Four Reasons Businesses Could Begin Spending Again Soon

Despite record profits and exceptionally high corporate cash levels, capital spending by U.S. businesses remains subdued.

While companies clearly have the means to invest, they lack the confidence in the face of a still nervous consumer and uncertain end-user demand. In other words, low confidence and an unusual amount of policy uncertainty are likely impeding corporate spending. In addition, capital spending has also been kept in check by the lackluster nature of the recovery.

However, as I write in my recent Market Perspectives paper “Sitting on Cash,” four interrelated reasons suggest capital spending may marginally improve this year.

Improving consumer confidence. Despite the government shutdown and unimpressive recovery in the labor market, consumer confidence, while low, is improving. During the back half of 2013, the Conference Board’s measure of consumer expectations averaged a little below 78, a material improvement from the previous four years when this measure of consumer sentiment averaged below 60. While today’s levels are still far below the long-term average, they are heading in the right direction.

Better economic growth. I expect the U.S. economy to grow by at least 2.5% this year, above last year’s 2% rate. This should provide CEOs and CFOs with greater conviction on end-user demand.

Normalization in real interest rates. The improving economy is leading to a normalization in real interest rates, which suggests higher rates of return on investment. In fact, to the extent the macro environment continues to improve and the Federal Reserve (Fed) exits its quantitative easing (QE) program by year’s end, I would expect real long-term yields to continue to normalize, a development that in the past has been associated with higher levels of capital spending.

Companies have little choice. While still relatively low by official estimates, capital utilization rates are probably overstating the amount of excess capacity, given the rapidly aging nature of the capital stock. In short, we are likely to see an increase in capital spending because in many industries, there will be little choice.

Given the above trends, my baseline expectation for 2014 is that capital spending continues to improve, a trend that was already evident in the latter part of 2013.

So why does this matter for investors? To the extent there is even a modest pickup in capital spending in 2014, this should help support U.S. equity market valuations. In terms of specific beneficiaries, I believe capital spending is likely to be led by financial, telecom and service industries. This suggests that technology stocks may be beneficiaries if capital spending begins to accelerate.

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog and you can find more of his posts here.

Source: BlackRock research

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