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Is corporate spending the missing link to push markets higher?

With companies remaining cautious on corporate spending, could capex be the missing link needed to secure a sustained recovery?

The global economy may be getting back on its feet but with companies remaining cautious on business investment, could corporate spending be the missing link needed to push markets higher and secure a sustained recovery in 2014?

Capital expenditure, or capex, continues to be low in some areas despite signs of improvement in major economies.

Data from Deutsche Bank reveals gross fixed capital formation, which is used as a measurement of business investment, currently remains below average levels in both the US and eurozone.

But in the UK, figures from the Office for National Statistics show gross fixed capital formation rose to 1.4 per cent in the third quarter of this year, marking the strongest growth recorded since the 3.6 per cent seen in Q1 2012.

The lack of corporate spending is unusual given that company balance sheets are currently very healthy, says Schroders global and international equities lead portfolio manager Simon Webber.

He attributes this reluctance around capex to the “still largely cautious corporate mind-set” created by the global financial crisis.

Whitechurch Securities head of research Ben Willis says this cautious approach has seen companies focus on investors rather than internal investment.

He says: “Although balance sheets are looking far healthier and cash levels are high, companies are still more prepared to return this to shareholders in most cases rather than on capex.”

But just as economies appear to be moving away from the scars of the financial crisis, investors say capex is the next essential driver for markets and economic growth.

Royal London Asset Management chief investment officer Robert Talbut believes corporate spending is essential to “break out” of the remaining issues in the UK economy and ensure a sustained recovery.

He says: “The only real hope for breaking out of this is for the corporate sector to step up its investment levels, in part to boost employment, but also productivity and the prospect of real wage growth.”

Willis goes further, arguing stronger signs of economic improvement may have to come through before corporate spending will pick up. He says: “The return of capex will be closely correlated to an increase in business confidence driven by a continuing positive outlook for economies.”

Corporate spending is also needed to generate the next stage of earnings growth in UK stocks that will in turn boost equity markets, according to Henderson Global Investors UK Smaller Companies fund manager Neil Hermon.

He says: “We have not seen a lot of earnings growth in corporates yet.

“We need to see economic growth translate into earnings growth of corporates in order for UK equity markets to make further gains. If companies start spending again this should certainly help profitability increase.”

Securities Trust of Scotland manager Alan Porter points out that at a global level, capex is currently “flat lining” with no current growth in aggregate.

He warns unless there is a pick up in corporate spending, the dividend growth of income stocks could come under risk over the long-term.

He says: “In the short-term dividend growth is fine but at some point this could peter out unless one of two things happens: the payout ratio goes up from where it is now or company confidence picks up and capex plans start rising.”

But Porter also points out the corporate confidence needed to trigger capital spending could be set to change after a long period of “cautious optimism” amongst businesses.

Indeed a number of managers are already pointing to signs that corporate spending will begin to rise next year, bringing with it investment opportunities across a number of sectors and underpinning the global recovery.

Webber expects early indications of an uptick in both consumer and corporate confidence in the US and areas of the eurozone will translate into capital investment in the new year.

He adds: “As confidence continues to recover next year, companies will step up investment.

“This will be particularly good for industrial cyclicals and capital goods industries. It will also give further momentum to the economic recovery.”

Standard Life Investments GARS strategist Andy Ford says the current low levels of corporate spending in the US are creating “pent-up demand” that should eventually come full circle to stimulate capex.

He says: “At this stage in the economic cycle normally you would be expecting to see quite a bit of expansion capex but we have not seen very much at all, not even in replacement capex.

“If you look at the age of the equipment US companies use for production, it is about as old as it has ever been. So we think there is quite a lot of pent-up demand, meaning capital spending could surprise on the upside in periods to come.”

European corporates are also beginning to invest in their own businesses, according to JP Morgan European Smaller Companies Trust manager Jim Campbell.

Campbell says: “What we have typically seen over the last few years is a massive focus on companies generating cash and getting balance sheets in shape. But I think we are going to start see companies investing at the margin a bit more internally than paying it out.”

The trust’s co-manager Francesco Conte adds that before corporates shift their attention back to capex, their focus on investors in the meantime could make current markets “a sweetspot for investing”.

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