Business Investment and GDP

November 20, 2012 | Mike Spychalski, CAIA, Vice President

This week’s Chart of the Week compares the rate of change in business investment spending to GDP growth. Business investment spending (formally known as non-residential private fixed investment) measures spending by private businesses and nonprofit institutions on fixed assets in the U.S. economy. According to the Bureau of Economic Analysis, fixed assets consist of structures, equipment, and software that are used in the production of goods and services. Business investment spending includes the creation of new productive assets, the improvement of existing assets, and the replacement of worn out or obsolete assets. Business investment spending serves as an indicator of the willingness of private businesses and nonprofit institutions to expand their production capacity. Thus, movements in business investment spending serve as a barometer of confidence in, and support for, future economic growth.

Given that business investment spending accounts for approximately 11% of total GDP in the U.S., it is not surprising that there is a fairly high correlation between business investment spending and GDP growth. As the chart illustrates, since 2000 the correlation between the quarterly change in business investment spending and the quarterly change in GDP is 0.7.

In 3Q 2012, business investment spending shrunk at an annualized rate of 1.3% compared to the previous quarter, while GDP grew at an annualized rate of 2.0% compared to the previous quarter. Business investment spending has historically been much more volatile than GDP growth, so it is important to note that a contraction in business investment spending in the third quarter does not automatically translate to a future contraction in GDP. In addition, external factors such as uncertainty surrounding the recent elections and the pending fiscal cliff in the U.S. may have caused businesses to temporarily delay investment spending. However, if this contraction in business investment spending continues over the next few quarters, it is likely indicative of a larger negative trend in the economy as a whole. In terms of impact on the financial markets, it is likely dilutive for the equity market, but accretive to Treasuries.