The Circular Capex Spending Problem
by Sinclair Noe
by Sinclair Noe
DOW + 61 = 16,713
SPX + 8 = 1955
NAS + 18 = 4453
10 YR YLD - .01 = 2.40%
OIL - .39 = 97.20
GOLD + .70 = 1313.90
SILV + .05 = 19.95
SPX + 8 = 1955
NAS + 18 = 4453
10 YR YLD - .01 = 2.40%
OIL - .39 = 97.20
GOLD + .70 = 1313.90
SILV + .05 = 19.95
Iraqi Prime Minister Nouri al-Maliki stepped down today, a
surprising reversal for a prime minister who a day earlier had assured his
supporters that he wouldn’t step down unless forced out by Iraq’s high court.
President Obama says the US operations have broken the
ISIS siege of Mount Sinjar. Thousands of Yazidi refugees were stranded on the
mountain. Many of those displaced had now left the mountain and further rescue
operations are not planned, however US airstrikes against ISIS will continue
for now. And Iraqi and Kurdish forces fighting ISIS will continue to receive US
military assistance.
Russian President Vladimir Putin said Russia would stand
up for itself but not at the cost of confrontation with the outside world, which
sounded like a softer, gentler Putin. Trust him about as far as you can throw
him. Intense fighting continues as the Ukrainian military kept up its offensive
to retake separatist strongholds in Eastern Ukraine.
A new, five-day truce between Israel and Hamas appeared
to be holding despite a shaky start, after both sides agreed to give
Egyptian-brokered peace negotiations more time. The second extension of the
ceasefire, this time for five days rather than three, has raised hopes that a
longer-term resolution to the conflict can be found; maybe.
The Missouri State Highway Patrol will take over the supervision
of security in the St. Louis suburb that's been the scene of violent protests
since a police officer fatally shot an unarmed black teenager.
Earnings season continued to wind down. WalMart reported
earnings and revenue that met expectations, but the company cut its forecast
for coming quarters. Last night, Cisco Systems offered a weak outlook for its
current quarter and announced massive job cuts despite reporting revenue that
beat expectations.
We’ve all heard of jobs offshoring; US jobs that once
built the world’s biggest middle class, have been sent overseas, and it’s been
going on for quite some time. The idea was heralded as free trade globalism and
the argument was that it was merely mutually beneficial free trade; but American
jobs have been lost and continue to be lost, not to competition from foreign
companies, but to multinational corporations that are cutting costs by shifting
operations to low-wage countries.
One result of offshoring is lower labor costs, but that
also means lower wages. University graduates in the US are just as likely to be
employed as bartenders or baristas as they are to get a job as a software
engineer of plant manager. And there’s a good chance that recent grads are
still living at home with their parents. More than half with student loans are
having a hard time paying down student loan debt; 18% are either in collection
or delinquent; another 34% have student loans in deferment or forbearance. And
if they do find jobs, they find those jobs don’t pay well. Wages have stagnated.
Even though the economy has been adding jobs, it has not
been enough to push a recovery in wages. In July, average hourly wages rose a
penny to $24.45, a disappointing result after strong gains in June and May. In
23 of the past 24 months, the yearly increase in hourly pay has ranged from
1.9% to 2.2%, or about one-third less than usual during an economic recovery.
The 12-month increase in wages as of July was just 2%; and inflation wiped out
about three-fourths of that gain. There’s been no change since the start of
2014. While it might seem counterintuitive that wages are flat while jobs are
being added, the likely reason is that there are a lot of poor paying jobs plus
a few very good paying jobs. According to revised data from the Commerce
Department, employee compensation, including wages and benefits, was lower for
each year from 2011 to 2013 than previously calculated.
Jobs off-shoring, by lowering labor costs and increasing
corporate profits, has enriched corporate executives and large shareholders, but
the loss of millions of well-paying jobs has made millions of Americans
downwardly mobile. Between October 2008 and July 2014 the working age
population grew by 13.4 million persons, but the US labor force grew by only
1.1 million. In other words, the unemployment rate among the increase in the
working age population during the past six years is 91%. Since the year 2000,
the lack of jobs has caused the labor force participation rate to fall, and
since quantitative easing began in 2008, the decline in the labor force
participation rate has accelerated. Clearly there is no economic recovery when
participation in the labor force collapses. In addition, jobs off-shoring has
destroyed the growth in consumer demand on which the US economy depends with
the result that the economy cannot create enough jobs to keep up with the
growth of the labor force.
