Savannah Chamber

12 6 Business Spending Due to growth of end markets, tight labor markets, higher commodity prices, technological advances, competitive pressures, high levels of corporate profits, new business formation and expansion, and less regulation business spending for nonresidential fixed investment will be about 4 percent larger in 2019 than in 2018. That percentage increase will be even higher should trade tensions loosen. Non-residential fixed investment therefore will be a tailwind to U.S. GDP growth. The need to improve productivity, good cash flows, and access to credit – albeit more expensive – will support such spending. The ratio of liquid assets to short-term liabilities is about double its long-term average, which bodes well for investment spending by businesses. With the economy at, or beyond, full employment, an acceleration in wage growth will incentivize businesses to substitute capital for labor, which bodes well for producers of durable equipment and software. Significant downside risks to business spending for investment include federal policy uncertainty, tariffs and trade tensions, inadequate public investment on infrastructure, lower stock prices, and possible turmoil in the financial markets. Due to top line growth, better profits, and better access to credit, investment spending by small businesses should grow strongly in 2019. Home price appreciation is adding to home equity, which is a major source of collateral for many small business loans. Small business owners are optimistic. Fewer federal regulations and tax reform also will help small businesses justify higher outlays for structures, equipment, and intellectual property. By historical standards, businesses' capital spending has been very weak. Consequently, there is a need to increase spending on nonresidential fixed investment despite low levels of capacity utilization. That is because the capital stock is getting quite old. The age of nonresidential fixed assets across all private industries is at its highest level in 40 years. The average age of equipment used in manufacturing is at an all-time high. In recent years, businesses have spent aggressively on stock buybacks and acquisitions, but have not spent aggressively on equipment and other forms of capital that raise productivity. Investments have been deferred for so long that replacement needs should raise capital spending in 2019. It helps that lending standards will not tighten appreciably. In addition, for many companies, cash flows will be adequate relative to the amount of funds they need for investment, lessening the impact of slightly higher interest rates. In 2019, capacity utilization will be a tailwind for business spending for equipment and software. the U.S. economy is just reaching the point where GDP growth generates more GDP growth because inadequate capacity begins to encourage more capital spending – the accelerator effect. Normally, the capital-spending accelerator would have kicked in much earlier in the economic cycle. Because it is kicking in so late, it probably will be weak – and might even be short-circuited – by the Federal Reserve's shift to tighter money. The rate of capacity utilization in all industries was 77.9 percent in mid-2018, which is up considerably from its low point of 66.7 percent in 2009. The long-run (1972-2017) average rate of capacity utilization for all industries in the U.S. is 79.8 percent. Because the rate of capacity utilization is approaching its long-term average, capacity utilization will spur capacity additions in 2019. Capacity utilization varies by industry, with some major subsectors operating above, or below their long-term averages. For example, in mid-2018, capacity utilization for industries producing crude goods was 89.3 percent, a rate 2.4 percentage points above its long-run average. Capacity utilization at the primary and semi-finished stages of production was 76.4 percent, a rate 4 percentage points below its long-term average. Capacity utilization for goods at the finished stages of production was 74.6 percent, a rate 2.3 percentage points below its long-run average. In 2019, producer prices for crude lumber and industrial commodities will increase faster than prices for crude, intermediate, or finished goods, which should raise capacity utilization for industries producing lumber and industrial commodity- type products faster than utilization in industries producing finished or semi-finished products. Corporate Profits Corporate profits, which are already at very high levels, are not expected to increase further in 2019 and may decline slightly. The pace of U.S. GDP growth is expected to decelerate modestly in 2019, which implies limited growth in domestically generated corporate profits. Tight labor markets will push up wage and benefit costs in 2019, which will be a strong headwind for corporate profits. Tariffs and trade tensions also could become a stronger headwind for corporate profits in 2019. Higher interest rates also will limit growth in corporate profits, especially for debt-heavy and capital-intensive businesses. On the other hand, businesses are likely to see some regulatory relief, which could lower production costs and increase productivity. Expense management and more broadly based – albeit moderate – growth in demand for goods and services will help to support profits. Cash flow should be good. In 2019, financing should still be reasonably easy to obtain, but as noted above it will be more expensive.

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