Where is the CapEx?

PmiIts been said that all Generals fight the previous war. That tendency is alive and well in corporate boardrooms today — and Capital Expenditure spending is a perfect example of that.

Throughout this entire post-crash bull market, business spending never really materialized in a major way. It rose and fell, with PMI peaking in 2003 at about 64 — but it simply didn’t ramp up the way many of the bulls had promised (especially if you back out military spending). 

That’s a curiosity worth exploring.

After the market crash of 2000-03, business execs remained unusually cautious in their spending and hiring plans. Even after rates were slashed, the dollar lowered, and the economy picked up, CEOs remained especially timid in their use of corporate cash for business purposes.

What we saw instead was a growing use of do-re-mi for financial engineering goals. Less R&D, more sharebuybacks, decreased hiring, greater dividends. That continues to this day, even as we have heard from some strategists who have been insisting for 3 years that Business CaspEx is about to increase.

The general capex spending we have seen has been very specific to efficiency improvements. If it doesn’t have an ROI of 100% over three years, no one seems very interested. Hence, Business Intelligence software has become a hot seller, as has CRM and other related, measurable purchases.

Some of the risk aversion to spending can be explained by just-in-time delivery, and better control of inventories. But only some.

Our own theory (back in 2003) was that Shell Shocked CEOs were afraid to spend on anything that might hurt their quarterly numbers; They had become so very short term in nature — more so than usual — as they were still stunned by the carnage of the 2000 crash. The brutal destruction of share prices and the turmoil caused by mass layoffs is not something any CEO or CFO wants to live through twice. Hence, the skittish cautiousness.

Four years later, and the short term fears remain. Today’s WSJ looks at this issue in the corporate sector, and asks "Where Art Thou, Business Spending?"

"Business spending was supposed to save the economy from the housing downturn. That lifeline would come in handy right about now.

In the fourth quarter, business investment in equipment and software registered its largest drop since 2002. And it doesn’t seem to be picking up. The Commerce Department reported last week that orders for capital goods excluding aircraft and defense orders — an important barometer of investment — were lower in February than in December.

Investors, rubbernecking the housing wreck, have paid little attention to this problem. But the Federal Reserve is concerned. Speaking Wednesday before Congress, Fed Chairman Ben Bernanke highlighted the weakness in business spending, and admitted some bafflement about what’s behind it.

Businesses are flush with cash. A lot of investors and economists thought business would use the cash to ramp up equipment spending and that this would help counter a weak housing market."

Why does this matter so much? According to Dallas Fed economist Evan Koenig, "when orders for durable goods — which include capital goods and other long-lasting items — fall, as they have been, it often presages a drop in factory employment." Add to that housing downturn and related Job loss in construction, and you have a formula for a weakening Labor market.

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Source:
Where Art Thou, Business Spending?
Justin LaHart
WSJ, April 2, 2007; Page C1
http://online.wsj.com/article/SB117547237002456331.html

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What's been said:

Discussions found on the web:
  1. Rick Hanley commented on Apr 2

    Top managers can get too rich, too fast. In a world that is so dangerous, these guys aren’t taking any chance to wait on their rewards to build companies. The mind set has gone to hell. A positive step, perhaps not a trend, is the ‘clawback’ provision that Intel (I think) has included for top managers. The company can take back bonuses that it turns out really were not earned (lies, dirty lies in the income statement). We may have let the short term thinking get a little too entrenched.

    Has anyone seen the dirty little lie on Bloomberg that says that stocks are the best buy in 20 years?

  2. Lauriston commented on Apr 2

    yeah, I had a good laugh when I saw that “filthy” lie on Bloomberg comparing bond yields to earnings when we know any CEO can make anything out of a set of number! Whoever wrote that piece has good sense of financial humor :)

  3. Francisco commented on Apr 2

    Barry,

    I’m a long-time reader from Portugal and although your articles are often quite self-explanatory, i do have a couple of questions on your recurrent stance on the macro front…

    Agreeing with most of your reasoning, i’m left with one question: How do you then explain the overall health in labour markets (should they not have been impacted after 3 years of limited capex growth)?

    One other interesting point would also be how to read the resilient consumption and private expenditure figures we’ve been having over the past year, despite the continuing downtrend in housing and higher interest rates…

    keep it up !

  4. Fred commented on Apr 2

    Barry…I remember that you respect David Kotok’s work. He wrote a piece today that suggests a coming pick up in tech capex.

    The backdrop for this change in spending lies in (the current) flat earnings growth.

    “Flat corporate profits have an optimistic side. They forecast an upsurge in the tech sector.

