How capital spending and wages are tied together

Increased automation enhances American productivity but holds down wages. There is hope, however: Long-muted capital spending is poised to finally expand, and thus raise stagnant pay.

On one recent morning, we drove past the Chevrolet Cruze plant in Lordstown, Ohio. In August, General Motors announced sales of the Cruze topped 3 million units, only 16 months after sales hit 2 million. GM has sold 1.13 million Cruzes in China since its launch in 2009. The plant is currently operating on a three-shift schedule. The parking lot of the manufacturing plant was roughly half empty.

That disparity – a thriving U.S. manufacturing plant and a successful product worldwide, against a half-empty parking lot – explains much of what is going on in our economy.

Gross domestic product in the third quarter was up 3.9 percent. Corporate sales and profits are growing. The U.S. is undergoing somewhat of a manufacturing renaissance, as we become increasingly cost competitive. Fracking technology has U.S. oil output at the highest level since 1985 and the higher supply is driving energy costs lower – gasoline prices are at 4-year lows. Other manufacturing costs are down, including steel (near a five-year low), copper and aluminum.

The PowerShares Commodity Index Tracking Fund is not a complete picture of materials input costs to businesses, but it provides an indication as to the direction of these costs recently.

Increasing automation is lowering the number of high-paying, skilled manufacturing jobs relative to unit of output. Low-paying service sector jobs represent most of the employment growth, which helps keep overall wage growth stagnant and productivity on an up-trend.

We enter 2015 with the U.S. in an economic leadership position. Demand is steady, balance sheets are strong, margins are expanding, input costs remain controlled and low interest rates are allowing for record amounts of stock buybacks, dividend increases and now faster mergers and acquisitions activity.

The next leg up in the expansion could come from an acceleration in corporate capital spending. So far, capital spending has been missing in action during much of this recovery. Standard & Poor’s reports that in real terms, capital expenditures fell 1 percent in 2013 and are expected to be down again in 2014.

Fundamental investment in productive capability through capital spending should have a longer lasting effect on our current growth trajectory, and may translate into higher wages than has financial investment in stock buybacks, dividend increases and M&A.

While their declining share of corporate profits frustrates many Americans, the current situation is beneficial to U.S. corporations and their stockholders. It also is creating an environment in which could keep Federal Reserve-controlled interest rates low for longer than expected.

For the past five years, the rate of economic recovery and stock market appreciation in the U.S. has led all major economies. The Federal Reserve has ended quantitative easing, its bond-buying stimulus program. But in China, Japan and Europe, the central banks continue to lower rates and engage in QE securities buying.

Many major international economies have yet to achieve sustained economic growth. Germany’s composite purchasing managers’ index, indicative of new orders, output and employment fell to 50 in November and is at a 16-month low. Mario Draghi, president of the European Central Bank, said he sees no sign of growth on the horizon and said the ECB will be aggressive in boosting inflation and growth.

Potentially higher U.S. interest rates, relative to the rest of the world, has caused the dollar to appreciate significantly since July. Rates have more potential to rise in the U.S. simply because the nation is taking its foot off the easing pedal while most of the world continues to press.

The risk is a rising dollar could slow demand for U.S. exports as they become relatively expensive in a global market.

The Federal Reserve is in a pro-growth mode. It appears that while the U.S. economy is near Fed targets for employment and inflation, the Fed may have to keep rates low for a considerable time because of the actions of our international competition. The 10-year U.S. Treasury rate is flat to down since the end of quantitative easing in October and remain in a downtrend for the year.

Several factors – steady end-market demand, rising margins, a pro-growth Fed, an eager and willing corporate bond market and mid-term election results that likely reduce the risk of federal government interference – are lifting the confidence of U.S. corporate management teams.

Confidence is most convincingly expressed with the checkbook. As of mid-November, U.S. targeted mergers-and-acquisitions volume was at $1.4 trillion, the highest year-to-date volume on record and up 43 percent from 2013’s comparable period. U.S. targeted cross-border M&A is also more than double the 2013 year-to-date total.

From an investment exposure standpoint, the U.S. stock market reflects much of the good news already. For stocks to continue advancing, there is an increasing burden that the news flow become even better. On the other hand, expectations and valuations in many international markets lag the U.S. and may begin to play catch-up.

Nicholas Atkeson and Andrew Houghton are the founding partners of Delta Investment Management, a registered investment advisory firm in San Francisco, and authors of the new book, “Win by Not Losing: A Disciplined Approach To Building And Protecting Your Wealth In The Stock Market By Managing Your Risk.”