Like many other categories of gross domestic product (GDP), business capital spending in the economic recovery that began in mid-2009 has lagged other recoveries. Seven years in, inflation adjusted business capital spending (also known as capital expenditure or capex) has increased by only 33% from the depths of the Great Recession. In contrast, the average gain in business capital spending in the other three economic expansions that have lasted seven years or more (those beginning in 1961, 1982 and 1991) at this point in the cycle was 62%.
The poor performance of business capital spending in this business cycle can be partially explained by the near historic drop in energy prices between mid-2014 and early 2016. Bur even outside of energy, corporations have been reluctant to spend on new plant, equipment, and research and development in this recovery (R&D). This reluctance is one of the key factors holding down post-Great Recession productivity growth, which, in turn, is causing overall GDP to lag prior recoveries; but perhaps even worse, it may be jeopardizing future growth as well.
Business spending on structures, one of the three major components of capex, has decreased overall (down 6% since the recession trough) and currently represents a smaller portion of overall spending. At the start of the current economic expansion in the second quarter of 2009, business investment in structures accounted for roughly 30% of all business spending. Today it accounts for just 20%.
Business spending on equipment, the second of the three major categories of capex, has increased by 65% over the same time frame. However, that still puts it behind the nearly 90% increase in the category at this point in other recoveries.
The final category of business capital spending is intellectual property, which can be thought of as business spending on R&D. Companies spent an annualized $700 billion on R&D in the second quarter of 2016, a disappointing 30% higher from the recession low of $549 billion. This category is the platform for economic growth, more business spending and higher productivity later on. To put the 30% gain from the recession low in perspective, spending on R&D in the prior seven years of comparable recoveries had increased 78%. Spending in this category includes computer software, chemicals, pharmaceuticals, computers and semiconductors, aerospace and defense, and motor vehicles. It also includes intellectual property (IP) developed by non-profits, educational institutions, and entertainment related IP in TV, film and the internet. Although the U.S. is among the world leaders in this type of spending, the slow pace of R&D in this business cycle is a concern.
Looking at all the major categories of business capital spending, only one component is running ahead of the pace seen in prior recoveries – transportation equipment. It has seen a 300% increase in spending, far exceeding the gains seen in previous expansions. Recall, however, that two of the three major U.S. auto companies were in bankruptcy as this expansion began.
The slowdown in potential GDP growth in the U.S. is due in large part to the growth rate of productivity. Wise investments by businesses (and governments) today are laying the foundation for future economic growth. While the U.S. remains above average among developed economies in the percentage of GDP dedicated to R&D, it lags global competitors like Germany, Korea and Japan.
We ask – with the average age of the capital stock at 50 year highs and interest rates low, corporate interest burdens low and corporate cash levels near records – why haven’t businesses invested more during this business cycle. Confidence (or lack thereof) in the economic recovery is clearly holding back investment. Fear of another recession has kept plenty of businesses from drawing down their cash piles to invest. A lack of clarity on the regulatory front has not helped, either. Surveys of small business owners consistently list “too much regulation” as a growth impediment. Businesses have, however, been hiring, making acquisitions, paying out dividends, and buying back stock.
Ultimately, business’ confidence – driven by certainty and clarity on many fronts – helps to determine the path of business capital spending. For businesses to open their wallets and spend, they need to believe the business cycle is still strong; that the legislative, tax and regulatory environment is capex friendly; that rates will remain low; and that their investment will pay off for their employees and shareholders. Business must have the confidence to spend now to enable the economy to thrive in the future.
The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. 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.
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Data provided Bloomberg and Gary Schilling.
- Bonds are subject to rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
- High yield/junk bonds (Grade BB or below) are not investment grade securities and are subject to higher interest rate, credit and liquidity risks than those braded BBB and above.
- The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.
- Indices are unmanaged and cannot be invested into directly.
- All investing involves risk including loss of principal.