    History shows that corporations spend on hardware and software upgrades when profits are flat because they want to raise their productivity. Tech investment is a quick pay back for capital investment. This was true in the mid-80s (1984-7) cycle and again in the early 1990s (1989-1992).

    …Business has amassed a lot of cash and will spend it vigorously to maintain a high profit share. The tech sector has produced an entire new generation of software and the hard assets to run it. And IPv6 rollout will rapidly expand telephony and related 3G devices.”

  5. Tom B commented on Apr 2

    Your blog today goes a long way towards explaining why the jobs picture has been WAY worse than the official numbers suggest. I work in a research-intensive field and I have seen a VERY weak market with regards to R&D hiring these past few years. I guess I see lots of people like me–scientists and professionals– struggling.

    Venture capital investments have also been weak and IPO’s thin.

  6. Michael Schumacher commented on Apr 2

    Fred-

    Those articles have appeared, in some form or another, for the last 5 years. I’ve grown tired of waiting for this spending to materialize and each and every time it does’nt. As far as spenidng to increase productivity. I suggest you look at the numbers as I can’t quite see how capex spending is going to increase productivity. Each and every time we get increases in productivity it usually has stemmed from lay-offs at most of the reporting companies.

    You can’t keep squeezing workers to produce more as you are decreasing the amount of them and expect a new conputer here or there to pick up the slack in not hiring any new workers.

    Just because some CEO syas they will some writer takes it as it’s already happened.

    I won’t be holding my breath again waiting for it to appear. Gotta protect those margins and capex spending does nothing but erode them in the short term…..where alot of there thinking is now centered.

    Ciao
    MS

  7. Grigoriy commented on Apr 2

    Barry, what about looking at the
    yield curve?

    The inverted curve is always looked upon as a reseccion sign, but clerly there is more in it.

    If i am, say, a bank, and i have a portfolio of bonds and a also lend money to people and enterprises.

    If demand for loans is high, i sell my bond holdings with corresponding maturity, to get money, or hedge it with futures, effectively doing the same impact on the bond market.

    So we can argue that inverted or flat curve is a sign of a high demand for short term speculative money, which is a sign of overheating and a potential buble forming, and also the sign of absence of demand for long term investment money.

    While a very steep curve shows that corporations are investing heavily.

    Now we are precisely in this situation, and it’s no wonder there is no capex – the curve showed it us a long time ago.

    While this may sound to vague, i’ve done some simple econometrics and the steepenes of the curve shows statistically significant relationship with future returns of stockmarket, measured as an average return in a year to come.

    May be it’s all textbooks, and everyone knows that, but inventing a bicycle means you have some talent for engenering:)

  8. Philippe commented on Apr 2

    The Capex is a budget item and subject to economic events and management’s estimations of these datas.

    Japanese industrialists are said to increase their capex for the fiscal year to come and European industries capex remains to be seen.
    For the USA the latest industrial survey January was pining hopes in an increase capex to compensate for the recession in many industrial sectors.

    This time Bloomberg article was more realistic

    “Fed policy makers, led by Chairman Ben S. Bernanke, last week stuck to their view that the economy will keep expanding “at a moderate pace.” Their most recently published minutes, from the January meeting, indicated that while business investment had proven weaker than anticipated, they still expect improvement before year’s end.

    Private economists may not be so sanguine. They have cut their forecasts of business spending three times since December, and now expect it will grow this year at the slowest pace since 2003, according to surveys by Blue Chip Economic Indicators. That’s after expenditures on equipment and software fell last quarter by the most in four years.”

  9. M.Z. Forrest commented on Apr 2

    Foreign capex has a tendency to grow less than domestic capex. I remember talking with an IT consultant out of Canada, and he remarked to me how different the US and Canada were in handling IT projects. In Canada, IT projects were significantly more likely to get axed after the project had been approved. This was due to IT projects being re-evaluated at various points during the project, including re-evaluating the economic assumptions over how much productivity would be improved.

    BTW IP6 will revolutionize technology about as much as the 9-digit zip code revolutionized the postal service.

  10. Tom B commented on Apr 2

    “BTW IP6 will revolutionize technology about as much as the 9-digit zip code revolutionized the postal service.”

    Whom do you believe will benefit?

  11. Fred commented on Apr 2

    Michael,

    I respectfull disagree, but understand your frustration over the last 5 years poor tech capex. After the Y2K hype, and subsequent collapse in spending, CIO’s have kept the wallet on the hip for obvious reasons — save cash. That can’t (logically) last forever. If you don’t spend to upgrade your business, you will lose market share…and once lost, much more dificult to regain it back.

