First, it was borrowing to refinance... Now, capex is the name of the game.

Many companies tried to wait for interest rates to come down before spending or borrowing. But as regular readers know, debt-laden businesses couldn't outwait the Federal Reserve.

We saw a wave of refinancing for U.S. corporations earlier this year. That's not all they've been waiting on, though. Many companies held off on investing in their businesses with rates so high.

At the beginning of the year, U.S. manufacturing companies were expected to grow capital expenditures by about 12% in 2024. That was when they thought rate cuts were just around the corner.

They've since changed their tune. As of May, the latest data available, manufacturing capex was only expected to grow 1%. Considering Federal Reserve Chair Jerome Powell kept interest rates flat in June... we don't expect that number to change much.

Companies' hesitation to invest in capex makes sense. They're better off borrowing at cheaper rates to finance their investments. So most of them have been postponing nonurgent spending on property, plant, and equipment (PP&E).

Yet, as we'll explain today, the manufacturing industry can't afford to put off capex investments forever. All those delays are accumulating... and building up significant demand for the coming quarters.

Companies need to invest to keep operations running smoothly...

Machines, technology, and even buildings are getting old... and they're starting to wear down.

The manufacturing industry has been doing its best to ignore these aging assets. However, it can't keep up the illusion for much longer. We're already seeing more investment in capex this year.

Take a look at the following chart. It measures the net-to-gross PP&E ratio of U.S. corporations since 2001.

Gross PP&E represents the value of a company's assets when they were acquired. Net PP&E reflects their current value. So the ratio indicates the age of assets... the lower the ratio, the older they are.

With so few U.S. companies investing in their assets recently, the net-to-gross PP&E ratio has plunged. It's down from more than 58% in 2001 to 54% through the first quarter of 2024.

However, in the past few months, that trend has reversed somewhat. Assets have stopped getting older, on average...

Some of this turnaround is thanks to massive new investment in hot areas like data centers, AI, and the infrastructure supporting AI.

We expect the trend to keep spreading as companies realize waiting does them no good.

They need to renew their assets eventually... and the Fed seems content to keep rates high through this year at a minimum.

It looks like capex is a few quarters behind refinancing...

Staying afloat is more important than refreshing your assets, after all.

That said, companies finally seem to be coming around to the need to invest... even if it means borrowing money at higher rates.

We're already in the early innings of a major AI and infrastructure investment cycle. We're also likely just a few months away from a broader reinvestment cycle.

Even if interest rates stay put, these companies have to start spending... or risk falling behind the competition. Expect more corporate investment in the U.S. over the next several quarters.


Joel Litman
July 1, 2024