Headed to recession? Keep an eye on business investment

The growing consensus is that even with all the trade tensions wreaking havoc in markets and global supply chains, as long as consumers stay resilient, the US will probably avoid recession. But a big enough decline in business investment —prompted by trade tensions and global manufacturing weakness — could be enough to create layoffs and dent consumption. So that’s the main risk to focus on.
A similar dynamic led to the 2001 recession, but the composition of business investment over the past 20 years has changed, and the current makeup of it doesn’t show the worrying signs that
existed in the late 1990s.
“Business investment” encompasses everything from building new office buildings to software to agricultural equipment — activities all tabulated as “private nonresidential fixed investment.” This category of economic activity is cyclical, generally rising as a share of gross domestic product in expansions and falling rapidly in recessions, the only exception in the past several decades being the expansion from 1983 through 1990. In the past 35 years, the highest it got as a percentage of GDP was
in the third quarter of 2000, right before the 2001 recession began.
Currently business investment as a share of GDP is slightly above its historical average but not showing the signs of excess that have sparked a downturn. But “slightly above average” could, given the types of external shocks we’re worried about, drop to “somewhat below average,” so investors might want to look closer.
Business investment is broken down with enough granularity for us to look at its components for signs of concern. It’s sliced into three main categories: equipment, accounting for 43 percent of business investment; intellectual property products, 35 percent; and structures, representing 22 percent.
Zooming in further, one element of the equipment category — information processing, which includes computers and other related communications equipment — makes up around 15 percent of business investment. This category saw huge expansion in the 1990s technology boom, peaking at nearly 3 percent of GDP in 2000. It then fell significantly in 2001 and 2002, as has never seen its share of GDP recover.
The second component worth looking at is structures. While the 2008 recession is thought of more in the context of housing and credit markets, the boom in nonresidential structures is apparent too. Part of it was the early growth in the fracking industry, which had a quick boom-bust cycle as oil prices peaked in 2008 before collapsing along with global growth. That also explains the smaller boom-bust seen between 2013 and 2016. What’s clear from the standpoint of 2019, however, is that there are currently no signs of excess.
Finally, there’s the component most under scrutiny, which is
in intellectual property. Intellectual property investment as a percentage of GDP is at an all-time high at 4.7 percent. In publicly traded markets, growth stocks in cloud software and software-as-a-service have some of the highest valuations.

— Bloomberg