Cash to burn and plenty to spend it on

Company bosses are opening their wallets after three years of watching the pennies. Memories of the excesses that characterised the late 1990s are gradually fading away, while the world outside is looking brighter as economic growth picks up. Their firms, now leaner and meaner, are at last giving them cash to play with. And, confident that they can sell their goods, company chiefs are starting to believe the time has come invest in churning out more. With money in the bank piling up rapidly as there are fewer staff to pay, it is no wonder bosses are splashing out on new equipment. And those companies in need of a little more funding could always issue extra stock – at much better prices than this time last year when markets were creeping towards their lows – or sell bonds without paying too much interest. IBM’s chief financial officer John Joyce is one of those benefiting from this spending trend, as firms come to him to buy their new computers. Joyce’s company, the world’s largest computer firm, produced stellar fourth-quarter results in 2003. Telecom equipment maker Nortel Networks’ chief executive Frank Dunn, until recently laying off workers in their thousands while grappling with crippling debts, appreciates the word “spectacular”, which was used by one analyst to describe his firm’s performance in the last three months of 2003. Understandably, fund managers are keen to have a piece of this action. Technology stocks are back on their radar screens, along with manufacturing companies. If investment experts believe the likes of Joyce and Dunn are going to give them a good return, it is also good news for the world in general. If companies are buying equipment from the IBMs and Nortel Networks of this world, it helps overall economic health. But just how important is this? At first glance the contribution might appear crucial – after all, the downturn of the past three years is largely due to firms reining in their spending. For once the consumer was not to blame. So if companies took us down, surely they will bring us back up again? That will depend on what happens to the consumer. If he collapses, companies will be unable to fill the gap, since their contribution to growth in developed economies is minimal and they would have to grow at an extraordinary rate. But if the consumer comes off the boil only slightly, then spending by companies on new equipment will make a difference. Economists certainly believe the spending habits of companies will have a role to play in the 12 months ahead. DWS Investments global chief economist Steven Bell is one of those who believes corporate expenditure is important: “The growth recovery we saw shoots of in 2003 is certainly deepening in the US, driven primarily by improving corporate fortunes – the area where we expect spending to pick up most this year.” Henderson Global Investors director of global economics and strategy Tony Dolphin is also counting on company spending having an impact on world growth: “If the consumer slows a bit, company spending could cover a gap.” He adds: “We are looking for a bit of slowdown in the consumer and acceleration in investment spending.” There is a belief among some that the austere constraints under which firms have been operating for the past three years mean there is potential for spending to spring back faster than it normally would at this stage in the business cycle. This is a view Dolphin shares: “There must be some pent-up demand – this is usually the case after a recession. The downturn was particularly focused on business, rather than the consumer. Companies cut spending very aggressively.” While bosses are spending more across the board, the picture is by no means uniform. Data shows US and Japanese bosses are more willing to spend than their European counterparts. US company chiefs ploughed an extra 12.8% into their businesses between last July and September. In comparison, their rivals in Germany, – the eurozone’s biggest player – pared back spending by 1.8%. The brisk pace of investment in the US continued into the final three months of 2003, jumping a further 6.9% in the fourth quarter. Underpinning this was a 10% rise in equipment and software spending. Indeed, IBM’s latest results show its hardware sales grew 4% over the fourth quarter. And Japanese bosses signed off more spending during the second three months of 2003 than in the previous quarter. The surprise in Europe is that business leaders, while still reluctant to dip into their pockets, are becoming happier about the future. This is illustrated by the data from Germany’s Ifo economic research institute. In January this year its closely watched business climate index rose for the ninth month in a row. So why doesn’t optimism equal investment? Dolphin believes there is still a lot of resistance to spending. Before things can move forward, this needs to be overcome. He says: “Bosses are being held back by doubts about the strength of final demand for their products.” He blames this on tighter fiscal and monetary policy in the eurozone, which has kept the consumer in check. Both Germany and France have been subject to spending controls as part of the EU stability and growth pact, although they broke with the agreement towards the end of last year. Furthermore, Fed rates have crept down to 1%, a 45-year low, while the European Central Bank has stuck at 2%. So are company bosses in Europe ever going to sign on the dotted line? Dolphin thinks they are. In his opinion it is just a matter of time: “These companies have to get through a certain threshold of happiness. It will happen in the first half of the year after you get the first-quarter results.” Fund managers on the whole agree with Dolphin’s analysis, although Allianz Dresdner UK Mid-Cap fund manager Trevor Green remains doubtful. He says spending will