CreditSights: The Week In Credit
As the first half of the year rapidly draws to a close, we will soon be able to test the theory that "things will pick up in the second half" once again. For three years running this mantra has been chanted repeatedly during the first six months of the year, and for two of those years the much-hoped-for second-half rebound has failed to materialize. Already this year, the widely predicted post-Baghdad economic boom has remained MIA but that has not prevented both the bond and equity markets from rallying. The justification for the optimism was just shifted a little further out on the calendar and now all eyes are eagerly gazing at the coming six months when the effects of another substantial fiscal stimulus and some likely further monetary easing will hopefully make it third time lucky for a second-half recovery.
One reason for remaining somewhat circumspect in our expectations of how strong this recovery will be however, is the ongoing depressed state of capital expenditure at U.S. businesses. A direct indicator of the decline in business spending at a macro level is found in the national accounts data. Non-residential business investment (structures, equipment and software) reported on a quarterly basis, peaked in September 2000, and has been trending down ever since. Also watched closely is the monthly macro data on capacity utilization levels, which provides sufficient evidence that excess capacity is here to stay--for now. Capacity utilization has languished below 80% since February 2001 and has been below 75% for the past seven months. Compare these statistics with the 78.5% seen at bottom of the last recession in 1990-91 and it becomes clear that we are hitting new lows, not seen since the early 1980s. Higher utilization levels indicate demand growth, which is clearly positive. Lower utilization levels can imply an increase in investment spending, if demand has not grown as projected, but in the current circumstances, lower utilization is basically a sign of weak demand. Equally troublesome is the fact that the capacity overhang is evident across a broad range of industries high-tech, manufacturing and the more traditional commodity processing sectors.
What all this suggests is that even if we do experience the economic rebound that is widely expected, it will be some time before improved growth levels impact prevailing capacity utilization measures and deliver some pricing power to companies. Given the degree to which the debt (and equity) markets have already moved to price in a more optimistic than operating environment than that which we are currently experiencing, a second-half recovery may hold few gifts for bondholders.
Analysis by CreditSights, Inc., an independent online credit research platform. Call (212) 340-3888 or visit www.CreditSights.com for more information.