Companies Accelerate Spending as U.S. Productivity Bypasses Jobs
Cummins Inc. (CMI) and Kohl’s Corp. (KSS) are accelerating equipment purchases to boost productivity, reinforcing an unprecedented gap between capital spending and employment in the U.S. that’s restraining a labor-market rebound.
Corporate investment will rise 11 percent this year as sales pick up, following a 15 percent gain in 2010, according to “Man vs. Machine,” a Feb. 2 report from Bank of America Merrill Lynch. Employment will grow just 1.7 percent, after a 0.7 percent increase last year, the study projects.
Inventory rebuilding, low borrowing costs and government policies that include a new tax break on equipment purchases are powerful spurs for capital spending, says Neil Dutta, the Bank of America economist who wrote the report. The job market lacks such drivers and will form a “mediocre” underpinning for household spending, the biggest part of gross domestic product, he said.
“Machines have the upper hand,” Dutta said in a telephone interview from New York. “You see this huge pickup in capital spending, but there isn’t a meaningful increase in employment; it’s being grudgingly pulled along. The consumer is not going to perform the way people expect.”
The Institute for Supply Management’s manufacturing index has risen for seven consecutive months, surging in February to the highest level since May 2004. While the labor market is “improving gradually,” unemployment remains “elevated,” according to the Federal Reserve. The jobless rate may hold at 8.9 percent in March for a second month, the lowest since April 2009, based on the median forecast in a Bloomberg News survey ahead of Labor Department figures due April 1.
‘Very Deep Jobs Hole’
Even if payrolls rise more than economists’ median estimates of 195,000 this month, that’s “nowhere near the kind of growth we need to see,” said Heidi Shierholz, an economist at the Washington-based Economic Policy Institute. “We’re still near the bottom of a very deep jobs hole from which we’re just starting to climb out.” More than 8 million positions were cut as a result of the recession that began in December 2007.
Investors are focusing on a factory-driven recovery, with the Standard & Poor’s 500 Supercomposite Machinery Index rising 44 percent since March 2010, compared with a 13 percent increase in the broader S&P 500 Index. (SPX)
“The capital-spending boom will continue this year and into next year,” helped by emerging markets, said Robert Baur, chief global economist at Principal Global Investors, which manages $232.4 billion. “Companies underinvested to such an extent and for so long that there’s a great deal of catch-up to be done.”
Baur, based in Des Moines, Iowa, said investors have opportunities for more gains this year in technology, energy, manufacturing and basic materials including commodities and mining. Principal Global owns shares of Eaton Corp. (ETN), AGCO Corp. (AGCO), and Joy Global Inc. (JOYG), which have risen an average of 55 percent in the past year.
The man-machine gap is evident at Cummins, a maker of diesel truck engines and generators. The Columbus, Indiana-based manufacturer has said it may lift capital spending this year to as much as $650 million, or 79 percent higher than 2010’s $364 million. In the same period, it will add about 2,500 workers, a 15 percent increase to its U.S. workforce of 16,500.
Menomonee Falls, Wisconsin-based Kohl’s is pursuing initiatives to reduce labor input as part of an increase in capital spending this year to $1 billion from $761 million in 2010. The department-store retailer is installing electronic signs in 500 locations, up from 100 in 2010, in a program that will cover the entire chain by the holiday season of 2012.
This means “payroll savings, because we don’t have to change several thousand signs in each of our stores anytime we run a new promotional event,” Chief Executive Officer Kevin Mansell said on a Feb. 24 conference call.
Some companies are shifting to “more flexibility in employment,” which means temporary staffing firms, especially those in information-technology and engineering, may outperform this year, said Tobey Sommer, an analyst at SunTrust Robinson Humphrey Inc. He recommends Tampa, Florida-based Kforce Inc. (KFRC), whose stock has gained 15 percent in the past 12 months, and On Assignment Inc. (ASGN), in Calabasas, California, which climbed 19 percent.
“The firmer footing for the economy is real, but it’s all relative,” said Sommer, in Nashville, Tennessee. Businesses still have a “muted desire to hire,” and “temporary hiring is a hedge against uncertainty.”
This helps explain why productivity last year climbed 3.9 percent, the most since 2002, while labor costs fell 1.5 percent after a 1.6 percent drop in 2009, the first back-to-back declines since 1962-63, government data showed.
