Prospects for Nonresidential Investment: Tales from Residential Investment and Corporate Profits

Nonresidential investment has been increasing until 2008Q1, at which time it essentially stalled (-0.2 ppts. annualized in log terms). On the basis of past historical correlations, what’s in store?

bfi1.gif

Figure 1: Four quarter growth rate in nonresidential investment (blue) and residential investment (red) lagged one year, calculated as four quarter log difference. Source: BEA GDP release of 29 May 2008, NBER, and author’s calculations.Figure 1 depicts the time series for year-on-year nonresidential investment growth, and residential investment growth lagged four quarters. There’s an obvious correlation (see e.g. most recently Calculated Risk), but clearly it’s not always a particularly strong one. There are periods where business fixed investment levitates above residential growth, such as the latter part of the 1980s (due to the dollar’s depreciation), and during the 1990s, as well as the most recent few quarters. The relationship can be summarized using a OLS regression of 4-quarter growth on 4-quarter growth rates.

d(nresinv)t = 0.035 + 0.311 d(resinv)t-1 + ut

Adj. R2 0.37, SER = 0.054, smpl 1967q1-08q1, bold face denotes statistical significance at 1% MSL.

Using quarter-on-quarter growth rates yields a similar result (i.e., the cumulative coefficients on four lags of changes in residential investment sum to 0.33, as opposed to the 0.311 coefficient above).

What does this predict for year-on-year business fixed investment growth in 2009Q1? That’s shown in Figure 2.

bfi2.gif

Figure 2: Four quarter growth rate in nonresidential investment (vertical axis) plotted against four quarter growth rate in residential investment lagged one year (horizontal axis), regression line (purple), and forecast for 2009Q1 based on 2008Q1 data (red square). Source: BEA GDP release of 29 May 2008, and author’s calculations.The regression indicates a 3.8% 4 quarter decline (in log terms) in 2009q1. It’s unclear to me how this fits in with other forecasts. The q4/q4 prediction I obtain of -2.9% is somewhat less than the 0.3% (non-log terms) decline forecasted by the participants of the Chicago Fed Automotive Outlook symposium [1].

An alternative approach would be to try to explain investment using variables that theory says might be important. As discussed in this post on the investment disconnect, corporate profits is one candidate. In Figure 3, I plot 4 quarter changes in nonresidential investment and in real corporate profits.

bfi3.gif

Figure 3: Four quarter growth rate in nonresidential investment (blue) and in real corporate profits (red) lagged one year, calculated as four quarter log difference. Real corporate profits calculated by deflating by GDP deflator. Source: BEA GDP release of 29 May 2008, BEA via FRED II, NBER, and author’s calculations.This relationship,

d(nresinv)t = 0.034 + 0.317 d(cprofits)t-1 + ut

Adj. R2 0.29, SER = 0.058, smpl 1967q1-08q1, bold face denotes statistical significance at 1% MSL.

predicts that the 4 quarter change in nonresidential investment will be about 0.3 ppts. in 2009q1.

In either case — using a lead-lag relationship [2], or one based upon a version of a cash-flow model — investment growth will be slowing down over the next year.


Originally published at Econbrowser and reproduced here with the author’s permission.

2 Responses to "Prospects for Nonresidential Investment: Tales from Residential Investment and Corporate Profits"

  1. Anonymous   June 20, 2008 at 12:28 pm

    the non-financial corporate sector resilient so far has started showing strains as consumers cut spending. Corporates are preparing for lower earnings and slower economic recovery.

  2. akmi   June 20, 2008 at 5:13 pm

    Consumer spending slowdown to pick up pace as companies lay off more employees to cut costs and withhold from making new hires. The tech hardware sector outlook looks bad as service sector firms (especially financials) cut down on capex. Even companies with overseas revenue will suffer as the rest of the world catches up with the U.S. slowdown or inflation dampens consumer demand.