Publish date:

Tech Getting Squeezed by Corporate Belt-Tightening

Not all sectors are likely to suffer equally, however.

With near daily reminders that the economy is cooling more quickly than forecasters can trim their numbers, and with more and more economists warning of recession, America is understandably tightening its belt.

We all know how this works at a personal level. Even if we ourselves remain comfortable and thus far unscathed by the slowdown, there is a tendency toward thrift. We will put off big purchases, or make our big purchases smaller. Suddenly the Taurus seems more appealing than the Explorer. And this gut feeling is occurring economywide. The latest jobs report puts unemployment at a low 4%, yet measures of confidence -- the latest was a dismal preliminary read on

University of Michigan's


consumer sentiment index -- show that people all over America are hunkering down.

The Slowdown

What is true for us individually is true for corporate America as well. Earnings growth was clearly pressured in the fourth quarter, and it looks like it probably will get worse before it gets better. Desperate to salvage the bottom line, businesses are cutting back. Back in the third quarter -- the last period there is hard data for -- the rate at which companies were shelling out money for new equipment was already beginning to slow. In the coming year, the rate of growth in such capital expenditures will likely deteriorate to its lowest level since the recession days of the early 1990s.

"We're expecting to see about a 5% increase in business fixed investment, which would be one of the smaller increases in the last 10 years," says

Goldman Sachs

senior economist Ed McKelvy. The first half will probably be the tough part. According to the Goldman economists, capital expenditures will grow 2.7% in the first quarter and only 1.8% in the second.

Such a cutback in outlays will deeply hurt the companies that supply corporate America with new equipment. Most profoundly affected would be technology, whose share of U.S. capital expense on equipment has risen to 60%. In the past, technology was a smaller part of companies' budgets, so tech spending was able to grow unabated during economic decline. But in the current environment it is virtually impossible for that to happen.

Signs of such a sharp drop in spending have already begun to turn up in the economic data. The December industrial production figures that the

Federal Reserve

put out Wednesday showed that growth in information technology production -- computers, communication equipment and semiconductors -- has decelerated sharply from the summer, auguring a tough first half of the year. Yet as a subgroup, production of computers -- which includes everything on and inside your desktop (sans the chip) along with servers and mainframes -- held relatively well.

"I think that tech spending, outside of computers, will be flat," says

Salomon Smith Barney

economist Christopher Wiegand. "January, February, we'll see that spending has completely leveled off."

But why the divergence in spending on computers and other types of information technology equipment? The answer may be in the boom that was. As the economy rolled higher, and the

TheStreet Recommends


surged, there was a tremendous enthusiasm for new technologies. Start-ups were flush with cash from free-spending venture capitalists and a flourishing IPO market, and they bought tons of technology equipment. Established companies, worrying about the newcomers, also stepped up to the table.

Ebb and Flow

But the spending boom didn't affect all areas of tech equally. There was a huge surge in spending for communications-based tech -- routers, switches, hubs -- but spending on computers, though it increased, did not increase as much.

"Usually, the aftermath of excessive speculation is excessive investment," says Bill Sterling, chief investment officer at

Trilogy Advisors

. "And the aftermath of excessive overinvestment is excessive underinvestment." Because companies didn't overinvest in computers, computer purchases won't take as much of a hit, one could argue.

Anecdotally, this makes sense. Go check out the age of the routers and switches at a typical company and you'll probably find that they are a more recent vintage than the typical desktop. So maybe the


(DELL) - Get Dell Technologies Inc Class C Report




will continue to grow -- albeit more slowly than the market would like, as evidenced by Monday's

most recent Dell warning.

Here, however, one needs to be careful. Computers are a broad category, and companies may not be interested in buying PCs. "It seems to me that when the typical chief information officer is told by the typical chief executive officer to go back and cut his budget," says

J.P. Morgan

equity strategist Doug Cliggott, "what's not going to be cut back is things that increase mobility, increase what you can get out of your data -- everything that the so-called networking economy can deliver to corporate America."