With a recent Moody's report counting up the ocean of cash on company balance sheets, strategists are eagerly awaiting the return of corporate spending like little kids during the twelve days of Christmas.
There have been false starts before, but evidence of a market-friendly rise in capital expenditures (capex) by businesses continues to mount. Corporate loans and leases – historically an early indication of increased business spending – have climbed sharply in recent months. Business sentiment is improving and executive surveys have raised spending expectations much higher than they were a year ago.
Corporate balance sheets are bloated with funds, and the U.S. capital stock – manufacturing equipment, desktop computers and infrastructure necessary for companies to operate – is older and more decrepit than at any time since 1964, according to Credit Suisse research.
The trick for investors is to find attractively-valued stocks in industries set to benefit from rising capex.
The U.S. Census Department releases Non-Defense Capital Goods Orders (ex-Aircraft statistics) each month and the data is widely used as a proxy for capital expenditure. In the chart below, we measure the correlation between capital goods orders and U.S. equity sectors.
S&P 500 Sectors correlation to capital goods orders (non-defence)
SOURCE: Scott Barlow/Bloomberg
Three of the top four market sectors with the highest correlation to capital spending are retail related, providing a reminder that correlation does not mean causation. In other words, food, beverage and tobacco stocks tend to rise along with capex, but it's unlikely that new orders for machinery translate directly into more spending at the grocery store (at least initially).
The connection between business spending and energy, technology and transportation stocks is more direct, at least subjectively. More energy is used, more goods delivered and telecommunications networks are expanded when business activity is rising.
There is a growing chorus of strategists supporting this analysis. Savita Subramanian, quantitative strategist at Bank of America, is recommending energy, information technology and industrial stocks – exactly in line with the chart. Similarly, the market sectors most favoured by ISI Research are trucking, rail, aerospace and construction.
Follow Scott Barlow on Twitter at @SBarlow_ROB.