldest since 1995
- Lodging – Currency-cost average age is 17.3 years; that’s the oldest since 1963
- Manufacturing facilities – Current-cost average age is 23 years; that’s the oldest since…wait for it…1946.
- Powerplants – 25 years
If this capital spending scenario comes to pass, there are a few likely sources of spending: consumer, corporate, and non-residential construction. And during the most recent recession, each of those categories of spending dropped to their lowest levels in 60 years.
Consumers will likely direct their investment at housing, home improvement, home furnishings, and appliances. Personal credit histories are undergoing rapid repairs, personal balance sheets are stronger than they’ve been in years, and we’re seeing early signs of credit expansion.
Corporations are sitting on two things: a mountain of cash and a ton of aging assets (see bullets above). Here are a few things to look for. Expect to see aerospace and defense companies to benefit from their customers replacing aircraft with more fuel-efficient models. Spending on infrastructure for the shale gas boom will be the wind in the sails of energy companies. IT spending should be directed towards a shift from device-centric to cloud-based models. Manufacturing is in the midst of a renaissance driven by 3-D printing and robotics, both areas of growth for cap-ex spending. Spending in the auto industry will be primed by fuel economy gains and infotainment (think ‘screens’ and ‘driver interactivity’). Consumer goods companies should see spending directed at building out capacity for e-commerce and non-cash payment trends.
As for non-residential construction, consider that the American Society of Civil Engineers estimates that over US$3.6 trillion of infrastructure spending is needed in the United States over the next seven years. Contemplate that and think about what US$3.6 trillion of airports, roads, bridges, electric grids, and water treatment plants looks like.
Those are a lot of arrows pointing in the direction of a comeback for capital spending in the United States. The trick will be getting ready and positioning to take advantage of it.
The information in this article has been derived from sources believed to be accurate as of March 2014. Information derived from sources other than Principal Global Investors or its affiliates is believed to be reliable; however, we do not independently verify or guarantee its accuracy or validity.
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