Despite the economic recovery in the United States underway since 2009, business investment is in a slump. This is puzzling after nearly a decade of extremely accommodative monetary policy: the fed funds rates have been virtually zero for seven years and the Fed has purchased $3.5 trn in assets since late 2008. In the two previous cycles, the Fed raised its Fed funds rate around two years after the resumption of non-residential investment. While the Fed will move toward hiking the fed funds rates in late 2015, private sector nonresidential investment still accounts for only 12.7% of US GDP, well below the highs of previous cycles, and even contracted in Q1 2015 (its worst quarter since 2009). We therefore feel justifi ed in deploring the fact that such aggressive monetary policy has had so little impact on private investment.
The environment is favourable
Corporate fundamentals are enjoying overall good health and are in no way impeding a dynamic recovery in investment. Corporate earnings posted strong growth in previous quarters: today profits make up more than 10% of GDP, an unprecedented level. In addition, margins are at record-setting highs. Balance sheet items are also favourable: debt remains far below peak cycle levels and cash on hand has reached amounts that have never been seen before.
Furthermore, financing conditions via bank lending and especially via the markets have been very accommodating. Bear in mind that US corporations get their funding mainly through the bond market. The transmission channels of monetary easing are therefore more efficient than in Europe. What’s more, corporations have enjoyed stronger investor appetite, stimulated by a low rate environment and ample liquidity. Financing on the bond market over the past few years has been easy and comparatively cheap.
Businesses have been able to raise massive amounts of capital on the financial markets
If measured only by the massive amounts of capital companies have been able to raise over the last few years, the Fed’s accommodative monetary policy stance has been very effective:
Relative to the massive amounts of capital raised, investment expenditure has proved to be something of a disappointment.
However, the rebound in business investment remains disappointing
It is very important to note that businesses have widely different attitudes about investment depending on the sector. Although some sectors have levels of investment far above their pre-crisis levels (mining sector, agriculture, natural gas and electric power suppliers), other sectors have levels of investment that are well below their pre-crisis levels (real estate, accommodation and restaurants, and water supply).
As a side point, it has to be mentioned that the mining sector, strictly speaking, is responsible for at least 15% of the increase in non-residential investment since the all-time low recorded in Q4 2009 and perhaps significantly more if you factor in all the ancillary activities. Falling oil prices and, more broadly, the uncertainly about their future will weigh on investment in the mining sector.
In light of the modest increase in business investment expenditure, we might reasonably question the usage of the capital that has been raised.
Businesses have primarily shown a preference for share buybacks...
Businesses have piled up record amounts of cash on their balance sheets over the past few years, reaching $2 trn at the end of 2014 (vs. $820 bn in 2006). A significant portion of this liquidity is frequently held overseas to avoid double taxation of profits. This trend is expected to intensify unless the US authorities adopt a more stringent tax system. This cash is concentrated primarily:
An increasing portion of this liquidity is being channelled back to shareholders in the form of dividends and share buybacks. The longer the high levels of cash combined with low debt continue, the stronger the shareholder pressure will be. The high-tech, healthcare and convenience goods sectors are at issue here. It is important to understand that businesses went into debt to finance shareholder dividends. The Fed’s unconventional monetary policy has driven bond yields to all-time lows, widening the gap between the cost of borrowing and the cost of equity.
Share buybacks have accelerated, reaching the soaring levels seen prior to the crisis. US businesses now divert more than 30% of their cash flows into buying back their shares. In fact, the portion of revenue set aside for buybacks has doubled in the past ten years while investment spending has declined from 50% to 40%. Total share buybacks have increased by more than $2,000bn since 2009.
...and M&A transactions
The M&A market has also clearly been revived, especially in the United States. Volumes have returned to peak cycle levels. This is mainly the result of the proliferation of large-scale transactions in the healthcare, telecommunications and energy sectors. The market recovery has also been characterised by an explosion of cross-border transactions, an efficient means of using capital held in foreign countries.
Corporate cost-cutting is taking precedence over business investment. Against a backdrop of sluggish economic growth, safeguarding revenue and margins remains a challenge for businesses. Executive motivation is very different from that avowed before the Lehman bankruptcy. They have to contend with low demand and deflationary pressures, which are putting a heavy strain on margins. Acquisitions are in line with the industrial strategies of cost-cutting, consolidation and winning market share.
The uncertain business climate is influencing investment decisions
As we have just seen, access to financing is not the reason why US companies are investing so little. There is no doubt that they are taking advantage of favourable funding, but mostly to finance share buybacks or M&A transactions. A far more plausible explanation for such low levels of business investment is that the Great Recession has been permanently etched into the memory of business leaders, who are now far more hesitant about making irreversible investments. It is now clearly established in economic theory that uncertainty reduces the responsiveness of investment to demand shocks and therefore the responsiveness of firms to any given policy stimulus (“Uncertainty and Investment Dynamics”, Bloom, Bond and Van Reenen, Review of Economic Studies). One of the most frequently used measures of economic policy uncertainty by major international institutions is that developed by Baker, Bloom and Davis (www.policyuncertainty.com), where one of the indicators counts the frequency of the terms “uncertainty” or “uncertain” in articles discussing the economy in major US newspapers. This indicator is still well above its pre-crisis levels and, more generally, its levels between 1995 and 2007.
Business leaders are still relatively pessimistic about the economic outlook and harbour doubts about the profitability of any plans they might have. Surveys of small business leaders (NFIB Survey) confirm that very few of them, in absolute terms and compared to previous decades, are planning capital outlays and/or think it is not an opportune time to expand. The most frequently cited reason for not investing or expanding more was the weak economy. Almost none reported that financing was a problem for them.
Some sectors, particularly high-tech, healthcare and convenience goods, are reporting record amounts of cash on their balance sheets, coupled with low debt. These businesses benefited from the exceptionally favourable financing conditions resulting from unconventional monetary policies. The large amounts of capital raised on the markets were used to buy back their shares, raise dividends and finance acquisitions. The cash that is often held in foreign countries will continue to grow. This is rational behaviour in the context of sluggish world growth. Expectations of soft growth and uncertainty account for the low level of business investment.