Why CapEx Matters | Royce
article 06-22-2018

Why CapEx Matters

Co-CIO Francis Gannon explains why upward revisions to CapEx spending could be very good news for small-cap cyclicals.


We’ve recently heard quite a few mixed messages regarding the current health and the future prospects for both the stock market and the economy.

Just a partial list includes concerns over peak earnings, which first surfaced earlier in the year, versus earnings growth that in many cases continues to show improvement; worries over tariffs and trade wars compared to a global economic picture that continues to be positive; and reservations about the health of the stock market juxtaposed against solidly positive returns year-to-date (as well as a marked decline in volatility levels from earlier in the year).

This is another reason that—while we always keep the macro picture in mind—our attention is focused squarely on individual businesses.

And in addition to a strong-to- solid small-cap earnings picture, we are encouraged by the growing pace of CapEx spending throughout the U.S.

Our friends at Furey Research Partners, for example, regularly track CapEx trends. To understand where spending stood at the end of May, they recently compared several years’ worth of CapEx revisions, in each year looking at the five-month period from 12/31 through 5/31.

Their study showed that “estimates for S&P 500 ’18 CapEx spending have risen by 7.9% since the beginning of the year. Partly due to tax reform and partly to accelerating economic growth, CapEx spending estimates are being revised higher at their fastest since 2012.”

They also found that companies in the Russell 2000 are also seeing upward revisions to spending this year, though through the end of May 2018 they’ve not yet matched the pace of large-caps.

Even with the lag for small-caps, we still see this as good news—potentially very good news.

First, CapEx has largely slumped in the years since the Financial Crisis, so any quickening of the pace is a positive. Anxiety about the slow rate of U.S. economic growth made many businesses hesitant to do more than the bare minimum over the last several years—but the signs are pointing toward a welcome shift.

Additionally, Furey found that two small-cap sectors which saw among the biggest revisions through 5/31 were Industrials and Materials—two key cyclical areas for our valuation-sensitive strategies.

Equally if not more important is the fact that CapEx spending requires companies—large and small alike—to buy from other businesses—most of them cyclicals, and many in the small-cap space.

Finally, Furey’s results are consistent with what company management teams have been telling us over the last year. Businesses are spending on new technology, automation, and related improvements. So far, these initiatives have been more common than larger-scale undertakings such as building new plants—though that could change.

What’s also interesting to us is that many of the companies we’ve talked to are increasing their CapEx spending based more on economic improvement than tax cuts.

We see this as another significant positive because of the longer-term optimism it indicates about growth.

Stay tuned…

Important Disclosure Information

Mr. Gannon's thoughts and opinions concerning the stock market are solely his own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above will continue in the future.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. The Russell 2000 Index is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. Smaller-cap stocks may involve considerably more risk than larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.)



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