On-shoring, energy infrastructure reinvestment and plant replacement are three trends in the making that will shake American business out of paralysis. In the last “Bond Deer in the Headlights,” I outlined the “Monetary Abolitionists” assertion that out-of-control government spending, made acceptable by historically low interest rates, was responsible for corporate paralysis in investing and hiring.
That camp also believes that as a result we are likely heading for credit crash, and shouldn’t be worried about the possibility of a rising-interest-rate environment. In terms of government spending, my conclusion was that while it’s too early to turn off the fiscal spigot, a plan to deal with government entitlements needs to be mapped out now. In this final installment, I look more closely at the assertion that corporate America has been paralyzed by political uncertainty.
The below graph shows corporate capital spending (capex) as a percent of GDP over the last 50 years.
The clear message is that while capital spending is down from the peak of approximately 14 percent of GDP in the 1980s it has also has been recovering since 2010. The recent downturn in capital spending could be ascribed to “uncertainty,” and anecdotal evidence points to this. However, it could just as easily be a momentary pause. This is the camp we are in.
The next few graphs present compelling evidence of building pent-up demand. If we disaggregate capital spending over the last 30 years into 2 chief components Equipment and software and Structures a fascinating tale is told:
Corporate investment has been all about productivity-enhancing equipment in recent years, while investment in structures (manufacturing plants) has flat-lined in the face of secular off-shoring. Three trends are beginning to show: re-shoring, a coming massive reinvestment in energy infrastructure, and the average age of our manufacturing plants. The first two trends are explored more fully in my colleague Paresh Upadhyaya’s recent Blue Paper, The U.S. Dollar, Awaiting the Upcoming Bull Market. The third theme is illustrated in the following graph.
If we are correct about the existence of the first two trends, we believe it will put intense pressure on corporations to refresh the manufacturing base in this country.
Finally, utilizing ISI’s capital spending growth model, which estimates growth based on key drivers and trade-offs, growth in capital spending will likely accelerate over the next few quarters
So if capital spending isn’t dead, has employment stalled out? Here, the picture is also positive, Over the last 4 years, job creation has climbed back and has been in solidly positive territory while unemployment claims have declined substantially:
Thus, despite assertions that corporate America is paralyzed by uncertainty, reinvestment in both human and monetary capital continues to grow since the end of the recession in 2009. Combining this with unprecedented levels of profitability in corporate America, we see little reason to believe the Abolitionists assertions that the Fed’s zero interest rate policy has created conditions for a near-term credit crisis. As a result, we come down squarely on the side of duration – the sensitivity of an investment to interest rate changes as the next great risk for fixed income investors.
This ends our “Bond Deer in the headlight series.” We hope you’ve found our exploration of the bond market risks to be helpful. Stay tuned as we begin to explore, in more detail, what investors can expect in the coming months as the risks of a high-quality bond market sell-off rises.
Mike Temple is responsible for oversight of Pioneer Investments’ U.S. credit research department. His duties include independent research of credits, sector analysis, and coordination of research efforts in high yield, bank loan, investment grade, emerging markets, and municipal credit. He has been the Portfolio Manager of an institutional “Credit Opportunity” strategy since 2008, and is also a Portfolio Manager of Pioneer Absolute Return Credit Fund.