GLOBAL EQUITY OUTLOOK

Capex: The good, the bad and
the murky

Jul 2, 2018

Companies globally are notching strong earnings growth, led by the U.S. With more free cash flow to put to work, capital expenditures (capex) also are perking up. We explore what it may mean for stocks.

Equity highlights

  • Capital spending historically has dented stock returns in the short term. But not all capex is created equal. Spending on new projects can lay the foundation for future growth. Maintenance spend (the “keep the lights on” variety) is typically less accretive.
  • Capex is picking up globally – but from depressed levels. This, combined with the fact that companies are unlikely to abandon fiscal discipline, suggests the risk to company margins and earnings will be more limited than in prior cycles.
  • Eyes on technology, construction and industrials. Tech companies could benefit as firms use free cash flow to upgrade systems and increase efficiencies. Tax law changes could mean construction projects are accelerated in the U.S.

Snapshot

The U.S. tax cuts in early 2018 gave companies a new incentive to spend. The provision allowing for immediate expensing of qualifying capex means U.S. companies can deduct their investment in year one rather than having it depreciate over several years. The provision will begin phasing out in 2023, and this has companies front-loading investment.

U.S. companies are not boosting their capex at the expense of other activity. Dividend payments have held firm, we find. And our review of company announcements shows share buybacks and mergers and acquisitions (M&A), supported by repatriation of foreign cash, are on track to exceed $800 billion and $900 billion, respectively, in 2018. See the Cash splash chart. These are the highest levels on record. The post-tax law spending has been broad-based: Capex and M&A are expected to increase in eight sectors and share repurchases in six, we find. Three sectors —tech, energy and real estate —are on pace to outspend in all three areas in 2018 compared to 2017.

Companies’ prudent and balanced approach in deploying their tax windfall, alongside unmatched earnings growth, underscores our preference for U.S. over other developed market equities.

Chart: Cash splash
Kate Moore
Chief Equity Strategist
Kate Moore, Managing Director, is Chief Equity Strategist for BlackRock and a member of the BlackRock Investment Institute.