The Big Idea

A business investment pause

| September 6, 2024

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

The ISM and other surveys of businesses suggest that executives are increasingly shelving their investment plans temporarily.  The two factors that are driving a pause are the prospect of lower borrowing costs as the Fed begins to cut its policy rate and election uncertainty. The data already show softening capital spending activity, portending a soft second half of the year for business investment.

What businesses are saying

The ISM Manufacturing Survey report for August highlighted the hesitance of firms to invest in the current environment. The report noted that “demand remains subdued, as companies show an unwillingness to invest in capital and inventory due to current federal monetary policy and election uncertainty.”  In an interview with Market News International, ISM Survey Chair Timothy Fiore predicted that the composite index would remain below 50 “for a couple of more months.”  He anticipates that the index will rise to just above 50 in the first quarter of 2025 as “the Fed begins cutting rates and uncertainty surrounding the U.S. presidential election comes to an end.”

The NFIB survey of small businesses found in July that the “Uncertainty Index,” which has generally been rising all year, jumped by 8 points to 90, the highest reading since 2020.  The commentary in the July report notes that “There isn’t a lot of time left for campaigns to educate voters and there is a lot of confusion.  Small business owners will be looking at proposed tax and regulatory policies, issues that directly impact small business owners’ ability to successfully operate their business.”

A long list of worries

The Fed half of this equation is straightforward. Rate cuts from the Fed should ultimately lead to lower borrowing costs for businesses, especially for those who mostly rely on floating-rate instruments.

The looming election presents a far more complicated set of issues.  It would seem that businesses have a uniquely large number of items to be concerned about as the election approaches.  A partial list would include:

  • Corporate income tax rates. The current rate is 21%.  One candidate (former President Trump) has proposed a cut, perhaps to as low as 15%, while the other (Vice President Harris) has proposed a hike to 28%.
  • Capital gains taxes. Public companies’ stock prices are sensitive to the prospective returns that their investors and owners can earn.  Vice President Harris recently proposed hiking capital gains taxes substantially for high-income earners.
  • Regulatory policy. If the experience of the last eight years is any guide, the stance of regulatory agencies could swing wildly depending on the outcome of the presidential election. Former President Trump’s Administration took a generally business-friendly attitude, while the current administration has favored some industries (for example, renewable energy) but has generally had a confrontational stance toward business (for example, opposing most mergers and favoring labor in union-business disputes).  For businesses in a number of industries (notably, energy), the potential returns on prospective investment projects will depend heavily on the regulatory environment.
  • Tariffs. Former President Trump has proposed increased tariffs across a wide array of goods, which could dramatically impact both export and import flows. There is also tremendous uncertainty over how, if such a policy is pursued, the trading partners of the US would respond.  In the prior Trump Administration, retaliatory tariffs were imposed on US exporters in industries entirely unrelated to the initial tariffs.  Thus, a broad array of firms engaged in global trade could potentially find themselves caught up in any trade war that develops.

This list could go on for pages, but these items should be sufficient to underscore the point that the outlook for businesses is highly uncertain.  This is usually the case in any presidential election, but it seems that the scope of possible policy outcomes may be wider than usual in the 2024 campaign.

Showing up in the data

The dynamic of business executives sitting on their hands for a time has begun to be evident in the data on capital spending.  The monthly durable goods report for July showed declines in both orders and shipments for core capital goods, core in this case is defined as excluding the volatile defense and aircraft categories.  Core capital good shipments represent a close proxy for the “business investment in equipment” component of GDP.

The 6-month annualized change for core capital goods shipments has been sluggish since around mid-2023 but has taken a new leg down in recent months, falling clearly into negative territory (Exhibit 1).  The monthly fall of 0.3% in July represented the fourth decline in the past six months, and one of the other two months was flat.

Exhibit 1: Core capital goods shipments

Source: Census Department.

In the first half of the year, business investment in equipment added to real GDP growth, contributing one tenth of a percentage point in the first quarter and a hefty 0.5 percentage points in the second quarter, helped along by a rebound in Boeing aircraft deliveries.  However, in light of the downward trend in core capital goods shipments and the anecdotal evidence of business hesitance, I have penciled in modest contraction for this component of real GDP in the second half of the year. Along with a contraction in residential construction and a slowdown in consumer spending gains, I look for soft business investment outlays to contribute to a noticeable slowdown in the economy late this year.

Stephen Stanley
stephen.stanley@santander.us
1 (203) 428-2556

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