by Dr. Charles Lieberman

Chief Investment Officer

The sluggish behavior of capital investment is commonly highlighted as one of the key concerns when people worry about a weak economy.  But investment spending is an amalgam of several types of spending with only one component that is quite weak.

Much of the weakness in capital investment over the past year has occurred in the energy space.  For several years, such investment grew very rapidly, as drilling equipment and oil and gas pipelines had to be built to connect newly developed major energy basins, such as the Permian and the Bakken, to the oil refining and natural gas processing infrastructure of the nation.  Much of that work has now been done and the U.S. has gone from producing around 5 million to more than 12 barrels of oil daily.  Exports of liquefied natural gas have gone from essentially zero in 2015 to more than 4 billion cubic feet per day.  (Gas exports by pipeline to Mexico are also growing rapidly.)  Indeed, the U.S. now exports significant quantities of oil and natural gas.  But much of that infrastructure required to bring energy products from the wells to market is now largely complete, so the pace of incremental investment is slowing down, especially with oil prices having retreated a bit.  Over the last four quarters, investment in mining, shafts and oil wells has declined by $21.7 billion, or 15.2% from $142.9 billion in Q3 2018 to $121.2 billion in Q3 2019.  So it is not at all a surprise that capital investment in energy is slowing and should slow further.

In contrast, capital investment in software and intellectual property continues to rise at a strong pace.  This category is comprised predominantly of software and technology products of all types, although it also includes entertainment products, such as movies.  Over the most recent four quarters, capital investment in intellectual property has risen from $938.1 billion in Q3 2018 to $1,025.3 billion in Q3 2019, a gain of $87.2 billion or 9.3%.  Not only does this investment propel growth, but it also significantly improves our living standards.

There are significant investment implications that emerge from this data.  Firms that provide the equipment to build out U.S. energy infrastructure or engage in drilling activity are experiencing serious weakness in their businesses, including such blue chips as Halliburton, Schlumberger, Transocean, or Diamond Offshore.  All have struggled and it has been years since we held any investments in such companies.  We also don’t contemplate making any such investments for quite some time, because it will take a few years for those businesses to stabilize, almost certainly at a lower level of sales.  We do have sizable stakes in pipeline companies.  The stocks haven’t done particularly well, but the companies are actually performing very well since someone must bring that increased supply of oil and natural gas to market.  And as the pace of investment in infrastructure slows, these companies will have reduced need to invest cash flows into new pipes, so they will be able to reallocate cash towards paying down debt, increasing distributions and buying back shares.

In contrast, technology products continue to evolve at a rapid pace and are becoming ever more pervasive in our lives.  Children now commonly have their own smartphones to remain in touch with their parents.  Everyone stays connected with computers, tablets, and phones.  And our appliances are increasingly also connected, from cars to washing machines to refrigerators to passengers on airplanes to gas meters.  There is no reason to think this won’t continue, so technology firms remain highly attractive for investment.

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