January 29, 2012 / 8:08 PM / 7 years ago

Worn-out machines as leading indicator

(Reuters) - Delivery trucks wear out, computers break down, software becomes outdated — and finally businesses have to start investing in new equipment. Companies that want to remain competitive have to start spending again as an economy slowly recovers.

Four years after the downturn began, the replacement cycle shows signs of kicking into a higher gear in the United States even among small businesses, and it could give an unexpected boost to growth and employment this year.

That assumes no further shocks to the world economy caused by the euro zone debt crisis.

Greece and its bankers have yet to agree on chopping the country’s debt load to 120 percent of gross domestic product by 2020, something the International Monetary Fund is demanding in return for the bailout money Greece needs to avoid a default in March.

But capital spending alone is insufficient to drive a U.S. recovery that will be strong enough to quickly lift employment as consumer demand is still limited by heavy debt loads.

In the United States, large corporations have already dug into huge cash piles to upgrade plant and equipment, adding incrementally to an economy that grew by 2.8 percent in the fourth quarter.

Now small businesses, which drive about half of U.S. economic growth and a big chunk of job creation, are increasing their spending on equipment, too, an important precursor to stronger hiring.

But the U.S. jobs report for January, due on Friday, is unlikely to show marked improvement in the labor market after strong gains in December.

Economists surveyed by Reuters forecast 150,000 new jobs in January against 200,000 the prior month. Some investment banks also warn the 8.5 percent unemployment rate could tick up as signs of a gradual firming of the economy encourages more people to return to the labor force.

Ian Shepherdson, chief U.S. economist at High Frequency Economics, said small businesses could start hiring more aggressively as the year progresses.

In the last economic cycle, they contributed about two-thirds of the jobs growth, and when they hang out the “help wanted” signs, they can be a powerful source of employment.

“Dollar for dollar in GDP terms, they generate two jobs for every one generated by a large corporation,” Shepherdson said.

For the early signs of this small business revival, Shepherdson points to two factors: access to credit has improved markedly as shown by a surge in banks’ commercial and industrial lending, and an index of capital expenditure intentions, as measured by the National Federation of Independent Business, is climbing.

The NFIB in December reported that capital outlays had increased for three straight months, the first solid improvement in three years. Owners planning capital investments in the next three to six months also rose to a 40-month high.

NFIB policy analyst Holly Wade said anecdotally she hears of more businesspeople talking of increasing their budgets.

“They have stretched out their machinery and equipment and would have normally invested in replacement, but they were waiting as long as possible. Now they are starting to see better sales and earnings, and they are more comfortable investing some of those dollars in capex,” she said.

“In the next three to six months, it wouldn’t be surprising to see the same rate of growth in capital outlays we have seen recently,” she said.

A similar pattern is evident in the Philadelphia Federal Reserve Bank’s Business Outlook Survey. In January the index for capital expenditure plans for the next six months more than doubled to a reading of 22.9 from 10.8. And the U.S. Commerce Department’s durable goods report for December showed capital goods orders outside of defense and aircraft rose by 2.9 percent.

Industrial conglomerate Honeywell International IncN> is one of the big companies expanding, although overall corporations give a mixed outlook for their plans.

“We’re looking to spend $100 to $150 million more in capital on a year over year basis. Some that is going into facility upgrades, some of that is going into technology centers,” Honeywell’s chief financial officer, Dave Anderson, said with the release of the company’s earnings last week.

“Don’t look for it to be a driving force for recovery, but capital spending will continue to be a supportive factor,” said Ellen Zentner, economist at Nomura Securities.

U.S. car and truck sales, due on Wednesday, are getting a boost from businesses replacing worn out models. They are seen holding at the 13.5 million annual rate in January.

The Institute of Supply Management, an industry group, will also release its U.S. manufacturing index on Wednesday; it is seen rising to 54.5 in January from 53.9.

Reporting By Stella Dawson; additional reporting by Nick Zieminski

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