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Good news and bad news
Tech spending may slow in 2005, but that could lead to an improving job market. Here's why.
December 29, 2004: 1:02 PM EST
By Paul R. La Monica, CNN/Money senior writer

NEW YORK (CNN/Money) Have corporations been splurging on big high-tech purchases before the end of the year? And if so, will that cause a hangover for the tech sector in the beginning of 2005?

Several analysts say that big businesses have probably been loading up on new software and hardware during the last half of the year in order to take advantage of so-called bonus depreciation rules that were part of President Bush's Jobs & Growth Tax Relief Reconciliation Act of 2003.

Under this law, a company buying certain qualified capital goods (it doesn't have to be tech-related but does not include real estate) has been allowed to write-off a greater percentage of the depreciation expenses of the asset this year as long as the product has been bought and put in use by the end of 2004.

Simply put, a company looking to buy new equipment that it may need early next year might as well buy it now in order to save a significant amount on taxes.

"If all else is equal, a company is going to buy something this year rather than January 1," said Michael Mahoney, managing director of EGM Capital, a hedge fund focusing on tech and telecom.

To that end, figures from the government's revised gross domestic product (GDP) report for the third quarter showed that corporate spending on software and equipment increased 17.5 percent from the second quarter.

And it appears that this momentum may have continued in the fourth quarter. Several large tech firms including semiconductor leader Intel (Research), telecom equipment manufacturer Nortel (Research), PC and server giant Hewlett-Packard (Research) and enterprise software firm Oracle (Research) have all raised revenue guidance for their current quarters in recent weeks.

That's obviously good news for tech least for the fourth quarter. Mahoney thinks that current tech spending expectations for the quarter are probably too low, which should lead to some better than forecast earnings reports in January.

First-half spending slump?

But this could be a mixed blessing if it turns out that a corporate spending binge in the final few months of this year turns into a slowdown in the first part of 2005.

Along those lines, Barry Ritholtz, chief market strategist with Maxim Group, said that the urgency to buy tech equipment now before the higher depreciation costs kick back in is somewhat similar to what happened in the end of 1999 when many businesses rushed to buy new equipment that was Y2K compliant.

The fact that companies binged so heavily on tech items back then was a major contributor to the tech stock bubble bursting in 2000. Businesses no longer felt a compelling need to upgrade their equipment as often and went through a period of cutting back on new tech purchases.

And while Ritholtz doesn't think that the magnitude of purchases is as dramatic as what happened five years ago, he does say that it would not be surprising if some tech companies wind up issuing first-quarter warnings in March because of a spending pullback by their corporate customers.

"We may see some of the capital expenditures spent this year were more or less pulled through from early 2005," Ritholtz said. "All these tech purchases would have been done anyway but they've just been moved forward."

But a job market recovery?

Still, there may be a potential bright spot in a sluggish first-half tech-spending scenario: A pullback in purchases of software and servers could coincide with a pick-up in the labor market.

Tobias Levkovich, chief U.S. equity strategist with Smith Barney, wrote in a recent report that "tech-related capital spending specifically has a close relationship with hiring activity, as most jobs in the U.S. economy today require some interaction with technology hardware, from cash registers to machine tools to onboard computers for truck drivers."

So if companies have been busy buying new servers, laptops and software at the end of this year, then presumably they are doing so with the intention of hiring more people to use this equipment.

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As such, Levkovich points out in his report that the most recent survey by labor staffing firm Manpower shows that U.S. corporations are expecting the strongest level of first-quarter hiring in the past four years.

Ritholtz said that this makes sense. After all, if companies are in fact looking to increase head count but also need to purchase more tech equipment, then they might as well have spent more money on capital expenditures this year in order to benefit from lower taxes and wait until next year to recruit more workers.

"This is one reason why recent labor numbers were lackluster," Ritholtz said. "Accelerated deprecation put a thumb on the side of the scale in favor of increased capital expenditures instead of hiring."

Mahoney agrees that the job market should improve if corporations go through a period of digesting their recent tech purchases.

"Businesses have been doing everything in their power to delay hiring decisions but gradually you get to a point where you can't keep doing that," he said.  Top of page

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