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US CAPEX STILL EXPECTED TO RECOVER THIS YEAR

03/06/2013

Despite improvement in the US outlook, capital spending remains under the normal trend. We reiterate our conviction that US sectors linked to investment and more specifically to capital expenditure should outperform in the second part of the year.

According to the most recent figures, investments continues to lag economic growth. As expected US capital stock slightly resumed in the first quarter of this year but the investment expansion continues to be subpar.
The fact that US investments growth remains low despite the relative stability of US GDP growth is consistent with:
1) corporates’ concerns about policy interventions (not only in the US),
2) low confidence in the global recovery and
3) normalizing capacity utilization rate which is still below the 80% level reached before 2008.

Despite the above-mentioned factors, we remain convinced that US spending should recover: US cannot defer spending indefinitely.
As more equipment becomes obsolete, companies must replace the ageing equipment, if they wish to maintain a competitive advantage - the lack of investment has led to a 15%-increase in the average age of all industrial equipment since 2002.
The CAPEX to sales ratio for the S&P 500 companies is about 6.5% close to the lower range observed over the last 15 years.

Now that the cost cutting is almost done, profit margins are still high, that US companies enjoy record-high level of cash (11% of their assets above the long-term average of 8%) and that credit (banking loans) is expected to further ease, revenue growth should encourage US companies to invest in capacity. Therefore, business spending should make a more important contribution to U.S. economic growth in the second part of the year.

A recovery in capital expenditures bodes well with our belief that the US market should enjoy further P/E expansion.

It also fits with our preference for sectors geared to the corporate spending cycle namely Information Technology (i.e. CAPEX-related and not consumer-related) and Industrials (Electrical equipment, Engineering & Construction, Alternative Energy, Software & IT services). Bottom-up, an increase in CAPEX should support the outperformance of companies characterized by high free-cash-flow and low dividend yield.

OUR VIEWS

-Capex increase means further P/E expansion (2013e P/E from current 14.7x to 16x) for the US market.

-Sector-wise, Overweight US business capex Information Technology and Industrials.

-High Free-Cash-Flow and low dividend yield companies perform better than Income names when capex recovers.

    Global Strategist Societe Generale Private Banking
    Global Head of Fixed Income Société Générale Private Banking