Posted on: Sunday, April 20, 2003

Hopes of postwar capital spending surge fading fast

By Rachel Beck
Associated Press

NEW YORK — Those hopes for a postwar surge in corporate spending are fizzling fast. Businesses aren't ready to put money toward capital goods just yet.

It comes down to this: When you buy new forklifts, build factories or upgrade technology, you want to see solid returns on your investments. But it's hard to guarantee any payback with such uncertain customer demand.

So companies feel paralyzed, at least for now, and that's very bad news for the already fragile economy. Corporate spending gains are key to getting the economy's engines roaring again.

Capital spending tumbled along with business confidence in February. That was disappointing after things had started looking up last summer after a two-year slowdown.

Much of the blame for the recent spending curbs went to executives' uneasiness over the prospects of war. They couldn't plan to buy when they didn't know how long the battle would last.

But now, with the fighting pretty much over, it appears war wasn't the only reason why spending stalled. Volatile stock markets and continued economic weakness remain the more crucial components in business leaders' decision-making.

With so much uncertainty looming, they worry they won't be able to get out of investments what they put in.

"We found that the cost of capital exceeds the return on capital" in many sectors, said David A. Rosenberg, chief North American economist at Merrill Lynch, in a recent report. "So where is the incentive to embark on a capital investment spree right now — or in the near future?"

A recent survey by The Business Roundtable, an advocacy group of chief executives from some of the nation's biggest companies, found that 27 percent expect to reduce their capital spending in the next six months. Fifty-five percent say they will spend what they do now, which is in many cases down drastically from just a few years ago.

Microsoft provided some evidence this week of the troubling outlook. The world's largest software maker said its customers — both computer manufacturers and companies investing in new technology — don't anticipate an upturn in demand.

The company therefore cautioned that its earnings going forward might fall into the lower end of Wall Street's estimates. The warning came as a bit of a surprise, given that Microsoft holds a monopoly on PC software and has largely weathered the downturn in the technology sector.

"There are no clear indications that the demand for PCs or corporate IT spending is improving, and hence our expectations are not dependent on an improved macroeconomic environment," said Chief Financial Officer John Connors in Microsoft's earnings conference call with analysts and investors.

High-tech isn't alone in clamping down. Plenty of airlines, hotels and telecommunication firms and manufacturers also have reduced their expected capital spending for the year.

Duke Energy cut its spending by $200 million, to $3 billion, this year to free up cash to pay off more of its debt. That means less money for such things as new power plants.

McDonald's reduced its expenditures to $1.2 billion this year, cutting $700 million from its budget as it attempts to boost sales and profits.

The big concern now is how the continued spending freeze will affect the overall economy.

Many economists based their postwar bullish growth scenarios on higher capital spending. Few anticipated any pullback by consumers.

Strong consumer buying has largely offset the steep decline in corporate spending in recent years. But now there are concerns consumers' spending pace could slow because of the troubled economy, namely massive job cuts.

Without consumers driving the economy ahead, as they have before, there is an increased need for business spending to kick in.

Complicating matters is the fact that companies might keep their spending on hold until they have clearer signs in hand that consumer spending hasn't faltered, said Wachovia Securities global economist Jay Bryson.

"If consumers spend at a halfway decent sort of clip, then businesses will feel better about capital spending," Bryson said.

So business waits on consumers, and consumers wait on business. The smoke from the war is gone, but the economic picture is no clearer.