Can Business Spending Rebound?
Many market observers have been quick to refer to the currently low rate of
US capacity utilization as evidence that business spending–the missing
component of an economic recovery–that business spending won’t pick up any
time soon. However, there have been two occasions in modern US history when
business spending has picked up despite levels of capacity utilization that
were even lower than the current ones.
What is capacity utilization?
In short simple terms, capacity utilization measures the percentage of total
resources/equipment that are currently being employed by businesses. And, as
far as equity investors are concerned, it is important because it has a high correlation with corporate profit margins.
Currently, capacity utilization stands at 74.3%, which means that 25.7 % of
business resources are idle. Although this level is admittedly low, here are
a few things for market participants to consider.
Most of the current excess capacity is coming from sectors–namely
technology–where the lifespan and obsolescence of the business equipment
is quite short. As a result, these goods need to be replaced more
frequently than more traditional business equipment.
There have been two times in modern US economic history when business
spending, and the stock market for that matter, have rebounded from even
lower levels of capacity utilization. As evidenced in the chart below,
capacity utilization measured at 73.9% in 1975 and 70.7% in 1982, yet
business spending rebounded in the subsequent quarters. Moreover, the
S&P 500 climbed 10% and 17% respectively.
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