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Where is the CapEx?

Monday, April 02, 2007 | 07:30 AM

in Corporate Management | Earnings | Investing | Markets | Psychology/Sentiment

Its 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.

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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Comments

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?

Posted by: Rick Hanley | Apr 2, 2007 8:40:44 AM

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