Stocks Struggle to Overcome Equipment-Spending Slowdown

No, it's not just Wall Street's imagination: American companies really aren't shelling out ever-increasing amounts of cash for new equipment like they were before. Two economic releases Friday made that abundantly clear.

The preliminary third-quarter gross domestic product report showed that spending on new equipment grew about 14% over last year, a decline from the second-quarter's 16.4% growth. Spending in information processing equipment and software -- which is to say tech -- grew at 24.7%, against the second quarter's 27%.

New Heights Growth in U.S. corporate spending on equipment

Bureau of Economic Analysis

Meanwhile, the National Association for Business Economists' October industry survey told a similar story. Of the survey respondents, 21% said they had reduced capital spending in the third quarter, the most since 1992, while 37% reported increased spending. Over the next half year, 24% expect to decrease spending.

This does not mean that U.S. companies as a whole will reduce the amount they spend on equipment; it would probably take a recession to do that. But it appears the rate of growth will not be as strong.

"It has to slow from its recent robust pace," says Mickey Levy, chief economist with Banc of America Securities. "If you look over the past 5 years, it's increased more than 11% annually. In the past year, it's more than 14%." Levy reckons that growth in capital spending will slip to 6% or 7% as we move into next year.

In the past, tech spending has been somewhat immune to slowdowns in capital expenditures, because even as spending as a whole cooled, tech as a percentage of spending increased. This time it looks like tech expenditures, too, won't grow the way they have been. In part this is simply because tech has become such a large portion of the equipment U.S. companies buy -- 60% of it, according to this last GDP report. Add to that the effects of what is happening in the markets.

Pullback Growth in U.S. corporate spending on tech

Source:Bureau of Economic Analysis

The trouble in the stock market, particularly in the Nasdaq Composite Index, is prompting companies to put off IPOs. Last week alone, 14 companies, all tech-related, withdrew their IPOs. A fair portion of the funding that they would have gotten from the capital markets would have gone to tech spending -- new servers, slim laptops for the marketing department and so on. Now it will not. Meanwhile, corporate bond yields remain prohibitively high, and the corporate bond market prohibitively illiquid, for companies to turn to the fixed-income arena as an alternative source of funding.

"There's an enormous dependency in the New Economy on financing," says J.P. Morgan economist Bruce Kasman. "These are not companies with big revenue sources. The ability to have financing is important for capex spending in the new economy."

None of this is good news for tech companies' earnings, but at least some of the slowdown has been priced into the market. There's a reason the Nasdaq has been in such a funk.

"If you ask yourself what the reason that the tech sector has declined so sharply is, it's basically been signaling a slowdown in spending on technology," says First Albany chief investment officer Hugh Johnson. "You see that not only in the decline of the tech indices, but you see it in the announcements by individual companies that their revenues will be below expectations."

Sustainable? Tech's share of corporate spending on equipment

Source:Bureau of Economic Analysis

It is hard, however, to say exactly how much of the slowdown has already been discounted. What we do know is that it is a challenging environment for tech companies to grow at the rate they used to, and no sector -- even the oh-so-hot optical equipment makers, as evidenced by Nortel's (NT Quote) recent woes -- is entirely immune. We have entered an era where the secular call may not work like it used to in technology. Investors can no longer simply go and blindly buy anything dot-com or anything wireless and expect to be rewarded.

"If there's growth, a company should do well," says Ed Hemmelgarn, who heads the Cleveland-based hedge fund Shaker Investments. "You're going to see some winners and losers here, but if you're positioned in companies that are growing, you should do fairly well, because multiples have come down."