Economy Enemy No - University of Vermont



Economy Enemy No.1: Soft Capital Spending

Forecasters Say Extent

Of Business Cuts Will Tell

Where Slowdown Ends

By PHIL IZZO and DEAN TREFTZ

April 13, 2007; Page A2

Weakness in business capital spending is edging out housing as the dark cloud on the U.S. economic horizon.

A new survey found that 20 of 54 economic forecasters responding to a query cited soft capital spending as the chief risk to their forecast that the U.S. economy will grow slowly but avoid recession this year.

Only 11 of the economists cited housing; the rest cited other threats, including inflation and oil prices.

Capital spending "scares me more than anything else because I can't explain the weakness," said Stephen Stanley of RBS Greenwich Capital.

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The Federal Reserve has similar worries. "The magnitude of the slowdown [in capital spending] has been somewhat greater than would be expected given the normal evolution of the business cycle," Fed Chairman Ben Bernanke told Congress late last month. And the International Monetary Fund, cataloging the risks to the U.S. economy this week, noted "concerns that the current softness of business investment could be extended."

The softness extends across industries. Semiconductor maker Advanced Micro Devices Inc. said this week that it is reducing planned 2007 capital spending by $500 million to about $2 billion amid sharply lower first-quarter revenue and difficulty in taking market share from rival Intel Corp. That spending would, however, still be up from last year's $1.86 billion.

Tecumseh Products Co., a smaller Michigan-based company that makes compressors and small engines for refrigerators and lawn mowers, plans capital spending of $34 million this year, down from $62 million in 2006 and $113 million in 2005, partly so it can pay down debt.

ABOUT THE SURVEY

 

The Wall Street Journal surveys a group of 60 economists throughout the year. Broad surveys on more than 10 major economic indicators are conducted semiannually, at midyear and at year-end. Between each semiannual survey, four monthly updates are conducted for the most closely watched forecasts. This is the monthly survey for April. For prior installments of the semiannual and monthly surveys, see: Economists.

Auto-parts makers, already reeling from the industry's woes, are pulling back more. "Most suppliers had predicted a soft 2007 and had scaled back 'cap ex,' but with very weak first and second quarters, they've looked for additional opportunities to reduce 'cap ex' further," said Craig Fitzgerald of consulting firm Plante & Moran.

Elsewhere, Ralcorp Holdings, a St. Louis maker of private-brand food, has said it expects capital spending of about $50 million in its fiscal year ending Sept. 30, down from $58.1 million in 2006 and below the previous two years as well. "Expenditures in these three years were unusually high due to information-systems projects and special projects at ... recently acquired businesses," the company said recently in a Securities and Exchange Commission filing.

A recent survey by found 16 of 26 food companies it surveyed project increased capital spending this year, but six are scaling back -- five by double-digit amounts. The online publication predicted the industry would step up capital spending by 7.6% this year, less than last year's 9.6% increase.

"Much of the weakness in recent months has been in types of capital goods used heavily by the construction and motor-vehicle industries," Mr. Bernanke said last month.

Capital spending, along with consumer spending and exports, has been supporting economic growth in the U.S. amid a housing slump, so signs of weakness aren't welcome.

"If there's something that keeps me up at night, it's the potential of corporate America really pulling back," said Nariman Behravesh of forecasting firm Global Insight. "We had expected 5%-to-6% growth in capital spending in the first half of 2007, but now that's down to 1.5%."

The Commerce Department says overall business investment fell an inflation-adjusted 3.1% in the fourth quarter, the first drop since early 2003. And government measures of orders for and shipments of capital goods so far this year have been unexpectedly weak. Business investment in buildings, equipment, computers and software amounts to about 11% of gross domestic product.

Economists responding to the survey were slightly gloomier about the prospects for the U.S. economy than they were a month ago. On average, they now estimate the economy grew at a 2% annual rate in the first quarter, down from the 2.3% estimate they made in March. They predict the economy will grow at a 2.2% pace in the current quarter and pick up momentum in the second half. By year end, they expect the unemployment rate to be up to 4.8% from the latest 4.5% reading, and they expect the Fed will have cut interest rates by one-quarter percentage point.

Not all companies are cutting back on spending. Manufacturer 3M Co. expects to make capital expenditures of between $1.4 billion to $1.5 billion this year, up from about $1.2 billion in 2006, a faster expansion rate than in recent years. The company has said it plans 18 new factories or major expansion in the next few years, nine in North America, devoted to products including optical film and respiratory masks.

Wal-Mart Stores Inc. plans capital spending this year of $17 billion, up 8.6% from 2006, which was up 7.5% from the year before that, but short of the double-digit increases of previous years. Some analysts suspect the retailer may yet pare this year's spending amid weakening sales.

There are some hints that business spending could perk up. A survey of 60 financial executives in manufacturing companies, released yesterday by the trade group Manufacturers Alliance/MAPI, found 55% expect this year's capital spending to exceed last year's and only 13% expect a decrease. When asked the same question six months earlier, 44% predicted an increase and 31% a decrease.

"What this quarter's results are saying is the floor isn't falling out, at least in the manufacturing sector," said Don Norman, who coordinates the survey. The late 2006 and early 2007 drop in manufacturing capital spending was anomalous, he said.

The Fed, in minutes of its March meeting released this week, said that "financing conditions and other fundamentals remained favorable for a pickup in capital spending."

But the current softness comes as a surprise to many analysts. Indeed, the Fed minutes noted, "Investment in goods and services other than transportation and high-tech equipment softened more than fundamentals had suggested."

On the whole, economists see limited risk of recession over the next 12 months, putting the probability at 26%, near the same level of risk they've forecast since last summer. When asked to identify the one economic indicator they would watch to determine if the economy will slip into recession, 23 of 58 named the Labor Department's monthly employment report, while four others cited the department's weekly read on claims for unemployment insurance.

Consumer spending has weathered the housing slowdown to date but would be vulnerable if weakness emerges in employment. "Consumers hang in there because paychecks have been getting bigger," said RBS Greenwich Capital's Mr. Stanley. "If we get a weakening in the labor market on top of other things, it's hard to imagine what would prop up the consumer."

Among other findings of the survey:

• Twenty-seven of the 46 economists who responded to a question on productivity said the current lull in productivity growth is temporary and the boom that began around 1995 will continue, while 19 said the boom is ending. On average, they predict annual productivity growth at 2.2% over the next five years. Productivity growth was 1.4% in the fourth quarter of 2006. As recently as early 2004, it was growing at better than 4%.

 

• When asked in which country, not including the U.S., they would buy equities seven economists chose Japan, five picked China and four singled out India. Canada and Germany were each chosen by three, while the U.K., Australia and South Korea each got two votes. Brazil, Chile, the EU, Ireland, Israel and Russia each were picked by one economist.

 

• Expectations for inflation were raised, with economists on average seeing 2.1% growth in the consumer-price index by May, accelerating to 2.7% growth in November. Those forecasts are up from the previous month's estimates of 1.8% for May and 2.5% for November.

 

• Some 69% of respondents expect the Federal Reserve's next move to be a rate cut, and 31% see an increase. Just seven of the 60 economists surveyed expect the Fed to move its target for the benchmark fed-funds rate from the current level of 5.25% by June. On average, the economists expect a quarter-point cut by December.

 

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