Wednesday, May 28, 2014

Profits Drive Capital Spending (excerpt)

Profitable companies tend to expand by hiring more workers and investing in capital equipment and structures. They’ve been more cautious about doing so during the current economic expansion. That’s because they were traumatized by the financial crisis of 2008. However, that was five years ago, and they should be getting over it by now. That means that if their profits remain strong, payrolls and capacity will continue to grow, which is why the current expansion is likely to be longer than average.

The profits outlook remains bright according to the S&P 500 forward earnings. This series has been highly correlated with capital spending in real GDP and with nondefense capital goods orders.

Comparing capital spending in real GDP during the current expansion to the previous six shows that it has also been growing at a subpar pace. Spending on structures, on information processing equipment, and on intellectual property products (including software and R&D) have been especially weak. On the strong side have been industrial and transportation equipment.

I believe that as a result of the IT revolution, companies may be getting more bang for their capital-spending bucks now than in the past. They can spend less on IT hardware and software in current dollars and get much more computing and communicating power. The industrial equipment they buy comes with powerful embedded IT capabilities. Nevertheless, if profits remain strong, their capital spending should grow.

Today's Morning Briefing: Durable Economy. (1) Slow, but steady. (2) Below-average expansion could last longer than average. (3) Forward earnings is a very upbeat leading indicator. (4) Other good omens. (5) Regional business surveys and flash PMIs are strong. (6) Young adults are more optimistic. (7) Profits driving capital spending higher. (8) IT revolution increases bang per capital-spending buck. (9) Transportation stocks outperforming ytd. (10) Focus on overweight-rated S&P 500 Industrials. (More for subscribers.)

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