Stocks Held Hostage as CEOs Plan Spending Cuts
The U.S. budget debate is holding stocks hostage, as chief executive officers prepare to cut capital spending for the first time since 2009 should President Barack Obama and Congress fail to reach an accord.
Expenditures by Standard & Poor’s 500 Index companies will fall 1.3 percent in 2013 after three years of growth, according to more than 10,000 analyst estimates compiled by Bloomberg. Companies from Verizon Communications Inc. to Rockwell Collins Inc. (COL) said they don’t plan to boost investment amid concern political leaders will fail to agree on a plan that would avert more than $600 billion of spending cuts and tax increases that threaten to throw the U.S. into another recession.
Bears say CEO pessimism will sap the rally that boosted the S&P 500 12 percent this year and note that the last time capital spending declined was at the end of 2008, just before stocks slumped to a 12-year low. Bulls point out that estimates for corporate spending show any decline will be limited and say the improving U.S. economy will lift equity valuations, now 12 percent below the 58-year average, Bloomberg data show.
“In an environment where the economic and political outlook is highly uncertain, it is hard for executives to make investment decisions,” Abi Oladimeji, who helps oversee $4.3 billion as head of investment strategy at Thomas Miller Investment Ltd. in London, said in a telephone interview on Dec. 12. “The danger is that we see policy errors, which could undermine equity markets and the broader economy.”
Whatever the outcome, investors say the negotiations in Washington are the primary catalyst for investment decisions as 2012 draws to a close. While the S&P 500 has risen 109 percent from its lows in March 2009, it is poised for the first fourth- quarter decline since 2008. U.S. stocks had the worst performance among 24 developed equity markets this quarter.
The S&P 500 slid 0.3 percent to 1,413.58 last week and snapped a six-day gain after House Speaker John Boehner, a Republican from Ohio, said again that Obama’s budget proposal is “anything but” balanced. Obama said the negotiations are “a work in progress.” It added 1.2 percent to 1,430.36 in New York today.
A Bloomberg National Poll showed a majority of Americans back Obama’s demand that tax-rate increases for the highest earners be a precondition for a deal that cuts U.S. entitlement programs. The Congressional Budget Office has warned that if talks fail, the economy may slip into a recession in 2013.
U.S. leaders will reach a compromise, diminishing the impact of any corporate spending reductions, according to Joseph Tanious, a global market strategist for JPMorgan Funds, which oversees $400 billion. While capital spending is projected to slip, it will remain close to the high reached in 2012 of $72.8 billion, he said.
“These are giant question marks right now and it’s feeding into these analysts’ estimates,” Tanious said by phone on Dec. 12. “I wouldn’t read into it too negatively. The opportunity moving forward in stocks is going to be multiple expansion, more so than earnings growth. The slowdown in capital expenditures (SPX), while it certainly depresses growth expectations, doesn’t mean there aren’t opportunities.”
The S&P 500 trades at 14.4 times profit for the last 12 months, about 12 percent below the average for the past six decades, data compiled by Bloomberg show. Options prices show the most bullish outlook for the S&P 500 in the last two years. Puts with an exercise level 10 percent below the S&P 500 cost 7.52 points more than calls 10 percent above on Dec. 12, the lowest since November 2010, according to data on three-month contracts compiled by Bloomberg.
Analysts following companies in the S&P 500 estimate that capital spending will decline 1.1 percent from a year ago to $17.2 billion in the second quarter, 0.6 percent to $17.5 billion in the third quarter and 7.4 percent to $18.2 billion in the fourth, according to data compiled by Bloomberg.
The measure has proved to be an accurate indicator for changes in corporate earnings and stock market performance. When CEOs limited expansion in 2009, the S&P 500 tumbled 12 percent to a low of 676.53 on March 9.
Analysts correctly predicted that companies would increase investment after the financial crisis and the deepest recession in seven decades. Spending gained 6.2 percent in 2010, 24 percent in 2011 and 15 percent this year, Bloomberg data show.
