Dear Valued Clients and Friends,
That the tax reform bill which became law at the beginning of 2018 contains stimulus for the U.S. economy is not subject to dispute. Opponents of the bill politically still acknowledge that there is a stimulative effect from the bill, though the magnitude and sustainability of that stimulus is subject to a bandwidth of perspective. Most skeptics of the long term economic stimuli of the bill argue that its savings will result in shorter term actions that have limited multiplier effect (one-time bonuses to employees, share buybacks, dividends, debt reduction, etc.). To be clear, no action or potential action we can think of out of what companies do with the net savings afforded them from corporate tax reform can be considered “negative” – in fact, all offer varying degrees of benefit to shareholders, laborers, customers, and the economy at large.
The issue, rather, is where the multiplier effect will be most magnified – for the longest period of time. I should say, that is the issue if sustainable top-line economic growth of > 3% is the policy agenda. And this is why business investment is so vital to the success of tax reform, but more importantly, the expansion of this bull market.
We start with the obvious: Capex spending is on the rise!
* Strategas Research, Charts of the Week, p. 1, May 12, 2018
* Strategas Research, Policy Outlook, p. 2, May 14, 2018
It is crucial to remember that capital expenditures are “spending” for one company, and revenue for another. For the company who receives revenue, it is growth-capital, top-line sales, and the critical mass that drives their business. Profit growth comes from revenue growth. Unless a company’s model calls for negative profit margins, an increase in capex spending is an increase in revenues, as the companies who build the factories, widgets, and new technologies, or supply the software, hardware, or vehicles, see their business sales expand. But that only tells half the story, and in this case, it is anything but zero sum. What about the companies “spending” the money? Is one company’s revenue just an expense to the other company, negating any profit creation opportunity in the macro? Quite the contrary! While there is a short term benefit to the company receiving the revenue, there is a long term benefit to the company spending the money. Indeed, that investment becomes the basis for future profit creation, as new factories, equipment, and technology set the table for business growth, improved efficiency, new markets, new products, and general innovation.
Capital expenditures do not merely drive growth and productivity; growth and productivity dry up without capital expenditures. Greater growth and productivity drives wage growth. Wage growth drives more consumption. More consumption drives more production. And the expanding profits from this whole virtuous cycle incents more of the same! Capex is the engine by which both short term and long term benefits are most realized in this cycle. The “supply side” potential of the tax reform comes to life where capex is effectuated.
Businesses that do not trust the sustainability of business conditions do not invest in their futures. When confidence or sentiment appears high, but capex spending remains low, it is a sign that things seem rosy in the short term, but an underlying belief in persistently robust conditions is low (often out of fear of government policies, excessive debt, interest rate vulnerability, etc.). The post-crisis recovery was impressive in short term conditions, but the noticeable lack of capital expenditures despite favorable borrowing conditions indicated a tepid confidence in the economic and corporate climate.
The early signs of reversal in this trend, and our forecast of a true renaissance in capital expenditures, are both a sign of better things to come, and the self-fulfilling prophecy thereof. The mandate of the national economy is growth, both to counter-act malignant debt assumption, but also to create wage growth for the middle class. The only known impetus to growth is the pursuit of profits. With a renewed vigor for capex, we not only will achieve greater profits in the near term, but set the table for the needed profits into the long term that will drive the next inning of this bull market.
David L. Bahnsen, CFP®, CIMA®
Chief Investment Officer, Managing Partner
The Bahnsen Group, HighTower