As Capex Booms, Gauging Economic Impact Takes Center Stage
Art by Melinda Beck
As corporate capex booms, gauging the broader economic impact on key variables like GDP and productivity growth is critical for investors. But assessing this impact is even more difficult than it previously was. History is no longer as reliable a guide as the economy becomes more technologically driven.
Capex is indeed climbing, hitting 7.2% in the year’s second quarter, according to the US Bureau of Economic Analysis. For 2018’s first period, it was 11.5%. That’s up from 5.3% for all of last year, and a big gain from 2016’s 0.5% and 2015’s 1.8%.
But assessing the impact of this spending will be more challenging for a variety of factors. Underpinning nearly all of them, however is that the US has moved from a manufacturing–centered economy to one more focused on services and technology.
Key to the complications is that current statistical models have not captured the full beneficial impact that tech advances already have yielded. Productivity may be better than we know. “Measurement trails technology,” said J.J. Kinahan, chief market strategist at TD Ameritrade. A couple of decades ago, he said, imports and exports were valued mostly by weight, so a brick was worth more than a compact disc.
By the estimate of consulting firm Ongoing Operations, a data center costs around $585,000 to build. But to erect a heavy manufacturing facility, the price is steeper: at an average cost to build of $300 square feet, for an average size factory of 19,000 square feet, the total is $5.7 million. Perhaps the cheaper-to-construct data center provides an equal or greater economic benefit than the factory, though the difference is not fully quantified.
As a result of the measurement difficulty, a strong capex pickup may not “have this positive impact on growth rates” that some expect, wrote John Mason, head of New Finance, on the Seeking Alpha website. Intangible assets from the likes of Google and Apple are driving the economy now, he pointed out. And the effect of these is more difficult to assess than the number of automobiles assembled.
Increased productivity is important because it allows companies to produce more things without bloating costs, which translates into better revenue and earnings, and in turn boosts the economy. Low productivity growth is widely blamed, at least in part, for the slow US GDP expansion in recent years, around 2%. Although GDP moved up an encouraging 4.1% in this year’s second quarter, a chunk of that increase may well be a temporary boon from the new tax cut.
Certainly, other explanations exist for why capex, productivity, and GDP haven’t been more robust in recent years. One is structural: No big innovations, on the order of universal electricity or the automobile, have come on the scene in a while. A burst of new technology in the 1980s and 1990s led to a productivity growth surge then, but that has played out.
Another explanation is cyclical. The Great Recession shuttered many factories and employers tried to get by with less. Companies were so shell-shocked by that nightmarish downturn that they held down capex on the theory that not enough customers were willing to buy more and more stuff.
A third possible cause, though, concerns measurement. Admittedly, the ebbing of productivity growth is no statistical mirage. Yet it might be overstated. A BlackRock Investment Institute study suggests that, perhaps, “traditional economic metrics simply have not kept up with fast-changing technologies geared toward greater efficiency at lower cost.”
A lot of efficiencies have been realized but perhaps not adequately counted. Some 20% of the largest 1,500 US companies by market cap have zero inventories, up from 5% in 1980, Morgan Stanley data shows. Maintaining inventories is an expensive proposition, which potentially eats into a company’s time and effort, and hence hinders productivity.
Along with the current pickup, there are signs strong spending will continue. A Duke University survey of corporate chief financial officers in June found they plan to increase capital spending by an average 8.3% over the next 12 months.
This uptick is partly owing to a turnaround in oil prices, which has brought drillers off the sidelines. Energy companies made up 30% of all capex this cycle, a lot of it for fracking. Plus, extra money is available. Thanks to the tax bill, $300 billion of US companies’ assets stored overseas came back to America in the first quarter, Strategas Research Partners reported. In addition, the tax overhaul made capex cheaper—now companies can write off capital spending all at once, instead of stretching it out over several years.
To be sure, most of the fruits of the tax bill have gone to shareholders in the form of stock buybacks. By Morgan Stanley’s analysis, stock buybacks have equaled 5.7% of sales among non-financial companies, while capex has averaged only 4.6%.
A Morgan Stanley study last year found that capex normally contributed 2.6% to real GDP growth over the course of a cycle. But for the present cycle, starting in 2009 after the recession ended, it has been only 0.7%. That’s “the worst recovery in capital spending in more than 50 years,” wrote Lisa Shalett, head of investment and portfolio strategies for Morgan Stanley Wealth Management, and lead author of the study.
Regardless of how capex fares in the near-term, a case also can be made that technology of recent vintage will eventually lead to better productivity. That’s reminiscent of the early days of personal computers and the internet, which in time led to the productivity jump of the 1980s and 1990s.
“We believe that, between now and 2023, a new wave of automation will ripple through the economy, driven by the diffusion of such major technologies as artificial intelligence, robotics, genomics, 3D printing, self-driving cars, and the blockchain,” Morgan Stanley’s Shalett wrote in her report.
A lot of money is going into this new technology. And therefore, TD’s Kinahan said, “It will at some point pay off.” The question is: How much?