Three years of expansion coincided with 10 quarters of S&P 500 earnings growth. Profits for the biggest American companies are estimated by the analysts to reach a record $114.76 a share next year. The U.S. stock rally is poised to reach the average length of bull markets since World War II in April, according to data compiled by Bloomberg.
Forecasts for capital expansion are inconsistent. Manufacturers will boost spending 7.6 percent next year, according to the Institute for Supply Management’s semiannual survey released Dec. 11. The increase is the biggest for any December survey in at least seven years, according to the Tempe, Arizona-based ISM.
A cross-industry survey by the Business Roundtable found more corporate leaders see a slump. About 23 percent of members surveyed said their company’s spending will fall in the next six months, compared with 19 percent in the prior quarter, the Washington-based CEO association said on Dec. 12.
Executives have “slightly lower expectations for sales and capital expenditures,” Jim McNerney, chairman of the group and CEO of Boeing Co., said in a statement accompanying the survey. “The continued softness in quarterly sentiment reflects deep uncertainty about the future overall economic climate, realities of a slow-growing economy and frustration over Washington’s inability to resolve looming ‘fiscal cliff’ issues.”
Federal Open Market Committee participants on Dec. 12 lowered their forecasts for growth next year. They now see the economy expanding as little as 2.3 percent, compared with at least 2.5 percent in September. The average pace of growth for the decade through 2007 was 3 percent. The economic slowdown is prompting companies to curtail technology spending and pushing consumers to favor mobile devices over personal computers, eroding profitability at Intel Corp. (INTC)
Chief Financial Officer Stacy J. Smith said in an Oct. 16 call with analysts that the Santa Clara, California-based company will reduce investment in the fourth quarter. Analysts estimate an 11 percent cut next year to $10 billion after a 7.6 percent rise in 2012. The stock has tumbled 15 percent this year.
“Semiconductors in general are seeing a lower-than-normal seasonal fourth quarter because we’re already feeling the fiscal cliff,” Doug Freedman, a San Francisco-based RBC Capital Markets analyst, said by phone on Dec. 13. “Capital budgets and people’s nervousness over the ability for macro growth to continue have already affected their spending patterns. Up and down the supply chain, we’re seeing cautionary behavior.”
Clay Jones, the CEO of Rockwell Collins, said in a phone interview on Nov. 7 that the aerospace supplier may cut about 6 percent of its workforce, or about 1,250 jobs, in part to prepare for lower military spending. Defense accounted for about 55 percent of Rockwell Collins’s revenue in the fiscal year ended in September. Shares are up 1.8 percent this year and 20 percent since hitting a low in June. Analysts estimate capital expenditures will decline 6.1 percent in 2013.
“We have no idea within the realm of 10 percent what the defense budget of the U.S. is going to be,” Jones said in an interview from Cedar Rapids, Iowa, on Nov. 7. “I am planning for the worst.”
Verizon (VZ), the second-largest U.S. phone company, said on Oct. 18 that spending for the first nine months of the year declined by more than $1 billion from the year-earlier period. Chief Financial Officer Francis Shammo said last month at a conference the number probably won’t rise in 2013.
Executives are delaying new contracts and investment decisions due to “the pending fiscal cliff, potential tax reform and other policy changes that may take place,” Shammo said in a call with analysts on Oct. 18 from New York.
The rate on dividends for high-income taxpayers may rise next year to 43.4 percent from 15 percent. More than 140 companies in the Russell 3000 Index (RAY), which represents about 98 percent of the U.S. equity market, have declared $18.7 billion worth of special dividends since Sept. 1, according to Bloomberg data. The payouts are more than three times the average market value of companies in the gauge, data show.
While distributions show corporate leaders are confident enough to pay out some of their cash, it also signals they’re not optimistic enough to invest in larger projects, according to Malcolm Polley, who manages $1.1 billion as chief investment officer at Stewart Capital Advisors LLC in Indiana, Pennsylvania.
“You have a lot of companies holding off spending,” Polley said in a Dec. 13 phone interview. “There’s a real risk that capex across the board declines in 2013.”
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