Capital Equipment Demand Growth Is Slowing, But The Stocks May Be Worth A Look

Our theme of Capex Cycle Stocks – which includes heavy equipment makers, electrical systems suppliers, automation solutions providers, and semiconductor fabrication equipment players – has gained about 15% year-to-date, roughly in line with the broader S&P 500. Now the underlying trends for the theme have actually been pretty mixed. While capital spending by U.S.-based companies remained strong in 2022, led by low-interest rates and a focus by companies on boosting capacity to ease bottlenecks seen post Covid-19, things appear to be easing this year as the impact of the Federal Reserve’s rate hikes take effect. The target Federal funds rate stands at between 5.00% to 5.25% presently, around 15-year highs. This is likely making it more expensive for companies to fund new projects. Capex by companies in the S&P 1500 is poised to rise by just about 7% this year, compared to a growth rate of about 21% in 2022, per Citigroup
C
. Moreover, capital expenditure growth is likely to slow to just about 2% in 2024, per the bank.

That being said, there is still good reason to invest in the capex theme. The U.S. government has been incentivizing companies to move production capacity back to the U.S., particularly in strategic areas such as semiconductor fabrication. Separately, automation and productivity improvements have also been key themes for manufacturers, given the recent surge in labor costs and the worker shortage. This could help to drive demand for capex stocks in the long term. Within our theme, Lam Research
LRCX
has been the strongest performer with its stock up by about 54% year-to-date. The company provides wafer-fabrication tools and related services to the semiconductor industry. On the other side, Deere & Company
DE
has been the weakest performer with its stock down by about 4% thus far in 2023. The company sells agricultural machinery, heavy equipment, forestry machinery, engines, and drivetrains used in heavy equipment.