Aggregate private investment

Categories : Category Insights | Economic Indicators Published on : Jul 27 2017

Nonresidential investment, or business investment, makes up the lion’s share of aggregate private investment. The actual proportion fluctuates between 60.0% and 80.0% in any given year based on a variety of factors, including changes in interest rates and government policy. In turn, the bulk of business investment is composed of equipment and software, with the remainder accounted for by spending on structures used for commercial purposes such as buildings, power lines, mine shafts and wells. The residential portion of aggregate private investment refers to expenditure on new housing units (ranging between 38.0% and 64.0% of residential investment) with net purchases of used structures, improvements and brokers’ commissions on the sale of residential structures accounting for most of the remainder.

Private fixed investment reached a new peak in 2006. The booming economy and ever-rising housing prices convinced Americans that any investment or home improvement would surely be recovered – most likely with a profit. Meanwhile, easy access to cheap credit enabled these beliefs to be put into practice with a rapid increase in spending across all components of investment. Unfortunately, this rosy outlook began showing cracks in 2007 as concerns about financial institutions raised the possibility of a potential economic slide. The subsequent housing market collapse and soaring unemployment transformed these jitters into a full-fledged freefall in investment in 2009. This nosedive was partly attributable to individuals cutting back sharply on renovations, and houses being sold at steep losses compared to peak values seen just a few years before. Meanwhile, soaring unemployment forced consumers to rein in spending. This rippled through to businesses, which had to scale back plans for expansion and new developments for fear that they would be unable to recoup their costs.

The economic outlook improved starting in 2010, clearing the way for renewed investment. The slow bounce back was led by businesses renewing investments in software and equipment that were put off just a year ago. Businesses financed these expenditures by spending vast cash reserves hoarded as a safety measure against the withering economy in 2008 and 2009, a trend that trailed off over 2011. The lingering effects of the recession-plagued the residential construction market significantly. Compared to nonresidential construction, housing projects are completed at a much faster pace, and thus the ups and downs of the economy are incorporated sooner. But persistently high unemployment and the looming possibility of a large "shadow inventory" of delinquent but not yet foreclosed homes entering the market led to persistent declines through 2010 and only a slight recovery in 2011.

Demand for housing accelerated from 2012 and 2015 and is expected to continue growing in 2016 and 2017 albeit at a slower rate. As a result, investment in residential construction is expected to increase. However, low commodity prices are forcing businesses to delay or cancel investment plans. Over 2015, investment in the mining and energy sectors dropped an estimated 35.0%. Continued uncertainty regarding commodity prices will delay capital projects through 2016 and into 2017. The combined effect of these factors will cause investment to fall an estimated 1.6% over 2016. The year-over-year decline in 2016 will be the first contraction since 2009. Despite the persistence of low commodity prices, particularly oil and natural gas, improved outlook for 2017 supported investment growth in the fourth quarter of 2016. This is expected to continue through 2017. While moderate appreciation in commodity prices is expected to have limited positive effect, the growth figure is expected to be magnified by the decline in the previous year. Anticipated changes to the business environment, including loosening regulations and corporate tax reform, are expected to stimulate greater capital expenditures. Although actual changes may not occur in 2017, businesses remain cautiously optimistic that various deregulation activity will occur while the Republican party controlled both houses of Congress and the presidency. This optimism effects current year investment decisions. Moreover, as the Federal Reserve continues to signal its interest rate plans, this is expected to entice investment to take advantage of relatively low interest rates prior to hikes. As a result, aggregate private investment is expected to increase 4.3% in 2017.



Forecast

Private investment is forecast to exhibit strong growth in the five years to 2022, but the components behind the growth will vary from those seen at the start of the recovery. With corporate profit at all-time highs, businesses still have plenty of cash on hand to invest. But upgrading of equipment and software will grow at a decelerating rate over the outlook years. The highest level of investment is expected to occur early in the period as commodity related industries react to firmer prices. Moreover, early investment will likely be key for companies seeking to take advantage of the rapidly evolving transportation sector.

Meanwhile, nonresidential construction, which has lagged in its recovery due to the long approval process and lead time associated with large-scale projects, is projected to significantly contribute growth. Most investment in this area will likely be in upgrading existing structures, however investment in new structures will slowly grow as the recession is put farther in the rearview. Anticipated interest rate increases facilitated by the Federal Reserve are expected to increase borrowing costs, thereby placing downward pressure on investment. However, in the short-term fixed investment is expected to demonstrate strong gains. Anticipated infrastructure projected are expected to be supported by private investment through incentive structures, which presents a potential boon to private spending.

Lastly, residential construction is projected to continue growing, but growth rates are expected to remain below pre-recession levels that were driven by unsound lending as the housing market remains in oversupply. The net result is that aggregate private investment will trend positively through 2022, growing at an expected annualized rate of 3.89%.


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