U.S. companies are preparing to invest again after years on the sidelines, and rising interest rates are unlikely to impede them.
Executives have grown more optimistic about growth, in part anticipating that President-elect Donald Trump’s administration and Republican congressional majorities will bring regulatory rollbacks, corporate tax breaks and increased infrastructure spending.
The Federal Reserve last month signaled interest rates would rise at a faster pace than previously projected, showing increasing optimism about the U.S. economy as it unanimously approved its second rate increase in a decade.
Despite years of near-zero interest rates that made borrowing cheap, many big U.S. corporations have been hoarding cash or plowing money into safer pursuits in the wake of the recession. Some, like General Motors Co. and railroad CSX Corp., borrowed to prop up pension plans. Others, including Home Depot Inc. and Yum Brands Inc., used cheap debt to repurchase shares. Meanwhile, overall spending on building new factories or upgrading aging equipment languished.
That is likely to change soon.
“We could be in store for a significant [capital-expenditure] boom,” said Charles Mulford, an accounting professor at Georgia Institute of Technology in Atlanta.
Steel company Klöckner & Co., which generates about 40% of its sales from its 50 sites in the U.S., expects to increase spending on steel-shaping machinery here in the coming year. The German company delayed such U.S. investments when demand slowed from industrial customers that make everything from railcars to storage tanks for oil producers.
Rising interest rates won’t interfere with the planned investments, said Gisbert Rühl, chairman of Klöckner’s management board. “If we have to pay 100 basis points more, that’s not an issue for us,” Mr. Rühl said. “Even 200 basis points is not an issue…It’s still cheap.” Fed officials have signaled that they expect to raise rates by another 0.75 percentage point this year, likely in three quarter-point moves.
The new optimism could mean the U.S. is poised to emerge from a pattern that has frustrated the usual business investment cycle. During downturns, businesses typically cut capital investment — spending that increases or improves physical assets like buildings, equipment and computers. As the economy picks up, they rapidly ramp up spending, or risk being overtaken by more aggressive competitors.
Business investment dropped sharply during the financial crisis, falling more than 17% for S&P 500 companies in the 12 months after Lehman Brothers’ September 2008 collapse. But even as the economy recovered, total expenditures took three years to regain the precrisis level, according to data from S&P Dow Jones Indices.
Companies saw little reason to invest when U.S. economic growth was sluggish. Quarterly gross domestic product has averaged an annualized 1.5% growth since the Lehman collapse, compared with a decadeslong average — going back to 1930 — of more than 3%.
Another culprit was a resistance among corporate leaders to lower the minimum rate of return on investment — known as a hurdle rate — they would accept from new spending, largely out of fear of disappointing shareholders.
“If returns are down and your hurdle rate hasn’t changed, you’ll stop investing,” said William Plummer, finance chief at construction rental firm United Rentals Inc.
Instead, many businesses pursued safer alternatives. In 2015 alone, companies in the Russell 3000 index bought back nearly $700 billion of their own shares, the most since 2007, according to research firm Birinyi Associates Inc. Last year through November, those firms spent another $488 billion on buybacks.
Companies in the S&P 1500 pumped $550 billion into their pensions between 2008 and Nov. 30 last year, according to Mercer Investment Consulting LLC.
“Businesses simply haven’t adjusted to a world of low interest rates,” said Paul Ashworth, chief North American economist for Capital Economics Ltd., a research firm. “They’re still looking for 5% or 6% returns, or 10% returns, on investment projects, and not realizing the cost of borrowing is actually much lower.”
