License
to Spend
In
our 2012 Outlook we wrote, “U.S. gross domestic product (GDP) is likely to
produce below-average growth of about 2% in 2012, supported by solid business
spending and modest, but stable, consumer spending” and that U.S. business
spending would grow at several times the pace of consumer spending in 2012.
With data on GDP now in hand for the first quarter of 2012, it appears that
business capital spending has plenty of catching up to do over the final three
quarters of 2012. While businesses have been generating record profits, leaving
corporate cash flows close to all-time highs, they have been reluctant to add
to staff or do much capital spending in early 2012, preferring other uses for
their cash.
The Skills to Pay to the Bills
· Acquire other
companies.
Merger and acquisition (M&A) activity, while nowhere near as robust as it
was prior to the Great Recession, has ramped up quickly since the end of the
recession. Global M&A activity has increased by close to 40% since the
middle of 2009, according to Bloomberg data.
· Initiate or
increase dividend payments to shareholders. According to Standard &
Poor’s Index Services, 677 companies either initiated or increased dividends to
shareholders in the first quarter of 2012, the most in any first quarter since
2007. S&P 500 companies paid out $240 billion in dividends to shareholders
over the four quarters of 2011, the best four quarters for dividends since the
four quarters ending in the third quarter of 2008, when many financial
institutions slashed or eliminated their dividends as the Great Recession
worsened. As we have noted in prior commentaries, corporate dividend strategies
face uncertainty at the end of this year as the Bush tax cuts (which put the
tax rate on dividends at 15%) are set to expire. Many firms may want to issue
special dividends ahead of this date, thus diverting funds that could be used
for capital spending.
· Buy back shares. According to
Standard & Poor’s Index Services, share buybacks, another way companies can
deploy cash to shareholders, totaled $409 billion for S&P 500 companies in
2011, a 40% increase from the $299 billion in buybacks in 2010. The year 2011
saw the most buyback activity since mid-2008, prior to the onset of the worst
of the Great Recession in the fall of 2008. Although share prices have
increased 25% since the fall of 2011, making it more expensive for corporations
to buy back shares, share buybacks should at least match 2011 levels in 2012.
Legislation and Weather May Have Sabotaged Business Capital
Spending in Early 2012
Part
of the slowdown in business capital spending in early 2012 relative to the
robust pace seen in 2011 (and to the pace of consumer spending) may have been
related to legislation and the weather. As we have discussed on several
occasions in these pages, the much warmer-than-usual weather in the first three
months of 2012 likely pulled forward some consumer spending into the winter
months from the spring months, artificially boosting consumer spending, which
grew at a 2.9% annualized rate in the first quarter. Business capital spending,
which is not as weather sensitive, grew at just a 1.7% annualized rate in the
first quarter of 2012.
The
slow pace of business capital spending growth in the first quarter of 2012, in
part, reflects the strength in capital spending in late 2011 which, in turn,
may be related to legislation. Business spending was strong in 2011, especially
in the final two quarters of the year, as spending rebounded from the supply
chain disruptions triggered by the devastating earthquake, tsunami, and nuclear
disaster in Japan in March of 2011. Business capital spending surged by 16% and
8% in the final two quarters of 2011, respectively, and increased by 10% over
2011. The year 2011 marked the second consecutive robust year of business
spending, after business spending all but dried up in 2007, before declining
sharply in both 2008 (4%) and 2009 (-16%). Business capital spending surpassed
its previous all-time high (set just prior to the onset of the Great Recession)
in the third quarter of 2011, and continued to set new all-time highs in both
the fourth quarter of 2011 and the first quarter of 2012.
As
noted above, part of the surge in business capital spending in late 2011 may
have been related to legislation passed by Congress in December 2010, which
allowed businesses to fully expense (for tax purposes) capital equipment
purchased before the end of 2011. This probably pulled some capital spending
that would otherwise have occurred in early 2012 into the latter half of 2011.
The law allows companies to expense only 50% of capital equipment purchased
before December 31, 2012 and, as the law stands now, even this provision would
expire at the end of 2012, as part of the “fiscal cliff” we have discussed in
recent weeks. This uncertainty may have the same impact on business spending
this year, especially as we approach the 2012 Presidential and Congressional
elections.