    “I can’t quite see how capex spending is going to increase productivity. Each and every time we get increases in productivity it usually has stemmed from lay-offs at most of the reporting companies.”

    The examples (in time) he gives are where true tech investment increased productivity…this productivity we have been enjoying since. They have squeezed out about the max they can, and employee cuts were (and have been) the logical by product of that process (the last stage). Yet, we’re now at a point where new initiatves are becoming available where a whole new round of efficiencies will be available. Those that ignore that will get left behind. This is obviously a minority opinion (see the tech valuations to verify) and is a bet I’m gladly making. The best secular bets are often scoffed at, and can be scary to make.

    I believe we’re on the cusp of a new leg of the “s” curve of technology. I recognize that this is a variant view.

    I also subscribe to GaveKal’s platform company model which explains why higher margins have been achieved.

    (From John Maudlin) “GaveKal calls this new model “platform companies.”

    The old model was to design or find something, manufacture it, market it and sell it. (Think Ford, Caterpillar, 3M, oil, mining.) The new model keeps just the high value added parts and ditches the rest. The new model focuses on research and development, treasury, marketing, and the business process and out sources as much of the low margin work as possible. Think Dell, Wal-Mart, IKEA, Li and Fung. Most hotel chains now do not own their properties.

    The new model is to “produce nowhere but to sell everywhere….Platform companies know where the clients are and what they want and where the producers are. Platform companies then simply organize the ordering by the clients and the delivery by the producers (and the placing of their logo on the product just before delivery).”

    Production is the least profitable of all the processes. It ties up capital, means a lot of volatile (and costly) inventory, it is labor intensive (and subject to all sorts of problems when there is a slowdown (unproductive labor costs) or a quick need for more product and overtime costs). The market does not give manufacturing companies the same investment multiple as they do the platform companies. Platform companies have more stable incomes and profits.

    Who would you rather be? The Chinese and other Asian companies that make the Ipod at a 2-3% margin or Apple who sells it at a 40% margin?”

  12. joao commented on Apr 2

    francisco

    how are prices of algarve beach houses holding up?

  13. evden eve nakliyat commented on Apr 2

    very very nice informations…thank you very much. mr suma…

  14. M.Z. Forrest commented on Apr 2

    And the old model is adjusting. To give you an idea of how far the leverage has shifted, see this story: http://www.steel.org/AM/Template.cfm?Section=Industry_News&TEMPLATE=/CM/ContentDisplay.cfm&CONTENTID=19036
    (Story discusses Navistar telling Ford to fly a kite.)

    It is well and good to pursue horizontal integration and strip verticals out of your lineup. I wouldn’t be suprised to see vertical integration come back into vogue by 2010.

    This also fits well with the capex discussion. If suppliers aren’t being compensated for the capex the spend, how long do you think they will keep spending it?

  15. Josh commented on Apr 2

    Very interesting points Fred.

  16. Michael Schumacher commented on Apr 2

    Fred-

    I don’t disagree what you are posting in the reply however all I’ve really said is that we’ve seen this story too many times to beleive it’s going to have the impact it implies…also I could’nt help but notice that you took quite a few paragraphs to basically say…it’s different this time……which is not meant as any offense. For me any time I see articles that take the approach that CAPEX spending will pick up I usually approach it as the boy who cried wolf to begin with. I still read the article but they have all said , simplisitically stating, the same thing…the names and/or faces are changed to reflect whatever they feel is “differenet” about this time around.

  17. KP commented on Apr 2

    Fred does make some very good points. I wonder what happens to those platform companies in an environment of a weakening dollar? Leverage that “cheap” production while you can. The universe is a self-balancing equation and Ipods are not immune.

  18. Fred commented on Apr 2

    Mr Forrest:

    “BTW IP6 will revolutionize technology about as much as the 9-digit zip code revolutionized the postal service.”

    That may be true if you see the internet not growing in exponential importance going forward. There is an excellent article in Businesssweek that I suggest you Google up on this subject.

    IP addresses are set to “run out” at some point (depending on many factors).

    “…once the hardware and software upgrades to IPv6 are complete, they will open up so much territory in cyberspace that a unique address can be assigned to every digital product in the world — and every one produced for the next several centuries. In theory, that means that everything from advanced weapon systems to home appliances will be able to configure its own Internet connections, update its software, and resist attacks from hackers.”

    I can imagine a shred or 2 of productivity might be enabled by these types of ubiquitous interent connections to many everyday electonic devices.

  19. jack commented on Apr 2

    No one answered Francisco’s question:
    “Agreeing with most of your reasoning, i’m left with one question: How do you then explain the overall health in labour markets (should they not have been impacted after 3 years of limited capex growth)?

