When the Trump administration pushed through the most significant overhaul of the US tax code in a generation two years ago, it anticipated a boom in corporate spending that would cover the shortfall in government revenues.
Companies would put the savings from lower corporate tax rates — which dropped from 35 per cent to 21 per cent — towards hiring workers, updating old machinery and expanding into new markets, asserting America’s economic hegemony and extending the post-crisis expansion.
The US Treasury calculated the activity would add $1.8tn to the economy over a decade — figures that confounded economists across Wall Street.
By one measure corporate spending did increase. Growth in US capital expenditure, or capex, hit 11 per cent in 2018 as profits surged during the first year of the new tax regime. But it has started to wither. In 2019 US capex growth will drop to just 3 per cent, according to S&P Global data published in June. The absence of such investment should spook equity investors.
“This is thin gruel after years of stimulus and means that capex will not offer much help in sustaining the current economic cycle,” said Gareth Williams, senior director for global research at S&P Global.
Anaemic capex growth is unsettling. The S&P 500 index continues to reach record highs and low interest rates — set to drop even further — keep corporate borrowing at cheap levels. Yet companies are failing to put money behind new ideas to expand their businesses.
Capex is a crude but important indicator of future profits. A new factory built today will churn out more products to sell tomorrow, the theory goes. An upgraded machine will operate more efficiently. Sales will increase and costs will drop, all boosting a company’s stock price.
“Capex is about the future,” said Krishna Memani, vice-chairman of investments for Invesco, the Atlanta-based money manager with $1.2bn in assets. “If the current trend in capex doesn’t improve, profitability and productivity will deteriorate, putting economic growth and US stock market performance in jeopardy.”
What is more, the impact of the tax boost is likely to fade. The tax changes included upfront advantages that phase out over time, reducing their impact as a driver of capital expenditure. Growth and profitability predictions are waning.
Central bank easing is seen as an alternative source of support, but again, caution is warranted. Worries over growth and subdued inflation have increased expectations the Federal Reserve will soon cut interest rates. The market is heavily betting on this course of action, yet many US economists — including those at Citi — believe a rate cut may not emerge at all this year.
Even if rates do tick downward, investors should take note: lower rates have in the past failed to spur capex or boost stock prices, according to Jonathan Golub, chief US equity strategist for Credit Suisse.
“We see no reason to believe that this relationship will be different going forward,” Mr Golub said. “Investors may be fond of central bank largesse, but such actions do little to address the structural causes of falling rates, inflation expectations and growth.”
The obvious cause behind muted capex: concerns over global growth, underscored by the trade tensions between the US and China. Companies are reluctant to invest because tariffs may disrupt supply chains, pushing up the cost of production and eroding the effects of fresh outlays of capital to support it, such as a new factory in Shenzhen or Guangzhou.
Instead, US companies have increasingly looked to the simple ruse of share buybacks to juice their share prices.
If a company takes large blocks of its own stock out of circulation, it boosts earnings per share, a metric used by investors to benchmark performance and by corporate boards to set pay. In 2018, US share buybacks hit $806bn, a record, but one which could be broken this year. First-quarter data showed US companies spent $205bn on buybacks, with the heaviest spender, Apple, buying almost $24bn.
Buying back shares can be a sensible way of putting free cash to use. But when companies rely on it too heavily, it signals a dearth of good ideas for growth.
Buybacks have also become a political focal point in the run-up to next year’s presidential election. Bernie Sanders, the Vermont senator vying to become the Democratic candidate, has called the practice “corporate self-indulgence”. In February he authored a bill banning buybacks unless companies raise employee wages to a minimum $15 per hour and improve parental and sick leave policies.
Presidential campaigns will soon crank into high gear, with business and finance taking a more prominent role than in prior elections. The likes of Mr Sanders and fellow Democratic challenger Senator Elizabeth Warren may benefit by offering voters a strident rebuke of companies’ failure to share the benefits of tax cuts. The companies themselves, with a heavy reliance on buybacks, are providing plenty of fodder.