Business Spending Rises as U.S. Profits Grow: Economy

Photographer: David Paul Morris/Bloomberg

Auto sales and the rebound in housing are driving gains in consumer spending. Close

Auto sales and the rebound in housing are driving gains in consumer spending.

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Photographer: David Paul Morris/Bloomberg

Auto sales and the rebound in housing are driving gains in consumer spending.

(Corrects location of leasing group in sixth paragraph from the end in story published March 6.)

The outlook for U.S. business spending is improving as rising earnings, easier credit and pent-up demand prompt companies from Warren Buffett’s Berkshire Hathaway Inc. to Chrysler Group LLC and Lowe’s Cos. (LOW) to expand.

Orders for non-military capital goods excluding aircraft, considered a proxy for future business spending on equipment and software, climbed 7.2 percent in January from the prior month, the biggest gain since September 2004, revised data from the Commerce Department showed today. They’re up 9.8 percent since November, the most for a three-month period since 1993.

Auto sales and the rebound in housing are driving gains in consumer spending, spurring companies including Chrysler and Lowe’s to update operations, hire staff or add stores. The biggest surge in profits since the 1990s, combined with near record-low interest rates, mean firms have the resources to soften the damage to the economy from federal budget cutbacks.

“The fundamentals that drive investment activity are improving rapidly,” said Diane Swonk, chief economist for Mesirow Financial Inc. in Chicago, which oversees about $67.5 billion in assets. “You really do have all this pent-up demand and catch-up activity.”

Stocks advanced, extending a record high for the Dow Jones Industrial Average’s record high, after a private jobs report showed companies took on more workers than estimated in February. The Dow climbed 0.3 percent to 14,296.24 at the close in New York.

The Federal Reserve said today in its Beige Book that the economy grew at a modest to moderate pace across most of the country amid rising consumer demand for homes and autos.

Private Payrolls

The ADP Research Institute said businesses added 198,000 employees in February after a revised 215,000 gain in the prior month that was more than initially estimated.

Elsewhere, euro-area exports fell in the fourth quarter for the first time in more than three years. Shipments from the euro area dropped 0.9 percent in the last three months of 2012, helping to drive gross domestic product down 0.6 percent, the European Union’s statistics office in Luxembourg said today.

Business investment was one of the bright spots last quarter that helped the world’s largest economy overcome the biggest drop in federal military outlays since the final years of the Vietnam War era. Spending on equipment and software rose at an 11.3 percent annualized rate from October through December, the best performance in more than a year.

First Quarter

Today’s report on factory orders indicated it will be difficult to match that gain in the first three months of this year. Shipments of capital goods excluding defense and aircraft, a measure used in calculating gross domestic product fell 1.1 percent in January after rising 0.1 percent the prior month.

Swonk projects investment will pick up in the second half of 2013 as companies put excess cash to work, banks make it easier to borrow, the housing and automobile industries reach “tipping points” where plants need to be expanded, U.S. energy production grows and technological innovations fuel new investments, she said in a Feb. 13 report that made the case for an “investment boomlet.”

Lowe’s, the second-largest U.S. home-improvement retailer, is boosting spending on store upgrades and hiring. It plans to open 10 stores in 2013, the Mooresville, North Carolina-based company said on a Feb. 25 earnings call.

The “drivers of industry growth, mainly job gains and stable to growing housing, should support a strengthening growth trajectory for the industry,” Chief Executive Officer Robert Niblock said on a Feb. 25 earnings call with analysts. “The macroeconomic transition from recovery to sustainable expansion, together with our initiatives and improving operational collaboration, give us confidence in our business outlook for 2013.”

Corporate Profits

Profit from companies in the Standard & Poor’s 500 Index will exceed $120 a share by next year, double the level in 2008, according to Wall Street estimates. That’s the biggest increase since the 142 percent gain during the rally in technology stocks from 1993 to 1999.

Forty-eight percent of investors reported that capital expenditures are the best use of corporate cash -- the highest reading since April 2011, according to a survey conducted last month by Bank of America Merrill Lynch.

“We see the continued elevated level of corporate profits as the clearest tailwind for investment growth this year,” David Mericle, an economist at Goldman Sachs Group Inc. in New York, wrote in a Feb. 15 research report.

