This is the third in a three-part series on the economy, earnings and equities. The first two posts examined the US Federal Reserve’s gross domestic product (GDP) goals and how they set the stage for businesses to increase their capital expenditures. This post discusses the US manufacturing resurgence and the outlook for equities.
As discussed in the first and second parts of this series, the US Federal Reserve has set the stage for businesses to reinvest in themselves with confidence. And few sectors have embraced the necessity of this task more than US manufacturing. Long term, a strong capex cycle is bullish for the economy, but the equity market may be ahead of itself in the short term.
I often say that middle America is my favorite “emerging market” thanks to the massive expansion of manufacturing facilities in the heart of the country — a trend that’s now taking shape after two generations of underinvestment. Citi Research recently compiled a list of US, European and Asian companies that have built or expanded manufacturing facilities — from aviation facilities to cable factories to appliance parks — in middle America. Of the 29 facilities listed, most were completed in 2012 or scheduled to be finished in 2013, and they carried an estimated price tag of more than $3.6 billion combined.1
In my opinion, the result of this is that the US is now the gold standard for manufacturing and building facilities in the world. US manufacturing productivity has grown at a compound annual growth rate of 4.8%, compared with the global rate of 3.5%.1 Increased productivity along with strict cost management has led to record margins; this is true in manufacturing and many other industries. This dynamic has fueled earnings growth in recent years. But today, companies are at a crossroads.
We believe companies are at the point where they must reinvest in their businesses. Increased capital expenditures may compromise margins in the short term, but they bode well for long-term growth. The question is, can the markets can see through this transition and stomach a hit to margins? Much of Wall Street believes falling margins are an ominous sign for future equity returns, but historically, there have been numerous periods when declining margins corresponded with positive equity returns. So for the short term, sometimes the answer to my question is “yes” and other times it’s “no.” But I believe that over the long term, increased business reinvestment is good for companies and investors.
By now you may be saying, “But Ron, the markets have been on a tear, what about valuations?” Valuation is certainly important, and I am not looking for further multiple expansion from here — that was last year’s story. Today, quality is what matters, and investors need to focus on companies with a forward-thinking view of reinvestment. This is also going to require that investors have a forward-thinking view about investing.
The market may be ahead of itself in the short term as it’s probably too early to start banking the benefits of a big turn in the capex cycle. So, there could be some market risks over the near term, but long term I am bullish on the economy as companies invest for growth, and that’s good for investors and our country.
1 Source: “Is There a US Manufacturing Renaissance”, Citi Research, Deane Dray et al, January 14, 2013
Capital expenditures (capex) are funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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