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Business Investment: A Sleeping Giant Awakens?

Investment has been quiet -- almost asleep -- for an inordinate spell. Is it on the way back? A sleeping giant may be on the verge of awakening. When this one does rouse, it's likely to do so in a hurry. Those who are armed and ready to supply business quickly with the machinery and equipment it needs stand to win big in the next cycle.
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Economy-watchers with a bent for the wild side love business investment. It's volatile, fickle, and often large and lumpy. It shows up when it wants to, often after the party is in full swing. There's also heavy global competition to win investment projects -- it is increasingly influenced by generous public incentives. And it's quieter these days, heavily affected by the global crisis, less gutsy, a prisoner of today's "you first" mentality. Will its prolonged slumber continue, or is it finally waking up?

Business investment falls into two general categories. First, there are the structures that house economic activity, from factories to warehouses, wholesale and retail outlets and of course commercial office towers. Second, there is the vast array of machinery and equipment that goes into these facilities. Together, these make up about nine per cent of GDP in the U.S. and Canada. It is a force to be reckoned with, so its prospects matter to the economic outlook.

Investment plays a key role in any economic cycle. It typically surges in the recovery phase of the cycle, as businesses quickly become convinced that the upswell of new orders is indeed the real thing. In the most recent recovery cycles, U.S. investment outperformed the economy by a large margin. It is impressive -- but it can also disappoint. In 2009 it collapsed, tumbling 21 per cent, and after five years, remains six per cent below its pre-crisis peak. Performance in emerging markets wasn't nearly as grim, but in general, it was shored up by substantial contributions from the public purse.

Investment has been quiet -- almost asleep -- for an inordinate spell. Is it on the way back? Maybe. Businesses the world over have been relying heavily on existing building and equipment to meet growing demand. There was lots to work with following the Great Recession, but spare capacity is now pretty skinny. U.S. capacity utilization is now just 1.6 percentage points below previous peak. Past experience suggests we are on the verge of a surge: It won't take much of an increase in orders to kick up the need for serious investment outlays. It is getting to that point in Canada too. These conditions dovetail nicely with the low cost of capital. True, market borrowing costs may be rising, but on balance, long-term market rates are still near historical lows. At the same time, those tapping into equity markets can ride the wave of optimism that has gripped the major global exchanges.

But will they actually need the financing? The severity of the economic and financial crisis caused widespread cash-hoarding. Post-crisis, mountains of cash accumulated that are now available for the next investment wave. In the U.S. alone, there is some $6 trillion -- just over 33 per cent of GDP -- of available cash or near-cash. A small sliver of this would be enough to trigger an investment boom. The U.S. is not alone; the hoarding mentality is widespread. Canada's cash-stash is estimated at $800 billion.

Tight capacity is justification enough for an imminent investment wave. But there's more. Aging populations are likely to see today's elevated unemployment rates tumble more quickly than usual in the coming growth cycle. One remedy for this widespread problem is increased mechanization. The intensity of investment may well be greater this time around than we have seen in the past.

The bottom line? A sleeping giant may be on the verge of awakening. When this one does rouse, it's likely to do so in a hurry. Those who are armed and ready to supply business quickly with the machinery and equipment it needs stand to win big in the next cycle. Best for Canadian exporters in this sector to keep their ears to the ground -- those who do are likely to hear big footsteps soon.

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