Monday, May 21, 2007

Will Business Investment Pull the US From the Brink of Recession?

An article in today's Wall Street Journal makes this case, based on the following points.

As the economy cooled last year, many companies found themselves with excess stock, particularly home builders, car makers and the suppliers that depend on them. The result was a sharp pullback in inventory accumulation that now appears to be over, a development that portends production increases. Business inventories declined in March. Although still 4.8% above year-earlier levels, they were 7.7% above year-earlier levels in August. Inventories in the languishing auto industry are running 2.7% below year-earlier levels, the U.S. Commerce Department says.

As the economy has become more technologically sophisticated the inventory to sales ratio has become less important. In other words, companies don't have to have as much product on hand to be successful. That means low inventory levels are the norm. While the inventory draw-down is good, I don't think it has the same predictive power as before.

However, the recent industrial production figures showed a marked increase from the previous month's levels giving this point more credence.

But so far this year, profit growth hasn't sagged quite as much as some anticipated, leaving many businesses with hoards of cash they can steer to capital purchases if the mood strikes. Noting plans by cable companies and telecommunications firms to increase capital spending, Federal Reserve governor Frederic Mishkin last month predicted a rebound in business investment this year. "Business balance sheets are strong, and although profits have slowed, profit margins remain elevated," Mr. Mishkin said. "The continuation of a moderate economic expansion is likely over time to restore confidence and lead to a firming in business investment."

The problem with this point is business was cash rich through the last two quarters. According to the Flow of Funds report corporations are the only economic sector that has contributed to national savings over the last 5 years. In other words, business already had the money to invest and didn't.

Strong global growth together with the recent weakness of the dollar have created what should be an excellent climate for U.S. exporters. Most economists chalk up the decline in exports in the first quarter to a statistical fluke that will soon be undone.

This is the strongest point in the article. A look at the earnings reports from the latest quarter show that companies with strong international exposure did well. The continued projected weakness of the dollar will most likely continue this scenario for the foreseeable future.

As with all matters economic, we'll have to wait and see how this plays out. However, the author does make some good points that provide excellent food for thought.