“At this point, productivity growth is bad news for employment, though in the long term it’s good for the economy,” Shierholz said. “The need to do more to create jobs is an open and shut case, but politically, it’s not going to happen.” The debate in Congress has shifted to the deficit, so “the job- market recovery is going to be a long slog.”
David Bowers, a managing director at London-based Absolute Strategy Research Ltd., is more optimistic. As demand strengthens, “corporate spending is going to be the heart of the recovery” and will unleash “favorable second-round effects in the labor market,” he said. “When that happens, people will be surprised at what a powerful effect it’ll have on consumer finances and consumer spending.”
‘Back in the Saddle’
Corporations hit by the financial crisis recoiled to a greater extent than ever before and “need to get back in the saddle” to take advantage of record amounts of cash generated by healthy profits and faster growth overseas, he said.
The economy already has added jobs for five consecutive months, and economists predict another gain for March. Small businesses also are joining the transition. Payroll-accounting manager Paychex Inc. (PAYX) said March 24 that checks per client rose the most in at least two years for the quarter ended Feb. 28. Most of the Rochester, New York, company’s customers have fewer than 20 people on staff.
Building momentum still may take time. Finance chiefs in a quarterly survey released March 9 by Duke University and CFO Magazine trimmed hiring intentions for 2011 to a 1.2 percent gain from 2 percent in the previous survey, while boosting estimates for capital-spending growth to 12 percent from 8.9 percent.
Even though employment tends to lag behind investment early in recoveries, BofA’s Dutta said the current gap is “unprecedented” in the postwar era: Capital expenditures are expanding at an almost 14 percent pace, while job growth stays below zero, according to calculations he based on a six-quarter annualized change from the ends of the recessions.
In addition, the “unintended consequences” of policy changes indicate the government may “undercut its own principal aim of job creation,” he said.
While the tax bill President Barack Obama signed Dec. 17 allows businesses to write off 100 percent of some purchases in 2011, there’s no similar incentive to speed up hiring. The Fed’s commitment to keep its benchmark interest rate near zero for an extended period also facilitates lower-cost financing for machines.
The administration’s goal to double overseas sales of American-made goods is another plus for investment over hiring, Dutta said, since the U.S. export sector is capital intensive rather than labor intensive.
“The policy environment is incentivizing firms to limit job creation,” he said. “The government doesn’t need to stimulate capex, which is doing fine on its own, compared with sectors that are impaired, like the labor market.”
Dutta predicts consumer spending will rise between 2 percent and 2.5 percent this year, below the average 3.5 percent gain in the decade leading up to the recession.
Many employers are waiting to see how changes in health- care will affect them, said Joe Trauger, vice president of human-resources policy at the National Association of Manufacturers in Washington. These and other regulations are “pitfalls that businesses could unknowingly fall into,” and the uncertainty “creates difficulty for hiring,” he said.
Even so, rising sales are causing companies to rebuild inventories after slashing them by a record amount during the recession, which ended June 2009. There’s plenty of room to expand: Machinery and software assets are growing at the slowest pace since World War II, and capital expenses as a share of GDP still are below pre-slump levels.
The focus on equipment and software purchases is benefiting Micron Technology Inc. (MU), the largest U.S. maker of computer- memory chips, whose second-quarter sales and profit beat analysts’ estimates.
“The demand signals from the majority of our customers are improving,” Steve Appleton, the Boise, Idaho-based company’s chief executive officer, said on a March 23 conference call.
Freeport-McMoRan Copper & Gold Inc. (FCX), the world’s largest publicly traded copper producer, will boost investment to $2.5 billion this year, a 79 percent surge from $1.4 billion last year, as it restocks after cutbacks in the last half of 2008 and through at least half of 2009 that included “cannibalizing equipment,” Chief Executive Officer Richard Adkerson said on a Jan. 20 conference call.
Meanwhile, the Phoenix, Arizona-based company will add 1,200 workers in the U.S. this year to ramp up mining at three locations -- a 12 percent gain in North American staff from 9,700 at the end of 2010.
“In terms of priority, it’s capex, capex, capex, capex,” Adkerson said in response to an analyst’s question about how Freeport-McMoRan will use its cash.