Barron's: Capital Spending Boom

By SIMON CONSTABLE

The prolonged capital-spending drought may soon end. If it does, which seems increasingly likely, equipment makers should benefit.

Over the last five years, Corporate America has spent barely enough to replace worn-out or depreciated machines, equipment, and factory buildings, according to a recent report from Société Générale. In simple terms, capital equipment, which typically costs at least $5,000 and lasts more than a year, is defined as the machines used to make other items.

"Today's capital stock [is] older than at any point since 1964," writes Aneta Markowska, a New York-based economist at SG.

Why? It's the result of chronic underinvestment. Capital stock grew at an average rate of just 1% per year during the past five years, well below the historical average of 2.6%, the report says.

Markowska concedes that capital expenditure orders are "not very encouraging" so far. Orders dropped from December through February, according to the latest government data.

Still, there are reasons why she remains hopeful.

The first is that corporate chieftains know that to remain competitive they need to invest. Second, executives have more of a sense about what the government will do. Stated differently, there is less policy uncertainty.

The Economic Policy Uncertainty Index, as designed by academics from Stanford University and the University of Chicago (Scott Baker, Nicholas Bloom and Steven J. Davis), has remained close to its long run average for the past five months. It spiked considerably during the financial crisis and then again during various fiscal showdowns in Congress.

"History suggests that capital expenditures levels tend to respond to changes in the uncertainly level with a 12-month lag," writes Jack Ablin, chief investment officer at BMO Private Bank in Chicago. The general idea being that when there is more certainty about what the government will do then businesses are more likely to make risky investments.

"I'm hopeful that based on the indicators that [capital expenditure] should rise toward the second half of the year," Ablin says.

If we see capital spending surge due to uncertainty staying low that would help equipment manufacturers like GE (ticker: GE) and Honeywell (HON). Alternatively, investors looking to place a broader bet might want to buy the Industrial Select Sector SPDR Fund (XLI), which holds a basket of industrial stocks.

See original story here.