By Rick MacDonald When will Corporate America finally remember where it put its checkbook? After a dismal 2002, one would think capital spending by U.S. companies would turn higher this year. Expectations are widespread for an ongoing rebound in profits and cash flow, along with the continuation of favorable interest rates and an increasing willingness by banks to lend, suggesting that more funds should be available in 2003 for companies to spend on property, plant, and equipment.
Other factors may help. The daunting geopolitical risks from the crises in Iraq, Venezuela, and North Korea could fade by the second half of the year. And we at MMS International expect Congress to pass a revised stimulus package by midyear, which should provide an additional boost to corporate spending.
Even with such positives in place, however, we're concerned that growth in investment spending will continue to fall short of the rate of acceleration that's typical in the second year of an economic expansion. Recent warnings from Intel (INTC) and Microsoft (MSFT) about the pace of their spending on technology equipment underline such worries.
EXCESS CAPACITY. One reason growth may not come up to snuff is that the pullback in investment spending over the last couple of years, combined with higher-than-normal depreciation rates, hasn't eliminated excess capacity in many industries. This overhang should limit any sharp jump in investment spending in 2003.
In fact, despite the investment restraint, production capacity grew last year, as many companies apparently believed an imminent cyclical recovery -- which never materialized -- would leave the capacity overhang as little more than a temporary problem. One need look no further than the Federal Reserve's industrial-production report, which pegged capacity growth in manufacturing at 1% over the past year, while growth in high-tech capacity reached nearly 9%.
Capacity utilization in the manufacturing sector is sitting at 73.6%, still below the low point seen in three of the last six recessions, while utilization in high-tech industries remains near an all-time low at 61.7%. While the Fed's efforts to spark the economy through aggressive interest-rate cuts are generally viewed as a positive, the rapid easing of credit conditions may have prevented factory closings that would have been useful in clearing out "supply-side" excess capacity.
ANOTHER TECH DROP? This may have served to prolong the capacity-overhang problem and further restrain investment. In addition, troubled companies have often emerged from bankruptcy, leaving production capacity in place rather than removing it from the market for good.
In the tech arena, spending on new equipment and software in 2003 likely will come nowhere near the nearly 9% annual average growth rate seen during the 1996-2000 boom period, though the sheer scope of the declines over the past two years should limit further weakness in capital spending. The cheap source of financing during the last boom period -- through both equity and bond markets -- is clearly a thing of the past, as evidenced by the declines in major indexes, the shriveling of the IPO market, and much wider corporate bond spreads.
Also, corporate managers are likely more cautious due to the uncertainty of more terrorist attacks. Supporting this view, the most recent Goldman Sachs Tech Spending Survey suggests that info-tech spending may actually drop again in 2003.
ONE-TIME GAINS. Other factors will keep a lid on spending growth as well. The high base level of investment spending makes sustaining high growth rates all the more challenging. And for the tech sector, the vast increase in computing power during the boom years will continue to allow several software cycle upgrades on the same PC without it becoming obsolete.
Finally, much of the rebound in profit growth through 2002 was due to cost-cutting rather than accelerating revenues, which would encourage a new round of investment spending. Corporations are aware of the one-time nature of many of 2002's gains, and so they'll likely hesitate to ramp up investment spending in 2003 -- until they see signs of a more sustainable upturn in revenues. And based on what we've seen so far as fourth-quarter earnings results come in, that may not happen soon. MacDonald is a senior economist for MMS International