Because of cooling demand, companies are investing less in heavy equipment.
Dreamstime
Companies are tapping the brakes on capital spending as they anticipate cooling demand.
They are conserving cash as they prepare for a tougher economic environment. That might be prudent on their part and good news for their shareholders, but it is bad news for the companies that sell the heavy equipment or technologies and systems used in capital expenditures, or capex.
Analysts expect aggregate capex for companies on the S&P 1500 index to rise about 7% to just over $1 trillion this year, according to
Citigroup,
down from about 21% in 2022. It is expected to rise just 2% in 2024. Weakness is expected in more economically-sensitive sectors, or those that see sales rise and fall with economic demand. The consumer discretionary sector, which includes retail, restaurants, hotels and the like, is expected to see capex drop 3% this year and grow about 2% next year. Industrials should see 7% and 2% growth this year and next, respectively. Those two sectors combine for a decent chunk of total capex, at almost 15%, or just under $150 billion this year.
The reason companies are watching their big ticket spending is because they’re preparing for muted demand and profits. The Federal Reserve’s interest rate hikes started last year, but usually reduce demand and inflation with a delay, so companies have only recently been responding, as they reduce large investments once they start seeing the beginnings of destruction to demand and sales. In fact, Citi data show that, in the past few months, banks have tightened their belts on lending as rates have risen and consumer and business credit worsens, which should curb demand. Tighter lending standards are highly correlated to business investment, so a drop in lending means a drop in corporate investment.
Overall, the declining capex “reinforces stagnating earnings growth concerns,” wrote Citi strategist Scott Chronert.
That is already seen in analysts forecasts. The S&P 1500’s sales for 2022 rose 14%, but they are expected to grow under 3% annually for the next two years, according to FactSet.
For industrials, especially, lower capex hurts. Many of them sell the large machinery that their corporate customers invest in, so lower capex across the board can hurt sales in the industrial sector. Analysts for companies on the S&P 1500 industrials index are expecting sales growth to fall to 3.7% annually for the next two years from almost 30% growth last year.
The good news, though, is that the stock market has already reflected much of the economic challenges. The S&P 1500, while above its low point of its bear market, is still down about 14% from its late 2021 record high.
The other piece of good news for stock investors is what lower capex means for what companies can do with their cash. They can return more cash to shareholders through dividends and buybacks, which amplify shareholder returns. S&P 1500 free cash flow is expected to gain 9% this year partly because of reduced capex, while buybacks for the marquee
S&P 500 index
could hit $1 trillion this year, supporting stocks.
The point is that investors should expect weak demand going forward, but that doesn’t mean to completely shy away from the stock market.
Write to Jacob Sonenshine at [email protected]
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