Goldman Sachs

Economists at Goldman incorporate profits, consumer spending, equity prices, banks’ willingness to lend, capacity use and the growth rate of the capital stock in a model used to project business investment. The most recent results point to about a 10 percent gain in business investment over the next year, enough to lift GDP by one percentage point, according to Mericle’s report.

Mericle cautions the model “is subject to considerable uncertainty,” and changes in fiscal policy may also slow growth. Goldman forecasts spending on equipment and software will grow 7 percent this year, compared with a 6.9 percent gain in 2012, reflecting a pickup in the second half of the year.

Companies that don’t have the cash are finding it cheaper to borrow. Average yields for corporate bonds rated in S&P’s BBB tier, the lowest investment grade, fell to a record low of 3.281 percent in January and stood at 3.356 percent as of March 4, according to data from Bank of America Merrill Lynch.

Extra cash and low borrowing costs may be enough to spur spending even as lawmakers in Washington debate how to trim the federal budget deficit.

Budget Cuts

A total of $1.2 trillion in automatic across-the-board budget cuts over the next nine years were triggered on March 1 when Democrats and Republicans failed to reach a compromise.

Government spending authority expires on March 27 and the federal government would shut down absent another budget deal among lawmakers and President Barack Obama. Washington policy makers also will have to negotiate raising the debt ceiling by May 19, when the suspension to that limit ends.

Markets have looked past the impending government spending cuts. The Standard & Poor’s 500 Index advanced 6.5 percent this year through last week, better than the 4.1 percent gain for the MSCI All Country World Index. (MXWD) The U.S. Dollar Index, which tracks the currency against six of America’s biggest trading partners, was the highest since August.

The fiscal-policy hurdles also shouldn’t keep companies on the sidelines as the world’s largest economy recovers, Buffett, chairman and chief executive officer of Berkshire Hathaway (BRK/B), wrote in an annual letter to shareholders posted online March 1.

‘Hand-Wringing’

“There was a lot of hand-wringing last year among CEOs who cried ‘uncertainty’ when faced with capital allocation decisions despite many of their businesses having enjoyed record levels of both earnings and cash,” Buffett said in the letter. “We will keep our foot to the floor and will almost certainly set still another record for capital expenditures in 2013. Opportunities abound in America.”

Buffett said his Omaha, Nebraska-based company spent $9.8 billion last year on plants and equipment as he bolstered railroad and utility units. That’s an increase of about 19 percent from the prior year, he wrote.

Twenty percent of 50 executives surveyed monthly by the Equipment Leasing and Finance Foundation based in Washington, projected in February that demand for leases and loans to bankroll capital expenditures will rise over the next four months, an increase from 12 percent in January. Thirty-seven percent of the respondents predicted their companies would boost spending on business development activity in the next six months, up from 30 percent the prior month.

Payroll Tax

Signs that consumer demand held up at the start of the year even as a two percentage-point increase in the payroll tax reduced take-home pay are another reason companies are willing to invest. Cars and light trucks sold at a 15.3 million annual rate in February, capping the strongest four months since early 2008, according to data from Ward’s Automotive Group.

Auburn Hills, Michigan-based Chrysler said Feb. 28 it will invest $374 million to increase output of transmissions.

Toyota Motor Corp., which built a record 1.78 million cars and trucks in North America last year, is completing a $400 million expansion of its Princeton, Indiana, plant where it’s consolidating production of Highlander sport-utility vehicles. The investment will create 400 jobs, the company said.

Honda Motor Co., the first Japanese automaker to build cars in the U.S., is also completing upgrades at auto and powertrain plants in Ohio and Alabama worth more than $800 million that will open up another 600 jobs.

The residential real-estate recovery is providing added impetus. Purchases of new homes, logged when contracts are signed, jumped in January to a 437,000 annual pace, the strongest since 2008, the Commerce Department reported. Sales of previously-owned houses climbed to a 4.92 million annual rate in January, and the number of available properties slumped to 1.74 million, the lowest level since 1999, the National Association of Realtors said.

To contact the reporter on this story: Michelle Jamrisko in Washington at mjamrisko@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

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