Fed Rate Cuts Fail to Restore Tech Spending
When the U.S. economy weakened early this year, Ameron International Corp. did what a lot of companies have been doing: It delayed buying some expensive new machinery.
The Pasadena-based industrial manufacturing company, whose products include protective coatings for ships and rail cars, put off buying a machine that would have poured the coatings into individual cans. Business wasn’t strong enough to justify the $100,000 cost, so Ameron is making do with employees handling the task by hand.
The Federal Reserve has cut interest rates aggressively this year in hopes of coaxing companies such as Ameron to resume purchases of big-ticket items. But in a scene being played out across much of corporate America, Ameron says it will remain tightfisted until the economy clearly has turned the corner.
“We will continue to try to defer where we can in the second half of the year,” said Gary Wagner, Ameron’s chief financial officer. “We haven’t seen any increase in demand that would warrant increases in our manufacturing capacity.”
In the late 1990s, companies bulked up on everything from factory equipment to new computers and software, and fed a buoyant economy in the process. But their dramatic retrenchment in capital spending this year, especially for technology equipment, has been one of the biggest forces dragging down the economy.
Despite lingering hopes to the contrary, capital spending shows few signs of a significant rebound any time soon--a factor that some analysts say could delay a long-awaited recovery in the overall U.S. economy.
Past slowdowns often have been caused by softness in consumer spending that spread to businesses. But consumers have been surprisingly resilient, and their continued spending has kept the economy from skidding into a recession.
Instead, the weakness has been centered in the business sector, with companies reining in spending as their profits tumble. The danger is that their cutbacks eventually could infect consumer spending.
Throughout the dismal first half of the year, optimists clung to the notion that rate cuts would stoke capital spending by year-end. But with the second half of the year underway, the best that can be said is that the worst of the spending declines appears to be over, analysts say.
U.S. companies aren’t scaling back at their earlier frenzied rate, analysts say. But they aren’t significantly boosting spending.
“The good news is the big [tech] slashing is either occurring right now or is behind us,” said Stephen Roach, chief economist at Morgan Stanley Dean Witter. “But the bad news is that a lot of [people] want to presume that just because the worst is over we’re now going to go back to the way it was. I’m telling you that’s not going to happen.”
Though he presented a generally upbeat message Wednesday in congressional testimony, Federal Reserve Chairman Alan Greenspan pointed to “the major scaling back of new capital spending” as one of the economy’s biggest risks.
“The demand for capital equipment, particularly in the near term, could pose a continuing problem,” Greenspan told lawmakers, and is a prime reason the Fed is expected to cut rates by another quarter point at its August meeting.
The technology sector, which until last year had been a driving force behind economic growth, has suffered the deepest cutbacks. Spending on technology equipment fell at a 19% annual rate in the first quarter and is believed to have slid at a whopping 23.63% pace in the second quarter, according to Goldman Sachs. In late 1999 and early 2000, tech purchases surged at a 25% annual pace.
Tech spending is important because it has been one of the fastest-growing parts of the economy. It accounts for 7.5% of the gross domestic product, up from 2% a decade ago, according to Decision Economics, a New York analysis firm.
Reduced tech spending will shave about 2 percentage points from the GDP this year, Goldman Sachs estimates. That’s substantial because the Fed expects the economy to grow an anemic 1.25% to 2% this year.
Rate cuts indirectly have helped tech sales by preventing the economy from slipping further. But they haven’t been the immediate tonic that some people expected because companies have been reluctant to spend until their own sales perk up.
On Monday, for example, Applied Materials Inc., the largest maker of equipment used to manufacture semiconductors, said it isn’t sure whether sales have bottomed out. Its customers are hesitant to place new orders until they’re certain of demand for their products.
“We’re kind of trundling along at the bottom,” said Joe Bronson, the firm’s chief financial officer, at a trade show in San Francisco. “I don’t see a change from that in the near future. We’re meandering along with no discernible trend.”
There have been some bright spots.
Chip giant Intel Corp. said Tuesday that despite weakness in communications products and flash memory, it believes the second half of the year will be stronger than the first.
But too few companies are saying that.
A Merrill Lynch survey two weeks ago found only 18% of companies promising to “loosen up” their tech spending in the second half of the year, compared with 72% who said they would not.
Most economists expect tech spending to improve next year, but at a modest rate. Goldman Sachs projects spending may rise only 3%.
Part of the problem is that companies stocked up on technology in the late 1990s, and equipment makers beefed up on the expectation that order rates would keep swelling. High-tech manufacturing capacity surged 50% just last year, Greenspan said.
That’s exacerbated by the fact that computers and software are far more powerful today and don’t have to be replaced as often.
“Our [tech] equipment isn’t that old,” said Bill Dudley, head of U.S. economic research at Goldman Sachs. “It’s not obsolete.”
Like other airlines, Delta Air Lines Inc. has been walloped by the combination of higher fuel costs and reduced travel demand, especially among premium-paying business passengers. The company on Thursday reported a $123 million second-quarter operating loss.
Delta has responded in part by slashing capital spending, from $4.3 billion in 2000 to $3.1 billion this year and a projected $2.5 billion in 2002. After buying 95 new aircraft last year, Delta plans to acquire only 74 this year, said Joe Kolshak, the company’s investor relations director.
As for technology, spending was cut to $250 million this year from $350 million in 2000.
“I would expect additional pressure on expenditures should the economy continue to deteriorate,” Kolshak said.
Yet some experts believe the fears are exaggerated. The slowing rate of decline in tech cutbacks is a critical first step toward recovery, they say.
Their optimism hinges in part on their confidence in the Fed. When the central bank began raising rates last year, some people said tech demand was so strong it could not be blunted.
In hindsight, that logic was obviously flawed: Interest rate changes clearly can influence spending decisions. And optimists say rate cuts eventually will spark buying demand.
“There’s no sign of a significant upturn, but we’re in the bottoming process,” said Lynn Reaser, chief economist at Banc of America Capital Management in St. Louis.
Optimists also maintain that companies can defer projects for only so long before it affects performance.
Boston-based mutual fund company Eaton Vance Corp. is a case in point. The firm delayed some tech work early this year as the stock market tumbled. But with stocks stabilizing and business picking up, the firm is moving ahead with previously shelved projects, including improvements to its Web site and to its internal computer system, said Ra’ad Siraj, chief information officer.
“We’re planning to catch up,” Siraj said.
Some companies whose fortunes have held up during the economic decline have increased tech spending.
IndyMac Bancorp Inc., a Pasadena-based mortgage banking company, has been doing a brisk business as low interest rates have sparked home sales. With offices opening or expanding around the country, IndyMac will boost its tech spending as much as 50% this year.
“We’ve been spending aggressively and consistently on technology,” said Richard Wohl, president of the firm’s mortgage banking unit.
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Bloomberg News contributed to this report
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Falling Hard
After years of surging growth, corporate spending on technology equipment is sinking:
2nd Quarter 2001: -23.63%*
Quarterly change in tech purchases on an annualized basis
* Estimate
Sources: Commerce Department; Goldman Sachs Group
