U.S. Investment Collapsed During the First Quarter

Investment was down sharply across the board. Real spending on equipment and software (E&S) plummeted 33.8%, the largest percentage drop since the first quarter of 1958. Nonresidential construction tumbled 44.2%, its largest quarterly percentage drop ever (data start in 1947). Residential investment plunged 38.0%, its largest drop since the second quarter of 1980. Altogether, these three pieces, which make up fixed investment, cut real GDP growth by 6.0 percentage points. The change in private inventories chopped off another 2.8 percentage points (the largest bite since 2000). So combined, investment cut GDP growth by 8.8 percentage points.

Equipment and software had its worst quarter in 50 years, with an across-the-board collapse. Transportation equipment took the biggest hit, with real spending tumbling more than 70% for the second straight quarter. Industrial equipment (down 46.5%), "other" equipment (down 35.7%), and information-processing equipment and software (down 18.3%) fared better, but still posted horrible numbers. Ironically, the bonus depreciation allowances for business purchases of new equipment that were part of the Economic Stimulus Act of 2008 contributed to the drop in E&S spending. These allowances expired at the end of 2008, and resulted in some companies buying equipment in 2008 that they otherwise would have purchased in 2009.

Tight credit and the recession, however, were the main factors behind the collapse in E&S spending. Tight credit made it impossible or too expensive for companies to finance projects they would normally undertake. The recession forced companies to cut back sharply on employment and long-term projects. The good news here is that once the economy gets back on track, most components equipment and software will recover as well.

The outlook for nonresidential construction, on the other hand, is grim because of an accumulation of forces. The economy is in recession, job losses are mounting, developers over-expanded during the good years when credit was cheap and easy to get, the securitization market for commercial real estate loans is totally frozen, commercial real estate prices are plummeting, default rates are rising, and credit is tight.

The sharp first-quarter drop in structures spending was partly due to the collapse in energy prices during the second half of 2008. The oil and gas rig count has fallen by more than half since peaking in September 2008. The Bureau of Economic Analysis uses this count to estimate real spending on mining exploration, shafts, and wells, which plummeted 77% during the quarter. Mining exploration, shafts, and wells make up about one-quarter of nonresidential construction.

Nonresidential construction plunged despite a 40% real gain in manufacturing construction. Manufacturing construction has been on a tear recently because of spending related to petroleum/coal (i.e., refinery upgrades). Outside of this building category, real spending on manufacturing construction is falling sharply.

The collapse in real spending on structures was mainly due to excesses of recent years that will take several quarters to work off. Indeed, with so many factors combining to bring it down, we are not expecting this spending segment to recover until the second half of 2010.

Residential investment chopped real GDP growth by nearly 1.4 percentage points, the 13th consecutive quarter that residential spending has cut into growth. The good news here is that with housing starts at low levels, the bite from residential construction will get smaller going forward. Indeed, we expect residential investment to start adding to growth by the end of this year. Single-family home starts will spur this recovery. Multi-family housing construction, unfortunately, will not recover until next year.

To combat sharply rising inventory-to-sales ratios, stocks were slashed by $103.7 billion, a huge rise in the rate of inventory decumulation relative to fourth-quarter 2008. Here, again, there is good news. With inventory-to-sales ratios moving back in line, companies may start ramping up production soon.

The first-quarter decline in investment was the fourth-worst quarterly decline on record (data start in 1947). The worst decline on record occurred in the first quarter of 1975, when investment chopped 11.7 percentage points off real GDP growth.

The worst of the bad news is now behind. Inventories, E&S spending, and residential investment will fare much better going forward than they did in the first quarter. The nonresidential construction outlook, however, remains grim.