    One other interesting point would also be how to read the resilient consumption and private expenditure figures we’ve been having over the past year, despite the continuing downtrend in housing and higher interest rates…”

    Let me try and pardon my ignorance:
    1. Illegal emigrants don’t claim unemployment’s
    2. Baby boomers in their prime earning years, scheduled to retire soon.

  20. M.Z. Forrest commented on Apr 2

    That may be true if you see the internet not growing in exponential importance going forward.

    That accurately represents my sentiment. Law of diminishing returns and all that. Presently, I can get 100 IP addresses for my business quite easily. We aren’t facing a shortage. You are correct that at current expansion rates, the IP address range will need to increase. Whether IP6 will be causative of further increases is debatable. While not a perfect comparison, transit theory is already entering into the Internet, i.e. greater usuage diminishes the ability of reliable usage. This is the reason we are seeing development of Internet2.

    Regardless, address availability isn’t a great impedence at this point. QOS is probably the greatest issue at this point. On the corporate side, you are seeing more money go into this area. (AKA packet prioritization, net neutrality.) If WIFI grows up a bit more, I wouldn’t want to be the company that has its Internet down because someone is jamming the signal. WIFI is just waiting for some enterprising delinquent to knock it out.

  21. M.Z. Forrest commented on Apr 2

    If your measure is unemployment, then the labor market is healthy. If your measure is wage growth, then the labor market isn’t very pretty.

  22. Fred commented on Apr 2

    “WIFI is just waiting for some enterprising delinquent to knock it out.”

    You are referring to Wimax perhaps. ;0)

    As far as the internet’s diminishing returns, I couldn’t disagree more. I don’t even know where to begin…

    Good luck.

  23. John Thompson commented on Apr 2

    Michael Schumacher is good for some very intelligent comments. Why can’t he ever spell the possessive form of their though? There.

  24. Amateur commented on Apr 2

    Where is the Capex ? In China, India, Brasil, etc., of course?
    Why should the Capex revive in the US? The country has a huge stock of capital goods and an expensive wrkforce. A modest level of Capex is enough to replace aging Capital goods and even grow total GDP.

    The highways and the bridges and the houses and th office buildings are there, no need to build them anew, just some upkeep and vegetative growth.

    Capex is trending secularly lower after the post WW2 reconstruction.

    Revivals happen after some technological breackthrough renders obsolete a large stock of Capital goods. In normal times, one should not expect any pull from it.

  25. Michael Schumacher commented on Apr 2

    Sorry….more important to get “there” first…LOL

    Duly noted

    Ciao
    MS

  26. Winston Munn commented on Apr 2

    As far as the employment question, the areas that show growth are in services and government – manufacturing and construction suck. Higher-paid jobs are being replaced by lower paid jobs, which explains how you can still have a reasonable creation/unemployment number yet have declining real earnings.

    Consumption in my view, is mostly psychologically based, in that as long as credit card funding is still available no one wants to admit that their real standard of living has declined. Consumption will continue until it simply cannot due to credit limitations (real savings has already been spent.) It is very much like the Kubler/Ross study of the 5 stages of grief – right now I’d say the consumer is still in the denial stage, hopeful for a miracle recovery to expunge the crushing debt buildup.

  27. Francisco commented on Apr 2

    Fred, MZ Forrest, Winston

    I guess you all have good points. Let’s assume unemployment is not a good proxy for the consumption expenditure that lies ahead (either because of imigrants, or because people can have more work for less pay). Assuming the argument holds, why were we not surprised yet with our consumption figures ?

    The way I see it, consumption expenditure leads the economy, so this should be the first place for a real recession to be noticed…. so far, there is no real sign of it. Capex reduction usually comes as an answer to lower consumption levels, and then goes all the way up the stream, from durable goods to services until it hits raw materials…. how can capex start to contract with such resiliance in consumption ?

    The answer is also provided by Wintson. I’m sure credit expansion makes up for a big part of it… that leaves just one crucial question which is, by how much? :)

    PS: Algarve beach houses are holding up fine as far as I know… baby boomers in europe need a place in the sun to enjoy retirement as well… : )

  28. Winston Munn commented on Apr 2

    “I’m sure credit expansion makes up for a big part of it… that leaves just one crucial question which is, by how much? :)”

    Something I read today may give a hint – if proposed lending standards had been in place, 50% of the home loans from the past 3 years would not have been made.

    The growth stocks for the next 3 years may well be Consumer Credit Couselling Agencies, Bankruptcy Attorneys, and Auctioneers.

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