For much of 2014 it was impossible to watch TV or read a financial article without coming across a reference to "the great rotation." The first iteration of the phrase was at the start of the year, when everybody was predicting that investors would be fleeing bonds. That didn't work out too well. Pundits didn't fare any better when the phrase was used to describe the risk-averse behavior of investors in January or again in March. The rotation by investors on those occasions was supposed to be from risky sectors, such as tech, into solid sectors like manufacturing, but on each occasion the NASDAQ composite quickly made up lost ground. It would seem that rotations by investors are unpredictable and short lived.
If the evidence of earnings season so far is to be believed, however, there is one rotation taking place amongst a somewhat more reliable group, whose decisions tend to be more forward looking. Businesses, particularly in the U.S., seem to be moving away from investing in tech to improve efficiency and toward investing in increasing production. Tech service companies such as Oracle (ORCL) and IBM (IBM) have posted disappointing earnings, while materials companies such as Alcoa (AA) have beaten estimates. Companies that actually make things, including United Technologies (UTX) and Texas Instruments (TXN) have also reported substantial beats.
The focus on tech investment in the last few years has been understandable. As the recovery from the recession ground on, many companies found themselves sitting on large piles of cash and looking around for where to use it. Most were loath to invest in actual equipment or materials that would enable them to increase production. Who can blame them? The recovery looked weak, with stubbornly high unemployment and a Congress that seemed intent on weakening it further. The politicians couldn't agree on needed tax reform and instead lurched from one manufactured crisis and threat of shutdown to another. Rather than increasing production, increasing efficiency looked like the best way to enhance the value of businesses.
Data analytics and anything to do with the cloud were all the rage, but that may be shifting. Could it be that companies that were behind in those areas have now caught up? IBM's poor earnings may, in large part, be company specific, but the general slowdown it described, combined with profit warnings from the likes of SAP (SAP) suggests that business investment in tech services is slowing.
This is bad news for IBM and could spell trouble for a company such as Salesforce.com (CRM), which is not making money and needs continued exponential growth to justify its valuation. Broader earnings numbers indicate that most businesses are making money though, and unless activist investor Carl Icahn gets his way and companies take just a short-term view of shareholder value and launch buyback programs, that money will be invested.
The recovery may be slower than most would like, but it is happening, with unemployment continuing to fall and the U.S. consumer showing signs of increased confidence. For many businesses, rotating away from efficiency improvements and toward production capacity increases now makes sense. The good results have given a boost to Alcoa, United Technologies and Texas Instruments, but if we are really witnessing a "great rotation" by businesses, then all three may still have a lot further to go.