Animal spirits returning?
14 February 2017
Will we see broad-based capex rebound in 2017? This is a question vexing most investors following years of weak investment in both EM and DM economies. Indeed, most indicators are now pointing to an improvement among G3 economies. Non-residential capex in the US began to improve in Q4 2016 and appears poised to continue as the tech cycle advances and energy sector investment recovers in line with improving commodity prices. The unwind of the commodity cycle over the past three years was one of the key causes of weak capex, both in DM and EM (see Chart 1); now with oil prices recovering, energy-related capex is set to recover. In addition, outside of commodity sectors, the corporate profit outlook has broadly improved. Global corporate earnings troughed in H1 2016 and we expect earnings to progressively accelerate this year. As a result, business confidence is rising and capex intentions are improving. It’s not just in the US: improving capital goods data in Germany and Japan suggest that both domestic and foreign capex have picked up. In emerging markets the picture is more nuanced, with countries at different stages of the capex cycle. Higher oil prices will boost capex in Russia and other oil producers after years of below trend growth; Chinese investment will likely turn down after a recent surge; and India is still suffering from weak balance sheets.
A rebound in G3 capex is particularly important for sustaining the nascent global trade recovery and reversing the trend of slow productivity growth. Because investment is the more trade-intensive component of aggregate demand, a DM capex recovery is critical for EM, particularly Asian economies. According to the IMF, slowing fixed investment, primarily out of DM, was responsible for three-quarters of real import decline in 2012-15. A key question, though, is whether this level of confidence in future growth and earnings can be maintained given the uncertainty around policy outcomes in the US, elections in Europe, and Chinese growth. Expectations of corporate tax cuts, deregulation, and fiscal stimulus have spurred renewed confidence in the US business outlook; should difficulties arise in implementing these policy goals, the nascent capex recovery could be stymied before it gathers any momentum.