With recent economic reports distorted by the unusually harsh winter, markets are watching capital spending as a reliable predictor of the GDP growth to come. Economic expansion is driven by private capital spending—investments that expand productive capacity, from building new factories to buying new software. Increased investment in this area is a solid early indicator of economic recovery.
Unfortunately, recent data on capital spending figures has been disappointing. Three major factors have contributed to slow the pace of capital investment:
- Volatile energy. Swings in energy policy and ongoing shifts from coal to natural gas may be slowing some businesses and causing uncertainty about the outlook for renewable fuels. Unpredictable fuel prices make long-term planning difficult for energy consumers and producers alike. Oil and gas exploration accounts for an outsized share of capital investment in the U.S., and these investments are especially sensitive to volatile energy prices.
- Changes in expensing provisions. The 2009 stimulus package included temporary tax benefits for capital investment. With the closing of this temporary “bonus” depreciation window, capital expenditures will become marginally more costly to corporate balance sheets. This change in accounting rules should exert a modest downward pressure on capital investment.
- Defense cuts. A smaller budget at the Department of Defense is shuttering a wide range of projects. The assembly plants and shipyards where the discontinued tanks, planes and ships were to be built are ceasing to invest in retooling and expansion.
Durable goods—in the form of machinery and other equipment—constitute a large share of capital investment, making this week’s durable goods report a reflection of the broader capital expenditure picture. The market will watch these figures closely, as a rebound in capital investment could foreshadow an eventual hike in interest rates.