After a strong run for equities since the COVID-19 crisis lows, some investors are turning their attention to what can go wrong. Yet, there is plenty that can go right. Yes, inflation continues to be sticky and is likely to persist into next year, while tax and spending policies remain in flux. That said, with robust third quarter earnings announcements we have noticed a meaningful increase in corporate spending that can give legs to this economic recovery.
This economic cycle began when the world emerged from the lockdown last summer, with government stimulus igniting expansion. But stimulus only goes so far, and the key to a more sustainable recovery is tied to corporate spending. As Warren Buffett said, “investing is laying out money now to get more money back in the future.” As the economic cycle moves further into its recovery, the driver of demand shifts from consumption to investment as companies look to meet future demand.
U.S. total capital expenditures set an all-time high in the first half of 2021. Current capital spending trends are strong as record corporate profits have left corporate balance sheets well positioned. Business profits tend to lead capital expenditures fairly consistently over time. Healthy corporate balance sheets provide additional support for capital expenditures. Elevated cash levels are driving companies to make plans to use cash to invest for growth. Robust demand and supply chain dynamics have further driven the need for more equipment, infrastructure, and technology.
We see increasing business confidence in many of the companies we own. Companies today are building new factories and trying to hire additional workers to improve their productivity and increase output. Reshoring announcements have spiked in the past year, especially for pharmaceutical companies given the extra sensitivity of this sector. Business investment in technology, equipment, software, and research and development has been solid. In Europe, the expectation for 2021 capital spending is at its highest level since 2006. In European markets, we also have seen strong corporate results. With the increasing conversion to all-things-electric, companies such as Siemens are expanding capital expenditures to take advantage of tailwinds from industrial automation, digitization, and electrification, which should drive higher growth going forward.
Finally, amid all the talk of higher inflation and taxes, we remind clients to maintain perspective. We do not know whether these trends are here to stay. We recommend that you follow your playbook, not the crowd. Ignore prevalent undercurrents in the markets, such as inflation concerns or higher taxes that can lead to crowd mentality that can cause some investors to stray from their plan. Know that patience and compounding are the fundamental cornerstones of successful investing.
We continue to wish you good health and encourage you to reach out for any support you may need. Thank you for your trust in Cardinal Capital.
