Two Steps Forward, One Step Back?

Be careful what you wish for.

For years economists have been hoping that capital spending will pick up. They look at business spending on new equipment as an indicator that the economy’s animal spirits are getting back to normal. And companies are flush with cash these days, but they’ve afraid they’ll need that money for a rainy day. The Financial Crisis caused a lot of managers realize how dependent on credit they really are.

The expectation is that once investment in the economy picks up, hiring will have to increase. Someone has to build all those new plants, equipment, and software. Business investment will also lead to increased productivity, lifting wages for everyone and getting the economy out of the doghouse. Analysts have been hoping this will spark a virtual cycle: more hiring, higher incomes, economic growth, more hiring.

Since 2010 business investment has been rising as a share of the economy, but it’s still at a low level.

Source: St. Louis Fed

A recent survey indicates that many firms plan to increase their expenditures, but increasing spending will cut into profits. Profit margins have been soaring—leading to record stock prices and extended valuations. If investment picks up, the economy will grow faster, but the market could be vulnerable. Add in higher interest rates from the Federal Reserve and we could see a pullback from these levels.

Nothing is certain. The economy needs more investment spending to get out of its funk, but that spending has to come from somewhere. If there’s a pullback in profits, watch out.

Douglas R. Tengdin, CFA
Chief Investment Officer
Phone: 603-224-1350
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