occur only if it is absolutely necessary: “Bosses have got to see the benefits and whether it will help them in cost-cutting or gaining market share.” He adds: “Telecoms is one area where you have to spend. But if you are an airport operator, for instance, do you really have to upgrade your baggage handling system?” HSBC European Growth fund manager Jeffrey Currington is one of those in the positive camp. He says: “The outlook is brighter now. Things are looking better in the US and Asia, so companies will be spending more money during 2004 than they have over the past two to three years.” However, he concedes: “They are still relatively cautious, since we are coming out of a difficult period.” The confidence that business spending will pick up is reflected in the stocks that managers pick, which currently include the electronic, engineering, aerospace and technology sectors. Among these are firms that are benefiting from more money being spent by companies on upgrading antiquated computer systems. Indeed, these trends are borne out by more than just IBM’s results. Marconi has reported strong third-quarter figures too. The group says it has won key new business, including an extension to its BT service support contract and a new contract to supply equipment to TeliaSonera. And if we are to believe what the companies are telling us, things can only get better. IBM’s Joyce says: “I would characterise 2004 as a year when the IT industry will begin its next growth cycle. In a recovering economy, customers’ first step is to update their technology infrastructure.” Nortel’s Dunn says strong demand for its products will push the company forward in 2004. He says: “I feel really good about bookings 12 months out. Companies are moving ahead with their programmes.” The story today is far removed from that of the past few years. In that difficult period, Dunn had to shut factories, laying off 60,000 people, to avoid Nortel collapsing under the weight of its debts. Telecom equipment makers in particular have caught the imagination of fund managers, and IBM’s results have certainly raised eyebrows. Newton American fund manager Simon Laing, who describes himself as “extremely positive” on company spending, says telecom bosses have just started spending for the first time in three years. However, Laing is avoiding these companies, believing they are “discounting a pick-up in capital expenditure that has not come through yet”. Instead, he is playing the theme through industrial stocks: “Firms will start to spend a bit more and these companies are not reflecting this.” Gartmore Govett US Opportunities fund manager Gil Knight is skewing his fund towards technology stocks, although he sees weakness in the short term: “We are probably going to cut back some of our exposure. We have recently become concerned about orders falling in the semiconductor industry. It will probably be temporary so I’m not eliminating this position.” And Threadneedle European Select Growth deputy fund manager Phil Cliff is also playing a company spending theme. He is upbeat about firms that supply the wireless telecom industry, as mobile networks are near capacity while the number of subscribers is growing. He also likes the aerospace industry, where he says orders are picking up too. Meanwhile, IT hardware and software should do well, as any pick-up in sales will look good compared with last year’s figures. Cliff also has his eye on truck manufacturers: “Trucking tends to lead capital expenditure in the cycle. As economic activity picks up, volumes of whatever is being shipped around the would also rise – so companies will need to increase capacity.” Credit Suisse UK Mid 250 manager Crispin Finn is opting for engineering and machinery, and the electronic and electrical equipment sector. He is slightly overweight these two areas compared with his FTSE 250 index benchmark, believing they will benefit from a trend towards re-equipment in the wider corporate arena. If equity markets continue to rise, it appears the outlook for capital spending can only improve further, making it easier for companies to raise money. This factor is decisive for some. DWS’s Bell says: “The fundamental reason why corporate spending is going up is that the financial conditions facing corporates have improved enormously. Equity markets are stronger and corporate bond yields have fallen. Government bond yields have generally fallen too, but the spread has narrowed.” This emphasis on improving markets is shared by Axa Investment Managers’ Nigel Richardson. He says: “With equity markets going up, the conditions are now in place for a normal upswing.” Judging by the way they are positioning their portfolios, managers are confident that capital spending is returning. There are some doubters, such as Allianz’s Green, and others who have concerns about valuations or are mindful that bosses remain cautious after a difficult three years. But generally the mood is positive. For the world’s two biggest economies, GDP numbers are proof that things are already starting to happen. This is backed up by results from companies such as IBM, Nortel Networks and Marconi, and is a trend that will be supported if stockmarkets continue to improve throughout the rest of this year. But being such a small part of today’s developed economies, the overall impact of capital spending on growth will always be limited. The key question for the global economy is about a different kind of spending – on people. Firms need to start hiring again if growth is really to take hold. They have to move from just replacing computers to buying in additional machines, and building up capacity with extra staff. For Newton’s Laing at least, this would require “much higher” growth rates. Once again, all eyes turn to the US labour market to see if the rapid growth experienced over the past months is here to stay.