What is going on with US business investment?

AMP Capital expert
Posts: 26
Registered: ‎11-03-2016

What is going on with US business investment?

Business capital spending growth, particularly across the advanced economies, has been stagnant over recent years. Businesses have continually cited a lack of demand as the key reason behind a subdued profile for their capital expenditure (capex) programs. There are also numerous country-specific factors that may hold back investment, including the exchange rate, political uncertainty and high business hurdle rates. Stronger business investment will lift productivity growth and have a positive multiplier effect to other parts of the economy and the labour market given the capital and labour intensive nature of investment.


The weakness in US business investment has been a drag on US GDP outcomes with annual GDP growth in 2016 looking like it will come in around 2% - not too bad, but not great either.


There are numerous timely indicators of US capex that financial markets tend to place emphasis on including the manufacturing ISM (Institute of Supply Management), the Markit manufacturing PMI (Purchasing Managers Index), durable goods orders and regional Federal Reserve district manufacturing indicators. These are all important activity gauges. But, they reflect growth only in the manufacturing sector. The manufacturing sector has more than halved in its importance to the US economy over the past 70 years (from 25% as a % of GDP in 1947 to 12% in 2015) as production has shifted to cheaper, offshore sites and the services economy has increased in its significance to the economy. 


While it is still important to watch the historically traditional indicators of manufacturing activity, business investment is a very broad category and consists of several moving parts, which we decompose in this note.


Decomposing business investment


Broadly, business investment is composed of three categories – structures (predominately buildings and mining-related), equipment and intellectual property.


Broadly, business investment is composed of three categories – structures (predominately buildings and mining-related), equipment and intellectual property.


US Business Investment 1.png

Source: FRED, AMP Capital


Equipment capex is (and historically has been) the largest component of business investment, with information processing, transportation and industrial equipment the largest sectors. Equipment capex spending is largely reliant on the performance of structures business investment.


The importance of intellectual property capex is often overlooked but its significance should continue to increase as technology companies lift in their importance to the economy.


Structures investment normally receives the most attention and also has the most available data. The largest component of structures capex is commercial & healthcare. Growth in this sector tends to be more stable, deriving its performance from population growth trends as well as broad activity in the whole economy.


US Business Investment 2.png

Source: Reuters, AMP Capital


Mining and manufacturing investment are another two important sectors in structures capex.


US mining investment has been through a major downturn over the past year and it is related to declining oil production as prices plunged. But oil prices are lifting again, and oil rigs are following as production increases. The positive upturn in the commodity price cycle is an important indicator for mining investment.


US Business Investment 3.png

Source: Reuters, RBA, AMP Capital


Manufacturing activity has been hit by a higher US dollar. But, the significant US dollar appreciation has probably run its course for now. While the Fed is likely to raise interest rates this year, the path of monetary policy normalisation should be slow and gradual. And this should prevent the US dollar from appreciating too far, too quickly – which will benefit manufacturing construction, as well as other exchange-rate sensitive industries like transportation.


US Business Investment 4.png

Source: Reuters, AMP Capital


The bottom line is that the worst appears to be over for structures capex as manufacturing and mining recover and this will have a positive flow-on effect to equipment capex.


Implications for investors


Growth in business investment looks to have reached a bottom for the current cycle as the commodity price cycle turns positive and a stable US dollar stops being a drag on manufacturing & transport.


Stronger business investment growth will lift productivity and should have a sizeable multiplier effect to other parts of the economy & the labour market. US GDP growth of 2%pa looks very achievable over the next two years, even in the face of rising US interest rates. This in turn should add to confidence that the US earnings recession is over.


And ultimately, higher business investment may start to fade talk of secular stagnation.


What are your thoughts on business investment growth across the advanced economies?


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