Business Investment Outlook

This is an important one to pay attention to.

After more than two years of declines, business investment is finally turning. Growth remains tepid and narrowly concentrated, however, which leaves the budding rebound vulnerable. Nevertheless, there are reasons for optimism.

Improving corporate cash flow, friendlier capital markets, a developing replacement cycle, new tax incentives, and firmer confidence will all facilitate accelerating growth in businesses investment over the next several quarters. After contracting in nine of the last ten quarters, real business investment posted solid growth in the second quarter of this year. Driven primarily by a sharp rise in computer and software replacement spending, real business investment jumped 8% on an annualized basis in the second quarter, marking the strongest quarterly growth in three years and the first year-over-year increase in two years. Rising spending on structures by energy, education and healthcare firms also contributed to the rise.

Recent monthly data indicate that growth has persisted over the last couple of months. U.S. factory shipments of nondefense capital goods excluding aircraft, a proxy for business investment, climbed by 5% on a year ago basis in July and are up 19% (annualized) over the last three months. Imports of capital equipment are also on the rise as are orders, which points to a more robust increase in investment this quarter.

The main driver of recent gains in factory orders and business investment is spending on computer equipment. Behind the pickup in computer hardware investment is substantial replacement demand. The Bureau of Economic Analysis estimates that the economic life of this capital equipment is approximately two and a half years. Most of the massive investment done in and around Y2K is thus now economically obsolete.

As such, as much as 40% of the existing capital stock of computer equipment needs to be replaced each year to keep the stock from shrinking. Currently, about three-quarters of computer investment is going toward just replenishing old stock (see chart). During the boom years, only half of computer investment was driven by replacement demand.

So, things are looking a little brighter. Let's hope it continues to gain momentum.

Read more here.