Down, Not Out: Late Cycle Business Spending

Executive Summary

Business fixed investment has shifted into a lower gear, but despite late cycle dynamics like fading profits and elevated debt levels, we have measured optimism for business spending in the second half of the year. The boost to business confidence and profits from the tax cuts is fading, but we argue that because the tax cuts were not terribly consequential to capex spending in the first place, there is little reason to expect a major unwinding now that the tax cut sugar high has worn off. There is, however, a reasonable case to be made for sustained outlays in categories that cannot be put off until the next cycle like intellectual property spending in the service sector or equipment spending by manufacturing firms to become more capital intensive at a time of rising labor costs.

The ongoing trade war is the most obvious roadblock we see that could present downside risk to our forecast, and not just for business spending.

Tax Cuts Were Great for Profits, but What About Capex?

When we talk about capex in economics, we are concerned with business fixed investment (Figure 1), which includes spending on equipment, nonresidential structures and intangibles like intellectual property. Other uses of capital, like M&A activity or stock-related maneuvers like share buybacks and increased dividend payouts, are not captured explicitly in the GDP accounts. It is evident that capital spending had a strong year in 2018, although the trend running toward the zero line at present is not terribly encouraging.

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