From Vadim Zlotnikov: Capital spending, which slowed sharply this year, may be poised for a rebound in 2017. That could be good news for certain cyclical sectors—provided governments make good on their plans to boost fiscal stimulus.

Companies around the world reduced capital expenditures in the years after the global financial crisis. But in 2016, despite historically low interest rates, spending on new equipment all but collapsed. That shaved about 1% from gross domestic product across developed markets.

What happened? To start with, oil prices declined sharply. They began falling in mid-2014, and by the start of 2016, they’d been more than cut in half. That prompted energy companies, most of which had overinvested when commodity prices were high, to slash spending.

But there’s more to it than that. Corporations seem to have consciously decided to extend the useful life of their existing equipment instead of buying new models. In general, corporate capital spending roughly tracks earnings growth, which has been lackluster. However, the capital-spending decline in 2016 was more severe than the most dismal earnings-growth-based forecasts. This suggests there may be pent-up demand ready to break out in 2017 as earnings improve.

There’s certainly a need for new equipment. In Japan, for example, the average age of equipment has climbed steadily due to a long period of underinvestment. In the US, tight labor markets may boost the demand for more investment in automation.

CYCLICALS AND A DREAM

If capex picks up, that could be good news for the global capital equipment and technology sectors; both are trading below their historical valuation multiples. But should we expect those multiples to expand in 2017? What if investors start focusing on how long the current economic expansion has lasted—the business cycle is moving into its later stages—and start pricing in an eventual recession instead?

History may offer some insight. There’s a correlation between sectors’ economic sensitivity and their relative performance. When the correlation is strongly positive (1980, mid- to late-1990s, 2005–2007), investors are willing to reward highly cyclical, volatile industries. These periods generally coincide with stronger sales growth (Display).

But this positive relationship alone isn’t enough. Investors also need a “dream”—a plausible reason to suspend disbelief. In other words, they need to believe that an important secular shift is underway that will sustain economic growth.

In the late 1970s and early 1980s, the dream was expectations of lasting commodity inflation and higher defense spending. In the mid-1990s, it was technological advances. By the early 2000s, it was the “Great Moderation” and what was thought to be a secular inflation decline.

PINNING HOPES ON INFRASTRUCTURE SPENDING

If investors don’t have a dream to latch on to, stable-growth and income-generating industries usually outperform. Today, the dream is very much tied to fiscal stimulus. Investors are increasingly relying on governments in Japan, the US and elsewhere to spend more aggressively.

Of course, it will take several quarters to draw up a comprehensive infrastructure spending plan—and even longer to implement it. But if spending of this nature becomes a reality, it can provide a long-term source of demand that will be critical to lifting valuations in industrials and other cyclical sectors.

This is important to remember, because we may well be at the outset of a great fiscal dream, even though not all the recent political promises may become reality. If investors start pricing in government largesse without waiting to see if it shows up, a rebound in capital spending will reverberate more widely. That could make 2017 a good year for industrials, technology companies and other cyclical sectors.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

Vanguard 500 Index Fund (NYSE:VOO) rose $0.50 (+0.24%) in premarket trading Friday. Year-to-date, VOO has gained 11.63%, versus a 11.47% rise in the benchmark S&P 500 index during the same period.

VOO currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #4 of 108 ETFs in the Large Cap Blend ETFs category.

---

This article is brought to you courtesy of AllianceBernstein.

You are viewing an abbreviated republication of ETF Daily News content. You can find full ETF Daily News articles on (www.etfdailynews.com)

Powered by WPeMatico