Weak business spending a bad omen
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Business investment is a leading indicator of the nation's economic well-being.
8/14/2008 -
LOS ANGELES — Pat Dahlson's wholesale flower business was blooming last year. He expanded from Los Angeles to Detroit, Cincinnati and other cities. He put more workers on the payroll, added trucks to his distribution fleet and dreamed of even more expansion.Then came the credit crunch. And the Hollywood writers' strike. And sky-high gas prices. And collapsing consumer confidence.
Business at Dahlson's Mayesh Wholesale Florist began to wilt. This year, he'll slash his spending on expansion and improvements by two-thirds. He already has laid off more than 50 workers, or about 15 percent of the payroll.
"We had been ramping up, and we were throwing human resources at our growth, and then we hit the wall in late fall," Dahlson said of his company, which had sales of $58 million in 2007. "We've had to pull back this year, just for the sake of trying to be smart about expansion."
As the U.S. economy teeters on the brink of recession, the biggest question mark has been the health of the consumer, whose hunger for cell phones, superhero movies, designer jeans and other goods and services accounts for about two-thirds of the nation's gross domestic product.
But some economists are increasingly worried about a slowdown in capital investment by businesses, which spend vast sums on everything from office buildings and fleet vehicles to software programs and telecom equipment.
Recently there has been a parade of sobering announcements: JetBlue abandoning markets and delaying aircraft orders, Starbucks closing 600 outlets, retailer Mervyns filing for bankruptcy protection and J.C. Penney scaling back next year's store openings.
Total planned capital spending by U.S. business declined on a year-over-year basis for four straight months through June, according to the Conference Board, the New York-based economic research company. The Commerce Department reported last week that investment in software and equipment — which accounts for two-thirds of business capital spending — fell again in July.
Business investment, which sends out ripples of financial stimulus like a pebble tossed in a pond, is a leading indicator of the nation's economic well-being.
"Almost universally, business spending is being scaled down to the absolute bare minimum," said economist Ken Goldstein of the Conference Board. "A few months ago, all those people were talking about a second-half recovery. If there's a second-half recovery, it's the second half of '09."
A sharp pullback in business spending was a major cause of the last U.S. recession in 2001. Another steep decline could prolong the current slowdown or even tip the economy into recession, although some economists note that the slump in business spending has been mild so far compared with 2001.
In the late '90s, amid the dot-com boom and efforts to avoid the Y2K software bug, businesses spent heavily on high-tech equipment and services. That meant there was plenty of excess inventory around when the recession hit.
Executives, hung over from the boom, were much more cautious about investing in equipment and buildings and hiring workers when the economy rebounded.
"You had record-high profits, but hiring remained very lean throughout this expansion," said Ellen Beeson Zentner, senior U.S. economist for the Bank of Tokyo-Mitsubishi UFJ in New York. That conservative approach could mean capital spending is headed for a soft landing rather than a crash.
That could change for the worse if the ills infecting the economy persist.
There are signs that is already happening. For example, commercial construction, which accounts for about one-third of business spending, defied gravity even as the housing market tanked and credit dried up. But an index of architectural billing activity — a key indicator of future building — has been falling for several quarters.
Restaurant companies are particularly sensitive to consumer sentiment, which has approached its lowest levels in three decades as expensive gas and rising unemployment bite into discretionary spending. Analyst Brian Moore of Wedbush Morgan Securities in Los Angeles said that July could be the worst month for U.S. restaurant sales in almost 15 years.
This year's rise in fuel prices, meanwhile, has tormented businesses just as it has consumers.
Some of the big aircraft orders booked in recent years by Boeing and its European rival, Airbus, could be delayed or canceled if conditions continue to worsen in the airline industry, said Ken Kremer, another Global Insight analyst.
Last month, JetBlue said it was suspending its near-term growth plans and pulling out of some airports. It also said it would delay for five years the delivery of 10 jets it ordered from Brazil's Embraer.
"Given the current environment, it simply does not make economic sense for us to grow our capacity in 2009," JetBlue Chief Executive David Barger told analysts. "We're prepared to reduce our growth even further."
There have been bright spots. Companies that have seen rising export sales because of the weaker dollar are pouring money into expansion. Caterpillar, for instance, is spending $1 billion over three years to expand plants in the U.S. and build factories in China and India to meet strong overseas demand for its heavy machinery. Utilities and energy companies also continue to spend heavily.
Economists predict that spending on capital equipment will tick up in the fourth quarter as businesses rush to take advantage of a tax break that was included in the stimulus package Congress passed this year, which expires at year-end.
But for the most part, that just pulls forward purchases that would have been made next year anyway.
"I think this is going to get uglier before it gets better," said Kremer of Global Insight.
