A surge in U.S. corporate investment provides an unambiguously positive sign of corporate profit growth at a time of year when the American economic activity usually falls short of expectations. Let's check analyst earnings revisions to both verify the trend and, if it's there, uncover the U.S. stocks most likely to benefit.
There is no doubt that U.S. corporate lending activity is improving rapidly. In year-over-year terms, total commercial and industrial loans are growing at a 10-per-cent pace, about 3-per-cent faster than in December, 2013, according to the Federal Reserve Bank of St. Louis.
For investors, the trick is uncovering where the borrowed funds are being spent and the companies set to increase profits as a result.
Industrials and technology are the two broad sectors where improving corporate capital expenditure (capex) has historically boosted profit growth. The accompanying chart shows selected members of the S&P 500 Industrials and S&P Information Technology indexes where analysts have increased forward earnings estimates over the past three months.
In my initial screen, the top of the list was dominated by U.S. defence stocks.
Raytheon Co., Northrop Grumman Corp. and Lockheed Martin Corp. were three of the top 10 stocks in terms of analyst earnings revisions. Investors can feel free to invest in these, but they are not part of the capex theme (corporations rarely buy fighter jets) and I left them off the chart.
The stocks that do potentially fit the trend are largely technology-based. Google Inc.'s primary source of revenue is online advertising and would benefit from a broad ramp-up in corporate marketing budgets. Small business software provider Intuit Inc.'s positive revisions may signal a resurgence in small business formation and growth.
IT consulting firm Computer Sciences Corp., Akamai Technologies Inc. and F5 Networks Inc. are more direct beneficiaries of rising capex than Google or Intuit. Akamai and F5 are both big players in the secular shift toward cloud computing for large corporate networks.
The cloud computing trend is already established and the increase in U.S. corporate spending should accelerate the transition.
We have to go pretty far down the list to find signs of a profit resurgence in old economy, manufacturing-related companies. Union Pacific Corp. and Illinois Tool Works Inc. could signal the long-awaited renaissance in U.S. manufacturing, but profit forecasts for them have been lifted only marginally – by less than a penny in the latter case.
The results of this screen are positive for the market, but less so for the U.S. economy. We are entering the time of year when the Citigroup U.S. Economic Surprise Index – which measures economic data relative to economist expectations – has dipped in the past five years.
More manufacturing-related stocks in the screen would be a more optimistic sign of economic and employment growth. The stocks that did measure best are efficiency-enhancing and more likely to cause future layoffs than hiring and wage growth.
But the increasing levels of corporate spending are definitely a positive for the S&P 500, particularly for investors who identify where the money will be spent.
Scott Barlow