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These 2 forces could cause companies to cut capital expenditures

Scott Gamm
FILE PHOTO: Workers are seen at Bri-Steel Manufacturing, a manufacturer and distributer of large diameter seamless steel pipes, in Edmonton, Alberta, Canada June 21, 2018. REUTERS/Candace Elliott/File Photo

There are two forces lurking behind the scenes that could prompt companies to lower capital expenditures (CAPEX): ambiguity around trade policy and higher interest rates.

After all, CAPEX spending was one of the expected benefits from President Trump’s tax cuts, which took effect in early 2018.

“A key risk is if trade policy (or uncertainty around it) curtails the CAPEX recovery,” said analysts from Bank of America Merrill Lynch in a note to clients on Monday. “So far, CAPEX spending remains healthy, +16% year-over-year for reported companies (vs. +20% in 2Q), but we note that CAPEX guidance has been weaker.”

The analysts pointed to weakness in the three-month CAPEX guidance ratio (instances of above- vs. below-consensus CAPEX guidance), which slowed to 1.14 in October, below the long-term average of 1.42.

This shows that companies are becoming increasingly worried about market conditions in the future, a theme echoed by JPMorgan chief economist Bruce Kasman in a note to clients on Friday.

“Perhaps most troubling are the signs that a wedge has opened up between the business sector’s perception of current conditions and its expectations of the future—with the latter dipping further,” Kasman noted. “This is the channel we have identified as a potential drag related to the US war on trade. If this wedge widens further it will create additional drag on global CAPEX.”

Excluding China, JPMorgan’s model is tracking a 6.4% gain in global CAPEX spending for 2018, down 1% since the beginning of the year.

Aside from tariff worries, the steep rise in interest rates has contributed to the dimming outlook for CAPEX growth.

“Despite upbeat sentiment and profits, interest rates have increased more than expected,” Kasman noted. “This rise in rates explains the bulk of our disappointment in global CAPEX growth through 3Q18.”

At the start of the year, the U.S. 10-Year Treasury yield, a key benchmark of borrowing costs, stood at 2.46%, compared to 3.197% on Wednesday.

Market implications

For companies taking on debt to finance CAPEX spending, higher rates result in higher costs.

Stock investors should care about CAPEX spending, as it has implications for the long-term health of the stock market.

“If CAPEX spending slows, the economy will undoubtedly slow,” said Dory Wiley, president and CEO of Commerce Street Capital with $1.5 billion in assets under management.

A slowing economy isn’t a bullish indicator for stocks.

Scott Gamm is a reporter at Yahoo Finance. Follow him on Twitter @ScottGamm. Follow Yahoo Finance on TwitterFacebookInstagramFlipboardLinkedIn, and reddit.

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