Capital goods aren’t immediately consumed or placed on our mantel to catch dust. Rather they are used to make other goods and often goods in great quantity. That’s what makes them special and something to watch as an indication of confidence in the economy. Companies aren’t often in a hurry to buy such equipment given the high cost. And when they do, it’s typically at the end of the economic growth cycle, a repeating cycle of capital-goods boom and bust that was most dramatic at Y2K and may be repeating itself right now.
Right now demand for consumer goods isn’t that great, in contrast to the strong demand for capital goods. And this is the rub. Below is a graph comparing the output of business equipment (dark line) against consumer goods output as measured by the Federal Reserve. The graph shows the swings in the capital goods sector. Businesses were trying to catch up to demand through the mid-90s, but they ended up over doing it which led to the painful contraction after Y2K. And now the trend is reappearing as the slope of business equipment output is once again steeper than the slope of consumer goods output. But that has been a classic pattern for capital goods.
Rockwell Automation sells factory automation equipment. If ever there was an industry poised to do well in today’s economic environment, Rockwell is in it. Productivity growth is the only way manufacturing companies can keep up with low-cost providers.
The Nasdaq danger
The Nasdaq has more than its share of capital goods producers, specifically makers of electronics equipment and electronics machinery…Start-up electronics firms may not be the best investment in the unlikely event the capital goods sector begins to turn south.
There seems little risk the capital goods sector would slow dramatically in a soft landing. Businesses would likely keep their investment plans in place, anticipating a sustained period of growth. But a hard landing, reviving memories and comparisons with prior busts, would be a different story.
Which is more or less what we have been saying for some time.