Setting the Foundation for the Future: How Will the CapEx Supercycle Shape Our World?

November 3, 2024

NOTE: THIS BLOG IS NOT FINANCIAL ADVICE NOR INVESTMENT ADVICE AND DOES NOT REFLECT THE VIEW OR OPINIONS OF MY EMPLOYER

Introduction to the CapEx Supercycle

Globally, financial markets remain volatile with continued uncertainty surrounding elections, fiscal policy, monetary policy, capital spending, and the strength of the consumer. However, markets have still provided robust returns despite the volatility with the S&P 500 index up ~20.1% year-to-date (YTD) and the CBOE Volatility Index (VIX) currently at 21.88 as of Friday's close. Based on historical results, the U.S. equity market will peak ~5 months prior to the start of a recession.

Financial markets are beginning to digest the potential future impacts on cash flow from increased capital expenditure (CapEx) spending. Increased CapEx is being driven by all the major global trends, including:

1. Technology - Artificial Intelligence (AI), 5G, Internet of Things (IoT), VR / AR and more;
2. Infrastructure - Inflation Reduction Act ($738 billion), Chips & Sciences Act ($280 billion), and Infrastructure Investment & Jobs Act ($1.2 trillion) will focus on energy production, semiconductors, industrials, EV production and more, for an estimated ~$2.2 trillion total impact;
3. Energy Transition - Investment in battery plants, solar panels, wind farms, EV charging infrastructure, and more as the world looks to decarbonize and meet net-zero goals;
4. Geopolitics - Ongoing conflicts in Ukraine and the Middle East along with rising geopolitical tensions;
5. Supply Chains - Reshoring and onshoring of supply chains driven by geopolitical tensions and increasing nationalism; 
6. Demographic Changes - Decline in the working-age population leading to labor force shortages and increasing urbanization.

A CapEx supercycle is a period whereby CapEx growth exceeds GDP growth and the world invests significant capital into medium to long-term projects. The cycle can last a long time and will not result in immediate impacts or noticeable productivity growth. Over time, periods of material capital investment have been followed by economic contractions.

Big Tech Catalysts

Big technology (Tech) companies have recently experienced a significant increase in capital spending as they are investing in data centers, hardware, technical infrastructure, servers, and network equipment to position themselves for the forecasted growth and adoption of AI. These technology giants are expected to spend over US$200 billion in CapEx in 2024, an expected increase of almost ~50%.

The increased spending on AI infrastructure will put pressure on free cash flow. This has worried investors as Meta shares fell (4%) and Microsoft fell (6%) after Q3 earnings despite beating on revenue and EPS. This coupled with recession fears and increased anxiety about the U.S. presidential election has caused some investors to rotate out of technology. Investors also worry that this increased CapEx spending is reminiscent of the development of cloud infrastructure and the 2001 internet cycle which resulted in the end of a decade-long appreciation of U.S. technology equities. Big tech executives are optimistic about the future of generative AI as a once-in-a-lifetime opportunity, however, the upward CapEx revisions and perceived lead time to mass consumer adoption have some investors worried.

BofA Research

Global Trends

The expected corporate and government CapEx spending and broader trends are expected to have a global impact as developed and emerging markets work to build infrastructure to support the global energy transition, development of AI infrastructure, and other macro tailwinds. China has shown this as their outward greenfield foreign direct investment (FDI) reached ~US$162.7 billion in 2023 showing a shift as China moves from importing to exporting capital, this trend should increase over time in-line with China's long-term belt-and-road initiative and growth plans.

In addition to the global trends driving increased capital investment, the world is also catching up from a period of material underinvestment. Following the Global Financial Crisis (GFC), the world witnessed a decade of lost investment as companies focused on the economic recovery and only kept maintenance CapEx to keep operations going but did not increase or grow productivity. As highlighted below in red, CapEx to GDP averaged ~27% from 2009 to 2018 compared to ~31% from 1999 to 2008.

The Role of Debt

Along with increased capital spending, the U.S. National debt sits at US$35.9 trillion. With this, comes concern over the size of interest payments and maturity of the debt. The United States Fed Funds Rate sits at 4.75 - 5.00% and is expected to be cut by 25 basis points (bps) at the next meeting. As all interest rates come down it is expected that there will be more corporate borrowing to support CapEx spending. This would be in-line with the trend as since the GFC corporate debt is up ~105% to US$13.9 trillion.

Summary

Overall, the global themes of AI, mega infrastructure projects, the energy transition, rewiring of supply chains, rising geopolitical tensions and demographic shifts are driving significant capital investment that is expected to set the direction of the world and the economy for decades to come. The beneficiaries in a period of intense capital investment will be sectors with significant tangible physical assets such as industrials, utilities, materials, and energy. The forecasted increase in capital investment coupled with high potential fiscal spending could result in an increase in inflation and rising bond yields.

NOTE: THIS BLOG IS NOT FINANCIAL ADVICE NOR INVESTMENT ADVICE AND DOES NOT REFLECT THE VIEW OR OPINIONS OF MY EMPLOYER

Reference

1. Wall Street Journal. Source. November 1, 2024. Accessed November 2, 2024.

2. Yahoo Finance. Source. November 1, 2024. Accessed November 2, 2024.

3. U.S. Securities and Exchange Commission EDGAR Filings. Accessed November 2, 2024.

4. Federal Reserve Bank of St. Louis. Source. Accessed November 2, 2024.

5. Russell Investments. How has the stock market historically fared during U.S. recessions?.  Evgenia Gvozdeva, Ph.D., Eric Thaut, Adam Field, FSA, EA. May 15, 2023. Source. Accessed November 3, 2024.

6. Bank of America. Global Research and Market Insights. Accessed November 2, 2024.

7. «The Future Winners Will Be in Sectors such as Industrials, Materials and Energy». Mark Dittli. September 13, 2024. Source. Accessed November 3, 2024.

8. Reuters. Big Tech's AI splurge worries investors about returns. Anna Tong, Aditya Soni and Deborah Mary Sophia. November 1, 2024. Source. Accessed November 2, 2024.

9. CNBC. Amazon CEO pledges AI investments will pay off as capital expenditures surge 81%. Annie Palmer. October 31, 2024. Source. Accessed November 2, 2024.

10. FDI Intelligence. China shifts to capital exports. Jonathan Wildsmith. June 3, 2024. Source.  Accessed November 3, 2024.