Rising capital deployment spawns opportunities for investors
By Thomas Ognar, CFA; Joseph Eberhardy, CFA; and Bruce Olson, CFA—Portfolio Managers, Growth Fund
Share thisFor a number of quarters now, we have been among those investors waiting for private-sector spending to replace government stimulus as the primary driver of economic growth. While the wait may not be over just yet, it appears that we are getting closer to that point. With the Federal Reserve’s second round of quantitative easing (QE2) scheduled to be completed in June 2011, capital deployment by cash-rich businesses is on the upswing, spawning potentially attractive investment opportunities across multiple market segments.
Not surprisingly, capital deployment plummeted during the
latest recession. Nearly two years later, corporate balance
sheets remain fairly laden with cash, suggesting that
companies in general are still being somewhat cautious
with their capital allocations. However, as many firms have
grown more confident in the sustainability of the recovery,
they have demonstrated a greater willingness to deploy
capital. As shown in the chart, capital expenditures by
nonfinancial companies in the Russell 3000® Index have
steadily increased in recent quarters after an extended
period in which their free cash flows rose dramatically.
Merger and acquisition (M&A) activity has also picked up,
with the total value of takeouts by U.S. companies more
than doubling in the first quarter of 2011 as compared
with the same period a year earlier.
The evidence gleaned from our own fundamental research paints a similarly encouraging picture. Some of the companies we follow have begun to step up their capital spending in spite of the still-challenging economy, while others have undertaken M&As as a way to put their idle cash to work. Unlike some of their shorter-sighted competitors, we believe these companies have correctly recognized the need to make sound business investments now in order to better position themselves for long-term growth as the business environment continues to improve. Naturally, more robust capital deployment can also directly benefit select companies in sectors with strengthening end demand—such as industrials, energy, and information technology—as well as companies that become strategic acquisition targets.
Concluding observations
The recent uptick in capital deployment signals that the handoff from government stimulus to business spending may finally be underway. After anticipating this trend for months, we expect it to gain further traction in the period ahead, creating a potential tailwind for a variety of stocks. The task for investors, of course, will be to identify which ones look most likely to emerge as “winners” going forward. As always, we think a rigorous, bottom-up stock selection approach is well suited to that task.Stock fund values fluctuate in response to the activities of individual companies and general market and economic conditions. The use of derivatives may reduce returns and/or increase volatility. Certain investment strategies tend to increase the total risk of an investment (relative to the broader market). This fund is exposed to foreign investment risk. Consult the fund’s prospectus for additional information on these and other risks.
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