Check it Out: What May Boost Business Capital Spending
Throughout 2012
Moving
beyond legislation, many of the factors we forecast would be in place in 2012
to continue to boost capital spending remain in place. They include:
· Record cash
levels.
The aforementioned record level of cash and corporate profits, combined with
very low rates of return on these cash assets, is forcing corporate boards to
ask corporate managements to put the cash to a more productive use.
· Near-record low
financing rates for businesses. The Federal Reserve (Fed) has promised
to keep rates at “exceptionally low levels” until at least 2014. In addition,
the Fed’s Operation Twist has kept long-term rates lower for longer, aiding
both business and consumer borrowers
· Steadily
increasing loan growth. Commercial and industrial loans by banks to
businesses, a key weekly metric of bank lending activity, is at a three-year
high, and is up more than 13% from a year ago, the strongest pace of growth in
nearly four years.
· Gradually easing
lending standards.
Lending standards for loans by banks to finance capital spending, especially
for commercial real estate, are easing, though still tight. As noted above,
corporate revenue is again growing strongly and is generating large amounts of
free cash that is available to finance investment. Yet, tight credit markets
are limiting the ability of small and medium-sized companies, generally those
without access to financial markets, from taking on new investment projects.
· Equity prices. The 100%-plus
gain in equity prices over the past three years and the 25%-plus gain in stocks
over the past six months are notable. No sector of the economy is more highly
correlated with movement in equity prices than business capital spending.
Further gains in equity markets should fuel more capital spending over the
remainder of the year.
·
“Onshoring”
trend.
We have observed ongoing anecdotal evidence of “onshoring” of jobs, especially
in the manufacturing area. Aided by: 1) poor quality control in China, 2)
relatively high unemployment, and lowered wage and benefit demands in the
United States, and 3) the low cost of fuels like natural gas to help run the
plants, an increasing number of big and small companies have moved production
back to the United States in recent quarters. Political considerations are also
hastening this trend.
· Capital for
labor.
An ongoing substitution of capital for labor is occurring, as businesses
continue to compete globally using the latest in technology and production
processes. In addition, adding new workers often involves paying benefits along
with salaries. New machinery, of course, does not require benefits like health
care.
· Average age of
productive infrastructure at multi-year highs. The average age of the nation’s
productive infrastructure is at multi-year highs, especially in traditional
manufacturing, but in many other areas as well. Industries including
transportation and warehousing, wholesale trade, retail trade, accommodation,
and food services all have seen the average age of their productive
infrastructure hit new multi-decade highs since the onset of the Great
Recession, as businesses cut investment to protect their shareholders in the
downturn.
The
sweeping regulatory and legislative changes and prospects for additional
changes, affecting sectors such as Financials, Energy, Utilities, and Health
Care, that took place in 2010 are fading and may even be reversed — with the
outcome of the 2012 election. Therefore, in 2012, business spending may
continue to enjoy what may be a new multi-year cycle supported by this clearer
regulatory and legislative environment.
__________________________________________
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are
not intended to provide specific advice or recommendations for any individual.
To determine which investment(s) may be appropriate for you, consult your
financial advisor prior to investing. All performance reference is historical
and is no guarantee of future results. All indices are unmanaged and cannot be
invested into directly.
Gross Domestic
Product (GDP) is the monetary value of all the finished goods and services
produced within a country's borders in a specific time period, though GDP is
usually calculated on an annual basis. It includes all of private and public
consumption, government outlays, investments and exports less imports that
occur within a defined territory.
Federal Funds Rate is
the interest rate at which depository institutions actively trade balances held
at the Federal Reserve, called federal funds, with each other, usually
overnight, on an uncollateralized basis.
Private Sector – the total nonfarm payroll
accounts for approximately 80% of the workers who produce the entire gross
domestic product of the United States. The nonfarm payroll statistic is
reported monthly, on the first Friday of the month, and is used to assist
government policy makers and economists determine the current state of the
economy and predict future levels of economic activity. It doesn’t include: -
general government employees - private household employees - employees of
nonprofit organizations that provide assistance to individuals - farm employees
The economic
forecasts set forth in the presentation may not develop as predicted and there
can be no guarantee that strategies promoted will be successful.
This research
material has been prepared by LPL Financial.
To the extent you are
receiving investment advice from a separately registered independent investment
advisor, please note that LPL Financial is not an affiliate of and makes no
representation with respect to such entity.
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