Early last fall, as the U.S. debt-ceiling debate came off the boil and Europe dithered, Lakshman Achuthan of the Economic Cycle Research Institute (ECRI) predicted that the U.S. economy was headed into recession. His firm's well-respected index of leading indicators showed a pervasive and persistent pattern which indicated (to him at least) that a slowdown was right around the corner. He may end up being right on the outcome and wrong on the timing, but since September a steady stream of improving economic data have him marooned on the wrong side of the argument. The question is: What did his indicators miss, and what factors might be responsible for the recent acceleration in economic activity, which seems to have come from nowhere?
Some numbers released this past week by the Congressional Budget Office may provide a clue. Federal tax collections during fiscal 2011 came in way short of estimates. Both the Wall Street Journal and the New York Times made a big deal of the shortfall, $10 billion in corporate taxes alone. It seems many companies took full advantage of so-called "bonus" depreciation rules for capital equipment put into service during calendar 2011. These allowances permitted firms to deduct from their taxable income the full cost of investments made during the year right up front, rather than spreading them out over 5 or 10 years. So they went to town buying computers, trucks, machinery, even entire factories. One firm in my area, Universal Stainless & Alloy Products (NASDAQ:USAP) bought an entire steel plant in eastern Ohio and wrote the whole thing off (for tax purposes - not for financial reporting purposes) in the first six months of operation. They reported a much-reduced tax rate for the third quarter and the year as a result, for which I congratulated management on a recent conference call.
The fact that USAP management was quite up front about the (very real) cash benefit to the company from bonus depreciation didn't seem unusual to me at the time, until I began to think about what some other companies had said on their calls about this same phenomenon, but this time from the sales side of the coin. Over and over on third and fourth quarter conference calls, Wall Street analysts probed for clues that bonus depreciation was boosting the top lines of various industrial businesses. They wanted to know if this "gift" from Uncle Sam was directly aiding results. To a man (or woman), top executives of the many industrial firms in which we've invested said NO, it had not been a big contributor to results.
Needless to say, we're skeptical. Managements are either clueless, lying, or they planned for this wave of tax-induced new business, and therefore saw it as not worth calling out to analysts. Right. The only other way of reconciling these data is if the wave of purchases went mostly for used equipment, some of which certainly occurred (much of USAP's purchase was existing equipment, for example). But when truck maker Paccar Inc. (NASDAQ:PCAR) reports a blowout fourth quarter because trucking firms like Werner Enterprises (NASDAQ:WERN) doubled their year-over-year spending on tractors, protests by managements that Federal tax help was no big deal begin to sound hollow.
My guess is that bonus depreciation gave quite a large fillip to U.S Gross Domestic Product during the year. The New York Times says corporate spending on equipment grew faster than any other category of economic activity over the past two years. We know that during this time anemic consumer spending and moribund construction markets certainly weren't key drivers of growth. But what of the next few quarters and next year? Bonus depreciation expired at the end of 2011. We're going to find out if the "multiplier" effects of big-ticket investment spending are real and lasting, or simply a figment of macroeconomist's imaginations. Lagged effects of all this spending may make for a decent economy throughout 2012.
If they're ephemeral, however, Mr. Achuthan may have the last laugh.