Some people argue that the problem with economic growth
doesn’t start with wages and jobs, but rather with credit, and they point to
graphs of the recent rise in auto loans; just as mortgages once fueled a
housing boom, now, subprime lending is fueling a boom in auto sales. Credit
tightened in the wake of the housing collapse and the housing market remains
weak, while auto lenders have become aggressively permissive and US auto sales
have made a huge recovery, leading some to argue that consumption depends on
access to credit. This is wrong. Access to credit is the lubricant for the
engine of economic commerce; it is not the engine. The real driver of the
economy is good paying jobs.
There have been magnificent innovations in
transportation, medicine, communication, and technology as commerce has spread
globally. Credit did not create technological advances, people did. Money and
credit could always be used to purchase the tools to make money in business,
but money could never produce anything by itself; food, clothing, shelter,
cars, and thousands of other worthwhile things were always made by the labor of
people, not the sweat and intelligence of a coin or a plastic credit card.
The Federal
Reserve just released a report showing that two-thirds of American
households have no savings set aside for an emergency, and 40% are unable to
raise $400 cash without selling possessions or borrowing from family and
friends. Offshoring, by lowering labor costs and increasing corporate profits,
has enriched corporate executives and large shareholders, but the loss of
millions of well-paying jobs has made millions of Americans downwardly mobile.
In addition, jobs off-shoring has destroyed the growth in consumer demand on
which the US economy depends for expansion. Corporations are borrowing money
not to invest for the future but to buy back their own stocks, thus pushing up
share prices.
A new
report from Morgan Stanley shows the average age of industrial equipment in
the US is now almost 10.5 year old. That’s the oldest since 1938, at the height
of the Great Depression. Nonresidential capital expenditure; in other words,
spending on equipment, nonresidential buildings like factories, and
intellectual property, has fallen short of the long-term trend by 15% per year.
That means businesses have pumped into the economy $400 billion less than they
normally would have every year. That's $1.6 trillion over the past four years,
and it's affecting every sector. Spending has been down 14% on buildings, 16%
on equipment, and 6% on intellectual property.
Instead of investing that money, corporations have been
hoarding cash; by some estimates, corporations are sitting on a pile of almost
$2 trillion. Occasionally they dip in for share buybacks. S&P 500 companies
bought back an estimated $160 billion in stock in the first quarter; that would
lag only the $172 billion in the third quarter of 2007, shortly before the worst
bear market since the Great Depression. Repurchases are all the rage, but are
all too often made for an unstated and ignoble reason: to pump or support the
stock price. Another corporate incentive for buybacks is that a pumped-up share
prices make the stock grants and options held by senior executives more
valuable. Occasionally they dip into the cash pile for mergers and acquisitions.
North American M&A activity stands at $1.2 trillion year to date, up 83%
from last year. This year is almost certain to be the best year for M&A
since the crisis. Boosting growth and returns through long-term investment in
their business hasn't registered nearly as highly.
The problem then becomes circular: weak demand holds back
capital expenditures, which drags on growth, which depresses demand. Productivity
growth in the United States, the rate of growth in the level of output per
worker, is near a 30 year low. Spending on research, development and
technology, would surely improve this trend. Productivity alone does not spur
capex spending. Rather, spending increases when demand increases. You don’t buy
a new factory or new equipment unless your customers are spending. However if
your customers are spending, you will happily invest in the facilities to fill
their orders. But real median household income fell 10% between 2007 and 2012. And
since the financial crisis, demand
across the US economy as a whole has been far below trend.
Several of America’s great cities, such as Detroit,
Cleveland, St. Louis have lost between one-fifth and one-half of their
populations. Real median family income has been declining for years, an
indication that the ladders of upward mobility that made America the
“opportunity society” have been dismantled. So, now we face a tipping point,
where we either start to reinvest in industrial production or watch the
infrastructure turn to rust, and the US becomes a third world country.
The good news is that we are making progress in some
areas. We add jobs every month, more than 200,000 jobs per month for the past
six months. Capacity utilization is now up to 79%. US exports now top $2
trillion, the highest level in history. Despite the numerous false dawns since
the Great Recession, analysts still expect capex to pick up. If it does, then
the broader economy should benefit. Factories and equipment will have to be
replaced, eventually. It might represent an opportunity; if we’re lucky.
